Trading with Candlesticks and Price Movement

Any performance focused measurement will ultimately use trading prices for its data, whether that be just looking at a quote panel once in a while and remembering where the price has been, using bars, lines, or candlesticks on a chart, or using technical indicators. Some technical indicators take volume into account, most do not, but all of them take price into account.

Volume can sometimes give us additional information, for instance if a rally is on higher volume this is more meaningful than if the volume is weak, or vice versa with a pullback which can be seen as more likely to continue if volume increases.

Ultimately though, it is changes in price that we are concerned about, because this is what our bets are on, price going either up or down. We want to measure not only our profit or loss at a given point in time but where the trend is heading, and then decide whether to keep the bet on the table or to take it off.

All technical analysis is based upon measuring current trends of various types. There is no way to predict the future, no indicator that can look ahead in time and tell us where the price will go, we instead look to where it has been to be able to tell where it likely will go in the near future.

Past price does deliver predictions in this sense, a probable prediction if you will, although our prediction does not have to be very far off into the future, and one bar on our chart is enough. We typically will want to see the bar close, the period that it is measuring price to end, before we decide, although there are some cases where the price action during the bar will be significant enough to make our minds up.

The nearer the prediction needs to be make, the easier it tends to be, and therefore it’s easier to predict the next bar on a chart than it is 10 bars from now, which is easier to predict than 100 bars from now, and so on.

Using Price To Decide

Those using technical analysis, using charts to trade, only need to be focused on the next bar, or at least they should be just focusing on the next bar. Traders who don’t know what they are doing will pay less attention to their charts, but that’s because they don’t know what they are doing.

Trading with Candlesticks and Price MovementInvestors generally don’t pay attention to charts at all, and don’t really trade with any sort of plan at all, other than perhaps exiting when they have endured more pain than they are capable of and can no longer maintain their strategy of hope based upon what is essentially an ignorance of price, an ignorance of the market.

While it is popular for traders to use various indicators to assist them in their trading decisions, one need not use them, and many traders just trade off charts using price alone. Indicators can help organizing the price data on charts, seeking to make sense of all the ups and downs and trends of all sizes, to sort out the meaningful ones from the ones that should be ignored.

One can do the same thing just with the bars on a chart, whether one uses traditional bar charts, line charts, or candlestick charts. Line charts aren’t used by many traders although they can provide good insight into how the price of something is trending, where a line is simply drawn from the closing price in one period to the closing price of another, which one uses to spot trends.

One will always use some sort of indicator to decide entry and exit points, although with trading right from the chart using only the bars, one comes up with a set of rules based upon the changing of the bars themselves.

Types of Charts

Line charts have less information on them, just the closing price with the previous periods plus the current price of the current one, and a lot of traders feel that this isn’t enough information, that they want to have the open, high, and low in there as well as a traditional bar chart or candlestick would.

There is something to be said for simplicity though, and one can simply trade based upon the line itself, the way it forms, it’s magnitude, it’s angle of ascent or descent, areas of support and resistance, trend lines, and so on. There’s not a lot of difference between just using the close and having the other prices built into the period, so excluding this isn’t necessarily bad and can simplify things.

Bar charts and traditional candlesticks measure and display exactly the same things, with the only difference being that candlesticks display the information in a way that is much more visual, and therefore allows for one to spot various patterns that one may be seeking to trade on more readily.

There is really no reason for anyone to prefer bar charts, other than from habit, and while some traders prefer them, there is no good reason for them to as they are an inferior form of price representation.

There is also a form of candlestick charting called Heikin Ashi, which seeks to address the problem of candlesticks and bars not having any smoothing built into them by using averaging. Heikin Ashi candles therefore tend to display trends much better on charts, for instance by tending to display candles of a given color together during trends, instead of the smattering of each color along the way that we see so often with normal candlesticks.

Heikin Ashi candles can therefore be seen as a superior way to represent price on a chart, due to their being a combination of a candle or bar and an average, where signals of trend continuation or reversal are more readily displayed and interpreted.

There are other forms of charting that isn’t used that much, ones that aren’t based upon time but on trades, such as tick charts or point and figure charts. There are also other charts that aren’t used that much but traders may have access to in their trading platform, such as Renko, Kagi, or Line Break charts, although these charts tend to not track price action as accurately.

We can also set our charts to display either the bid or ask of the instrument that we’re tracking rather than the mid-point or trading price if we wish, although provided that the spreads offered are tight, which they really should always be for us to want to trade something, this won’t really matter.

Using Chart Data To Determine Trading Signals

What we do with the data is going to matter the most, although it is still important to organize our charts to best suit our trading strategy. As with all trading, it is far preferable to have a plan in place, rather than to just look to wing it and decide based upon something like intuition.

Many newer traders decide that they are going to trade purely on intuition, although at this point the quality of their intuition tends to be very poor, and this just results in their making bad decisions and doing damage to their accounts.

One may develop their intuitive skills over time to be able to trade just on feel, but to do this well takes a lot of experience, a lot more than newer traders imagine. Even if one has these skills, it is generally better to have some sort of idea of what your strategy will be in a trade, what idea you are trading and what evidence you will accept that this idea is either not valid or becomes invalid at some point in the trade.

Some people think that trading just from the price action on the chart does not involve technical analysis, but it is pure technical analysis that is used, it’s just not the same set of rules that a trader would use with indicators.

Prices on charts do tend to be pretty choppy though, and you can’t just act on the first move away from your position, so we do need a set of rules to look to organize this data in some way. There are a variety of things that price based traders may use here to guide their trading decisions, and they all have to do with looking to assign various degrees of significance to the patterns that emerge.

There are many books written on interpreting candlestick action for instance, where the appearance of certain types of candles, or more often, candles appearing in combination, may prompt traders to enter or exit positions.

Support and resistance areas, trend lines, channels, or other chart features may also be used, which are all part of the technical trader’s tool kit. In the earlier days of technical analysis, much more weight was put on interpreting chart patterns, in an era where stocks were pretty much the only thing people traded.

Top traders these days focus more on derivatives, where you aren’t looking to select from hundreds of instruments and tend to specialize on just a few, and don’t just pore over chart after chart looking for a pattern. You are interested more in measuring the current momentum, and along the way, if certain patterns emerge such as a head and shoulders or a wedge, you may pay attention to this, but the trade will still be primarily driven by the way the price responds.

One of the biggest things that attracts people to trading with price action is the belief that the chart itself displays in real time while indicators lag, but this is an illusion, as one cannot trade purely on the right side of the chart with price or with anything other than guessing.

We all need to consider what has happened, to the left of the period we’re in, and while one could purely trade based upon the present bar on the chart, exiting if the bar goes against us, this is no way to trade as one would become the victim of one insignificant move after another.

All trading is based upon assessing recent price action, not just accounting for the current bar but a number of bars prior. When we account for this, we are going to benefit from smoothing but suffer from some sort of lag, but we need that because in order to tell what moves are meaningful, we need to measure the past as well as the present.

Trading with just price is something that can be done well provided one has a good set of rules that have been proven to work, just like all trading requires, but we do need to have a good plan in place whenever we are looking to trade, and regardless of what we want to be looking at.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.