Why Do Candle Charts Patterns work so well?
The reason is just one word- psychology. Candle chart patterns let you gauge the psychology of the market at the time the candlestick lines are formed. This gives immediate insight into who is winning the battle between the bulls and the bears. For example, look at the candlestick signal in the image below, called a hammer. We see the market sold off at some point during the session (remember – candlesticks work in all time frames and all markets that have an open high low and close), but by the end of the session, it came back strongly to close at, or near the highs. So, in this case we could see the psychology the market is turning more positive.
What do candlestick charting patterns mean for your trading and investing strategy?
John Maynard Keynes, a very famous 20th-century economist, said “it’s extremely dangerous to have a rational investment policy in an irrational world.” And truly the only way to gauge the irrational, that is the emotional aspect of market, is through technical analysis. And the most accurate, fastest way to gauge this aspect of the market is through candlestick charts. So, in the above scenario with the hammer the bulls will be getting a little bit more optimistic, and the bears will be getting little bit more nervous. After all if the market was weak once it sold off it should close near the lows, but instead bounced back. So with the hammer we can see the psychology of the market is turning more positive.
Another example of gauging market psychology with a candle signal is a bullish engulfing pattern where a green real body wraps around the prior red real body. We can see in this classic signal on this chart the bulls are wresting control the market for the bears. And as soon on this example many candle signals, such as the bullish engulfing pattern, can be used as a potential support area and thus a good area to set a protective stop if one uses this pattern to initiate a long.
All of our favorite candlestick pattern indicators have the sound psychological foundation behind what the candlestick signal is forecasting. And one particularly important aspect is that while candlesticks can be used to the Western indicators, because candlesticks are gauging what’s happening right now in the market, unlike Western indicators which are lagging, it means you will frequently get the first signs of market reversals with candlesticks before those who use only Western indicators. As such you should be able to jump on a new trend, or exit before the trend turns against you, just as a trend is changing.