Advanced Candlestick Analysis

This article will delve into the topic of Advanced Candlestick Analysis in the context of trading. Before proceeding, it's recommended to check out our previous article about Trading with Support and Resistance to build a foundational understanding. In this discussion, we will explore the following key points:

1. In-Depth Exploration of Advanced Candlestick Analysis

2. Determining the Price Action That Confirms a Resistance or Support Level

3. Identifying the Price Action That Casts Doubt on a Resistance or Support Level

Candlestick Analysis in Trading

Every individual candlestick on a price chart serves as a narrative, portraying the actions of buyers and sellers, and conveying insights about the overall market sentiment. To gain a more comprehensive understanding, it's important to combine candlestick analysis with support and resistance zones.

- When support levels are breached, it often signals the initiation of a downtrend in the market.

- Conversely, the breaking of resistance levels often indicates the commencement of an uptrend.

- Support and resistance zones are prone to breakage when the price exhibits a tight trading range around these levels.

- Repeated testing of support or resistance zones tends to weaken them, making it more likely for these levels to eventually be breached.

Determining whether the price will reverse from a support or resistance level or break through it involves assessing whether price action confirms or disconfirms these levels. This evaluation is crucial in trading decisions.

DISCONFIRMATION AND CONFIRMATION

When dealing with a resistance level in trading, the expectation is that the price will reverse its current upward movement. This reversal is often associated with the concept that supply (selling interest) surpasses demand (buying interest), effectively confirming the presence of supply in the market at that point.

What price action validates the resistance level?

- A distinct sign of rejection at a resistance level can manifest through candlestick patterns such as the pin bar, outside bar, or engulfing bar.

- As the price nears a resistance zone, it may lose its momentum, displaying a slowdown in its upward movement.

- Failing to achieve a closing price above the resistance level is another signal of resistance strength.

- When approaching resistance, if trading volume is notably low, it can indicate a lack of conviction or interest in breaking through that level.

CANDLE REJECTION

Single candle rejection (pin bar)

Within a well-established downtrend, any distinct signs of rejection from a resistance point, often depicted through candlestick patterns like the pin bar, outside bar, or engulfing bar, serve to validate the strength of that resistance level. These patterns indicate a significant obstacle for the price to continue its downward trajectory.

MULTIPLE CANDLE REJECTION

It's particularly compelling when several consecutive candlesticks exhibit rejection from a specific area, as this demonstrates that the price made repeated attempts to move higher but was consistently thwarted. When multiple candles show a reluctance to rise, especially when encountering resistance, it often foreshadows a subsequent downward movement. Here are some instances of multiple rejection candles from a specific area for illustration.

THE REJECTION CANDLE SHOULD CONFIRM BY A FOLLOW-THROUGH CANDLE

The next candle should follow-through candle for validation of the rejection candle

Momentum loss is the key to reversal when approaching a key level

A significant factor that often precedes a reversal near a critical level is the loss of momentum in price movement.

- This loss of momentum is often evident when candles become smaller in size and exhibit multiple colors with visible wicks. It suggests that both buyers and sellers are losing their grip on the market.

- An even stronger indication of a potential reversal occurs when this diminishing momentum is reflected in candles finishing with long wicks. For a bullish reversal, this would typically involve a long lower wick, while a bearish reversal would be marked by a long upper wick.

Here's an example of a bullish reversal to illustrate this concept.

Price unable to close above the resistance

When buyers make persistent efforts to achieve a close above a resistance level but repeatedly fall short, it reflects a situation where supply is consistently challenging and attempting to surpass demand. In essence, these unsuccessful attempts highlight an ongoing battle between buyers and sellers, with supply gaining the upper hand and preventing a sustained breakthrough.

Volume

During an upward price movement, as the price approaches the upper trendline or resistance line, the presence of low trading volume indicates that, at that moment, the trendline is likely to remain intact. This is because in order for a trend to change, you generally need a strong buying force to break through resistance. The resistance area relies on demand pressure to be breached, and when there is low volume, it suggests a lack of significant demand. Consequently, the trendline is expected to hold in such circumstances.

What price action disconfirms the resistance?

Price actions that disconfirm the strength of a resistance level include:

- A significant expansion in candle spread and a noticeable increase in trading volume as the price approaches the resistance level. This implies heightened buying interest and can challenge the resistance.

- When the price closely follows the resistance and manages to hold at that level, it disconfirms the presence of supply and suggests that buyers are overpowering any selling pressure.

Candle spread and volume increase when approaching the resistance level

In an upward price movement when the price nears the upper trendline or resistance line, low trading volume suggests that the trendline is likely to hold at that moment. This is because there is insufficient buying pressure to overcome the resistance, and a change in the trend would require a surge in buying interest.

Conversely, if there is high trading volume with a wide upward spread as the price approaches the upper trendline, it indicates a substantial effort to break through the resistance. If the next day's price remains level or even higher, it signifies the potential for further price increases. This expectation is confirmed when there is a subsequent low-volume down-day, which reinforces the view of continued upward momentum.

When the price tightly hugs a resistance level and manages to maintain that position, it indicates a disconfirmation of supply and highlights the presence of demand in the market.

This is observed through the following characteristics:

- The price remains relatively stable and doesn't exhibit strong reactions after a significant upward drive.

- The price movement at the resistance level forms a compact trading range, with the price not retracing more than 50% of the previous upward move. The tighter this range, the more significant it is.

A key characteristic that signifies buyers are prevailing over sellers is the repeated failure of prices to move away from the resistance level, effectively hugging the high point. Such persistent hugging of the resistance, often accompanied by heavy trading volume, usually foreshadows an imminent breakout.

In the upcoming article, I will provide an in-depth exploration of the Trendline Trading Strategy. In the current article, I've aimed to elucidate the concepts and techniques related to Advanced Candlestick Analysis within the realm of trading. I trust you find this discussion on Advanced Candlestick Analysis in Trading enjoyable and informative.

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