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In today’s episode, you’ll discover 3 common candlestick patterns myths (that fooled most traders).
So listen to it right now…
Resources
The Monster Guide to Candlestick Patterns
Transcript
Hey, hey, what’s up my friend?
In today’s episode, I want to share with you the 3 biggest candlestick patterns myths that many traders fall for.
Let’s get started…
Myth #1: Candlestick patterns can predict the markets
Now, that’s a myth. Because if you understand candlesticks, they only tell you what has happened for a given candle.
For example on a daily chart, a hammer simply tells you that the buyers for that day were in control and pushed the price higher to close higher for the day. That’s all it tells you. It’s not going to tell you that over the next week or month, the market is going higher.
It can’t predict. So don’t make the mistake of thinking candlestick patterns can predict what the market will do next week, next month or next year – it can’t do any of it. If you want to predict what the markets will do, your best bet is to understand the market structure.
In other words, look at the trend. If the price has been steadily grinding higher over the last 200 candles, then guess what? Over the next week or month, the price is likely to continue moving higher. And that’s your best bet to predicting what the markets will do.
Don’t rely on candlestick patterns. Rely on market structure, rely on the trend to give you a much better prediction.
Next…
Myth #2: Candlestick patterns are the same as price action trading
That couldn’t be further from the truth. Let’s break it down. What exactly is price action trading? There different websites, videos, forums talking about price action trading. What exactly is this?
According to my definition of price action trading which might differ from somebody else’s, price action trading is, in essence, understanding the market condition and then using the trading strategy to trade the market condition.
If you think about this, price action trading is not a fixed set of strategy. Rather, it’s a way of analysing and trading the market.
Let me give you an example. If you see the market in an uptrend, then as a price action trader, you want to be buying the pullbacks and buying into the rallies in an uptrend.
If you take things a step further and classify the trend as a strong uptrend, you might be willing to buy the breakout of the swing highs and maybe ride the trend as long as the strong trend remains intact. That’s what I mean by price action trading.
You must analyse the market condition and then find the right trading strategy to trade it.
On the other hand, if the market is in a downtrend, then as a price action trader you’ll look to sell the rallies or sell the breakdown. Can you see where I’m coming from?
Candlestick patterns are only a subset of price action trading because as a price action trader there are a few things that you want to be aware of like:
- Market structure
- Area of value
- Entry trigger
Candlestick patterns can serve as an entry trigger to get you into a trade. Maybe you’re bullish and you want to buy, then a hammer could be the signal that you’re looking for to time and enter the market. This is where candlestick patterns come into play.
I would say price action trading is at the top, then candlestick patterns are a subset of price action trading. Make sense?
Moving on…
Myth #3: Candlestick patterns are a leading indicator
You might already know that indicators are lagging. Moving average, stochastic, RSI, they all lagging tools. You should look at the candlestick patterns, these are leading indicators. And again, that couldn’t be further from the truth. Why is that?
Because if you think about this, whenever a candle has formed, let’s say a weekly candle closed higher and you have a bullish engulfing pattern. Well, guess what? The move has already happened for the bullish engulfing pattern to form.
In other words, you are trading something that has already happened. The market has already closed higher. And that’s how you get your bullish engulfing pattern. If you think about this, this is actually a lagging tool as well.
It won’t be as lagging as compared to the moving average or the RSI where they take into account the mathematical formula. But in the grand scheme of things, it still is a lagging tool, because it has already happened. So what exactly is a leading indicator?
A leading indicator can be like the stock markets. For example, before the economy goes into a recession, the stock markets usually fall first because of expectations. The stock market can be a leading indicator of what the real economy is doing.
Or how about support and resistance? Before the price comes into support, you can pull up that level ahead of time in anticipation that buying pressure could come in and push the price higher. That is another leading indicator.
Or maybe the Fibonacci extension where you can project the extension ahead of time to find where selling pressure might come in to push the price lower. These are leading indicators.
They are not a 100% fool-proof, but that’s my definition of a leading indicator. Before something happens, these indicators can already predict what’s going to happen.
Candlestick patterns are clearly not a leading indicator. Because the move has already happened. But that doesn’t mean that candlestick patterns are useless because as I’ve said earlier, they are useful to serve as an entry trigger to enter a trade.
Candlestick patterns are useful to help you feel what the market is doing, to see if volatility is contracting or expanding, and stuff like that.
But be aware of the limitations of the tools that you’re using, including candlestick patterns, and that’s what today’s message is all about.
Here’s a quick recap…
Recap
- Candlestick patterns cannot predict what the markets will do. If you want to predict what the market will do, then look at the market structure (if it’s in an uptrend or downtrend).
- Candlestick patterns are not price action trading. They’re more of a subset of price action trading, and they’re useful as entry triggers to get you into a trade.
- Candlestick patterns are not a leading indicator. They’re a lagging indicator, although they lag less than moving averages or RSI, but the fact is – candlestick patterns still lag behind the market.
With that said I’ve come to the end of this episode. Wish you good luck and good trading. I will talk to you soon.
