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Today I want to go through some more candlestick patterns. But one thing that I really want to point out, and I mentioned this earlier in a previous episode, is that you should look at candlestick patterns as “principles” instead of exact patterns, you need to look at the whole picture, the whole chart, instead of mechanically look for a candle or a few candles that look a certain way.
You see if you could only look for specific patterns, like one of the reversal patterns we had a look at in the last episode, and trade when you found one of them — if that was possible we could just program an algorithm and automate it, like the other software that we provide. In my opinion, these candlestick patterns can be powerful tools that will help you in your price action day trading, but you shouldn’t just mechanically trade them. You always need to consider the whole picture.
Today’s example will be such a pattern – one that can have unlimited variations. There is one “core” pattern that is usually taught in candlestick theory – it is called the Rising Three methods, or falling three methods. In itself, this pattern is not that good. I have programmed this and tested it – but it is just not that good to base your day trading on, and the reason for that is the pattern is not that common. You would find it very often in your charts. And that creates a lot of uncertainty in backtesting. Even if it produced good trades, I don’t recommend trading it mechanically. But I use ideas from this in my own trading. When I was an equity options trader for a trading firm I used the ideas from this all the time.
So what I recommend you to do is to simply understand what the pattern means. What it stands for.
So let’s break it down. This is the original Rising Three Method – I’ll show you how I use it in my own market analysis afterwards.
First, you have one big green candle. Right? You remember the big green candle from a few episodes ago. So the big green candle is a big, strong bullish move. Then you get three small red candles pulling back towards the same level where the Big Green Candle started – so the market is pulling back to the same level where the pattern started, but the candles should not move lower than the low of the first big green candle. And then finally after the three red candles, you get another big green candle. The idea in the candlestick theory is to trade when the market breaks the high of the first big green candle.
So that is the Rising three methods pattern. We also have the opposite on the short side: the falling three methods. A big red candle, three small green candles, and then another big red candle.
The way I use this:
First of all – I don’t really care if there are one big green candle or 10 candles on the initial up-move. It is irrelevant really because I always look at this as an idea, as a principle – what I look for is a strong up-move. Then at some point, after one candle or 5 candles or ten candles, you will get the pullback. Now I look at the candles, I look at how big they are, I look at how many they are. Essentially I am simply comparing how much effort was required to make the up-move, and then compare that with how much effort is required to make the same distance on the down move. And with effort, I mean basically counting the number of candles it took. If the market made 10 points over two candles on the up move, then took 10 candles to move down – that means the market does not have to work as hard moving upwards compared to moving downwards. The up move was easy, there is a lot of demand. The down move is harder because there is a lack of supply compared to the demand.
The market might not even go down as far, and that’s a good thing. The lower it goes the weaker the market is, so if it reverses back up again near the top third of the big green candle the market is strong if it reverses at the bottom third of the big green candle the market is weak. Anywhere in between is what I would consider a normal pullback. You just use the 50% line, it doesn’t have to be exact to the decimal, but just eyeball the chart, determine where the half of the green candle is by eyeballing, doing it manually, just find the middle of the big green candle, if it reverses above or below that 50% line. The higher up the better.
And then when we get the up move after the pullback, I again compare that against the pullback. How much effort is required to travel that distance? Does it happen on fewer candles, then that’s great. If it happens on one or a few big green candles then that’s optimal.
If the candles in the pullback and the last big green candle have long shadows, then that’s an even better sign. It tells us that the market tried to move down lower, but it wasn’t able to, the price was forced back up and closed there. If the market can’t move down, then it is likely to move up instead.
Volume, big, small, big
OK, and one important thing will be to look at the volume. The volume should be higher on the up moves than the down moves. What does that tell us? Well, it tells us that there is more demand than supply, and that means that prices ought to move up. There are more and stronger buyers participating than sellers. Everybody wants to buy, nobody wants to sell. So the big green candles or the up moves happen on strong volume, then the pullback is on lower volume, the volume dries up. Then when the market starts moving up again, more and stronger market participants are joining in on the trading and volume picks up again. We want strong moves that show the market’s determination to move upwards, and small, slow, sluggish pullbacks just giving the market a breather and lets it regain its energy.
Alright, so a few words also on trading this:
If you only look at the Rising Three Methods pattern itself, only the five candles, if you are going to trade that, then you should only trade that in uptrends. The Falling Three Methods should only be traded in Downtrends. The market can be so erratic sometimes that you can see the Rising pattern in downtrends and the falling patter in uptrends – or during sideways channels. In those situations, don’t trade it.
The idea and the principle of the strong up move, weak down move and strong up move can be used in sideways channels as well. It tells us that the demand is bigger, so the odds favor a breakout to the upside. In uptrends, the principle tells us that the market is strong and that the uptrend is more likely to continue than to reverse.
Alright, that concludes today’s episode. Please go to Daytradetowin.com to download our free “get started day trading”, get our free day trading simulator with live real-time data, and check out our software products and courses. And last but not least – check out our 8-week day trading mentorship class. If you are looking for day trading coaching you have found the right place.
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