Thursday, March 22, 2012
The Inverted Hammer and Shooting Star
Inverted Hammer and Shooting Star Patterns: How to Trade Them
Inverted Hammer and Shooting Star Patterns: How to Trade Them
The Inverted Hammer Candlestick Pattern
As its name implies, the inverted Hammer looks like an upside down version of the Hammer Candlestick Chart Pattern which we learned about several lessons ago. Like the Hammer Pattern, the Inverted Hammer is comprised of one candle and when found in a downtrend is considered a potential reversal pattern.
The pattern is made up of a candle with a small lower body and a long upper wick which is at least two times as large as the short lower body. The body of the candle should be at the low end of the trading range and there should be little or no lower wick in the candle.
What this chart pattern is basically telling us is that although sellers ended up driving price down to close near to where it opened, buyers had significant control of the market at some point during the period which formed the long upper wick. This buying pressure during the downtrend calls the trend into question which is why the candle is considered a potential reversal pattern. Like the other one candle patterns we have learned about however, most traders will wait for a higher open on the next trading period before taking any action based on the pattern.
Most traders will also look at a longer wick as a sign of a greater potential reversal and like to see an increase in volume on the day the Inverted Hammer Forms.
The Shooting Star Candlestick Pattern
The Shooting Star looks exactly the same as the Inverted Hammer, but instead of being found in a downtrend it is found in an uptrend and thus has different implications. Like the Inverted Hammer it is made up of a candle with a small lower body, little or no lower wick, and a long upper wick that is at least two times the size of the lower body.
The long upper wick of the chart pattern indicates that the buyers drove prices up at some point during the period in which the candle was formed but encountered selling pressure which drove prices back down for the period to close near to where they opened. As this occurred in an uptrend the selling pressure is seen as a potential reversal sign. When encountering this pattern traders will look for a lower open on the next period before considering the pattern valid and potentially including it in their trading strategy.
As with the Inverted Hammer most traders will see a longer wick as a sign of a greater potential reversal and like to see an increase in volume on the day the Shooting Star forms.
Other Links to Help You Learn About Inverted Hammers and Shooting Stars
Shooting Star Candlestick Pattern
Candlesticker by Americanbulls.com - Bearish Shooting Star Pattern
Shooting Star Candlestick Chart Pattern
Inverted Hammeri Candlestick Chart Pattern
Bullish Inverted Hammer Japanese Candlestick Chart
That completes this lesson and wraps up our series on candlestick chart patterns. In our next lesson we are going to start a new series with a look at Money Management and how this applies to profitable trading so we hope to see you in that lesson.
As always if you have any questions or comments please leave them in the comments section below so we can all benefit and learn to trade together!
PreviousLesson
NextLesson
In our last lesson we learned about the Morning and Evening Star Candlestick Patterns. In today's lesson we are going to wrap up our series on candlestick chart patterns with a look at the Inverted Hammer and the Shooting Star candlestick patterns.
In our last lesson we learned about the Morning and Evening Star Candlestick Patterns. In today's lesson we are going to wrap up our series on candlestick chart patterns with a look at the Inverted Hammer and the Shooting Star candlestick patterns.
The Inverted Hammer Candlestick Pattern
As its name implies, the inverted Hammer looks like an upside down version of the Hammer Candlestick Chart Pattern which we learned about several lessons ago. Like the Hammer Pattern, the Inverted Hammer is comprised of one candle and when found in a downtrend is considered a potential reversal pattern.
The pattern is made up of a candle with a small lower body and a long upper wick which is at least two times as large as the short lower body. The body of the candle should be at the low end of the trading range and there should be little or no lower wick in the candle.
What this chart pattern is basically telling us is that although sellers ended up driving price down to close near to where it opened, buyers had significant control of the market at some point during the period which formed the long upper wick. This buying pressure during the downtrend calls the trend into question which is why the candle is considered a potential reversal pattern. Like the other one candle patterns we have learned about however, most traders will wait for a higher open on the next trading period before taking any action based on the pattern.
Most traders will also look at a longer wick as a sign of a greater potential reversal and like to see an increase in volume on the day the Inverted Hammer Forms.
The Shooting Star Candlestick Pattern
The Shooting Star looks exactly the same as the Inverted Hammer, but instead of being found in a downtrend it is found in an uptrend and thus has different implications. Like the Inverted Hammer it is made up of a candle with a small lower body, little or no lower wick, and a long upper wick that is at least two times the size of the lower body.
The long upper wick of the chart pattern indicates that the buyers drove prices up at some point during the period in which the candle was formed but encountered selling pressure which drove prices back down for the period to close near to where they opened. As this occurred in an uptrend the selling pressure is seen as a potential reversal sign. When encountering this pattern traders will look for a lower open on the next period before considering the pattern valid and potentially including it in their trading strategy.
As with the Inverted Hammer most traders will see a longer wick as a sign of a greater potential reversal and like to see an increase in volume on the day the Shooting Star forms.
Other Links to Help You Learn About Inverted Hammers and Shooting Stars
Shooting Star Candlestick Pattern
Candlesticker by Americanbulls.com - Bearish Shooting Star Pattern
Shooting Star Candlestick Chart Pattern
Inverted Hammeri Candlestick Chart Pattern
Bullish Inverted Hammer Japanese Candlestick Chart
That completes this lesson and wraps up our series on candlestick chart patterns. In our next lesson we are going to start a new series with a look at Money Management and how this applies to profitable trading so we hope to see you in that lesson.
As always if you have any questions or comments please leave them in the comments section below so we can all benefit and learn to trade together!
The Morning and Evening Star
How to Trade the Morning and Evening Star Candlestick Chart Patterns
In our last lesson we looked at the Hammer and Hanging Man Candlestick Chart Patterns. In today’s lesson we are going to look at two more reversal candlestick patterns which are known as the Morning and Evening Star.
The Morning Star
The Morning Star Candlestick Pattern is made up of 3 candles normally a long black candle, followed by a short white or black candle, which is then followed by a long white candle. In order to have a valid Morning Start formation most traders will look for a close of the third candle that is at least half way up the body of the first candle in the pattern. When found in a downtrend, this pattern can be a powerful reversal pattern.
What this represents from a supply demand situation is a lot of selling into the downtrend in the period which forms the first black candle, then a period of lower trading but with a reduced range which forms the second period and then a period of trading indicating that indecision in the market, which is then followed by a large up candle representing buyers taking control of the market.
Unlike the Hammer and Hanging Man which we learned about in our last lesson, as the Morning Star is a 3 candle pattern traders often times will not wait for confirmation from the 4th candle before entering the trade. Like those patterns however traders will look to volume on the third day for confirmation. In addition traders will look to the size of the size of the candles for indication on how big the reversal potential is. The larger the white and black candle and the further that the white candle moves up into the black candle the larger the reversal potential.
The Evening Star
The Evening Star Candlestick Pattern is a mirror image of the Morning Star, and is a reversal pattern when seen as part of an uptrend. The pattern is made up of three candles the first being a long white candle representing buyers driving the prices up, then a short white or black second candle representing indecision in the market, which is followed by a third black candle down which represents sellers taking control of the market.
The close of the third candle needs to be at least half way down the body of the first candle and as with the Morning Star most traders will not wait for confirmation from the 4th period’s candle to consider the pattern valid. Traders will look for increased volume on the third period’s candle for confirmation, the larger the black and white candles are and the further the black candle moves down the body of the white candle the more powerful the reversal is expected to be.
Other Links to Help You Learn about Morning Star and Evening Star Patterns
The Morning Star - A Powerful Candlestick Reversal Signal
Evening Star Candlestick Formation -- A complete definition
Evening Star Candlestick Chart Pattern
Morning Star Candlestick Formation, Definition - Trading Glossary
That’s our lesson for today. In our next lesson we are going to finish up our series on Candlestick patterns with a look at the Shooting Star and Inverted Hammer Candlestick Patterns.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
The Hammer and Hanging Man
Hammer & Hanging Man Candelstick Patterns - How to Trade
In our last lesson we learned about the Bullish and Bearish Engulfing Candlestick Patterns
which can represent reversal patterns when found in an uptrend or a
downtrend. In Today’s lesson we are going to look at two more candlestick Patterns which are known as the Hammer and the Hanging man.
The Hammer
Like the Spinning Top and Doji which we have studied in previous lessons where we learn to trade chart patterns, the Hammer candlestick pattern is made up of one candle. The candle looks like a hammer as it has a long lower wick and a short body at the top of the candlestick with little or no upper wick. In order for a candle to be a valid hammer most traders say the lower wick must be two times greater than the size of the body potion of the candle, and the body of the candle must be at the upper end of the trading range.
When you see the Hammer form in a downtrend this is a sign of a potential reversal in the market as the long lower wick represents a period of trading where the sellers were initially in control but the buyers were able to reverse that control and drive prices back up to close near the high for the day, thus the short body at the top of the candle.
After seeing this chart pattern form in the market most traders will wait for the next period to open higher than the close of the previous period to confirm that the buyers are actually in control.
Two additional things that traders will look for to place more significance on the pattern are a long lower wick and an increase in volume for the time period that formed the hammer.
The Hanging Man
The Hanging Man is basically the same thing as Hammer formation but instead of being found in a downtrend it is found in an uptrend. Like the Hammer pattern, the Hanging man has a small body near the top of the trading range, little or no upper wick, and a lower wick that is at least two times as big as the body of the candle.
Unlike the Hammer however the selling pressure that forms the lower wick in the Hanging Man is seen as a potential sign of more selling pressure to come, even though the candle closed in the upper end of its range. While the lower wick of the Hammer represents selling pressure as well, this is to be expected in a downtrend. When seen in an uptrend however selling pressure is a warning sign of potential more selling pressure to come and thus the categorization of the Hanging Man as a bearish reversal pattern.
As with the Hammer and as with most one candle chart patterns most traders will wait for confirmation that selling pressure has in fact taken hold by watching for a lower open on the next candle. Traders will also place additional significance on the pattern when there is an increase in volume during the period the Hanging Man forms as well as when there is a longer wick.
Links Around the Web to Help You Learn More About the Hanging Man Candlestick Pattern
Bearish Hanging Man Japanese Candlestick Chart
Investopedia Entry on the Hanging Man Candlestick Pattern
Hammers and Hanging Man Candlestick Patterns
That completes our lesson for today. In our next lesson we will look at two additional reversal patterns which are known as the Morning and Evening Star Candlestick Patterns so we hope to see you in that lesson.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
The Hammer
Like the Spinning Top and Doji which we have studied in previous lessons where we learn to trade chart patterns, the Hammer candlestick pattern is made up of one candle. The candle looks like a hammer as it has a long lower wick and a short body at the top of the candlestick with little or no upper wick. In order for a candle to be a valid hammer most traders say the lower wick must be two times greater than the size of the body potion of the candle, and the body of the candle must be at the upper end of the trading range.
When you see the Hammer form in a downtrend this is a sign of a potential reversal in the market as the long lower wick represents a period of trading where the sellers were initially in control but the buyers were able to reverse that control and drive prices back up to close near the high for the day, thus the short body at the top of the candle.
After seeing this chart pattern form in the market most traders will wait for the next period to open higher than the close of the previous period to confirm that the buyers are actually in control.
Two additional things that traders will look for to place more significance on the pattern are a long lower wick and an increase in volume for the time period that formed the hammer.
The Hanging Man
The Hanging Man is basically the same thing as Hammer formation but instead of being found in a downtrend it is found in an uptrend. Like the Hammer pattern, the Hanging man has a small body near the top of the trading range, little or no upper wick, and a lower wick that is at least two times as big as the body of the candle.
Unlike the Hammer however the selling pressure that forms the lower wick in the Hanging Man is seen as a potential sign of more selling pressure to come, even though the candle closed in the upper end of its range. While the lower wick of the Hammer represents selling pressure as well, this is to be expected in a downtrend. When seen in an uptrend however selling pressure is a warning sign of potential more selling pressure to come and thus the categorization of the Hanging Man as a bearish reversal pattern.
As with the Hammer and as with most one candle chart patterns most traders will wait for confirmation that selling pressure has in fact taken hold by watching for a lower open on the next candle. Traders will also place additional significance on the pattern when there is an increase in volume during the period the Hanging Man forms as well as when there is a longer wick.
Links Around the Web to Help You Learn More About the Hanging Man Candlestick Pattern
Bearish Hanging Man Japanese Candlestick Chart
Investopedia Entry on the Hanging Man Candlestick Pattern
Hammers and Hanging Man Candlestick Patterns
That completes our lesson for today. In our next lesson we will look at two additional reversal patterns which are known as the Morning and Evening Star Candlestick Patterns so we hope to see you in that lesson.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
The Bullish and Bearish Engulfing Formations
Bearish and Bullish Engulfing Patterns: How to Trade the Bullish and Bearish Engulfing Candlesticks
In our last lesson we looked at two candlestick patterns
which represent an indecisive moment in the market and can also
represent a potential trend reversal when seen during an uptrend or
downtrend in the market and are known as the spinning top and doji candlestick patterns. In today’s lesson we are going to look at two more candlestick patterns which also can represent potential reversals which are known as the Bullish and Bearish Engulfing Patterns.
The Bullish Engulfing Pattern
The Bullish Engulfing pattern is another candlestick formation which represents a potential reversal in the market when seen in a downtrend. The pattern is made up of a white and black candle where the latest candle (the white candle) opens lower than the previous candle’s (the black candle) close and closes higher than the previous candle’s open. When this happens the current period’s white candle completely engulfs the body previous period’s black candle.
Unlike the Spinning Top and the Doji we learned about in the last lesson, the Bullish Engulfing Pattern represents not indecision in the market, but a situation where the control has shifted from sellers to buyers. The long body of the current candle completely engulfing the body of the previous candle to the upside is representative that the buyers have not only taken control, but have taken control with force. As such, when this pattern is seen during a downtrend in the market it is seen as a potential sign that the trend may be reversing.
There are several instances where traders will normally see greater potential for a reversal which are:
- The longer the white candle and the smaller the black candle which precedes it the greater the potential for reversal
- When the white candle completely engulfs the black candle that precedes it
- When there is large volume during the period in which the white candle forms
The Bearish Engulfing Pattern is a Mirror Image of the Bullish Engulfing Pattern so the same rules apply, just in reverse. The Bearish Engulfing pattern when seen in an uptrend is representative of a potential reversal of that trend. The pattern is made up of a white and black candle where the latest candle (the black candle) opens higher than the previous candle’s (the white candle) close and closes lower than the previous candle’s open. When this happens the current period’s black candle completely engulfs the body of the previous period’s white candle.
There are several instances where traders will normally see greater potential for a reversal which are:
- The longer the black candle and the smaller the white candle which precedes it the greater the potential for reversal
- When the black candle completely engulfs the white candle that precedes it
- When there is large volume during the period in which the white candle forms
Other Links to Help You Learn About Bullish and Bearish Engulfing Candlestick Patterns
Bullish Engulfing and Bearish Engulfing Candlesticks -- Technical Analysis Education
Candlestick Engulfing Patterns - Bullish and Bearish Engulfing candlestick charts
the bullish engulfing pattern
Bearish Engulfing Japanese Candlestick Chart
That completes our lesson for today. In tomorrow’s lesson we are going to learn about two more candlestick patterns which are also potential reversal patterns known as the hammer and the hanging man candlestick patterns so we hope to see you in that lesson. As always if you have any questions or comments please feel free to leave them in the comments section below so we can all learn to trade together, and have a great day!
The Spinning Top and Doji
How to Trade The Doji and Spinning Top Candlestick Chart Patterns
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In our last lesson we learned how different candlestick formations
can tell us different things about whether the buyers or the sellers
won out in a particular time period. In today’s lesson we are going to
look at some of the basic candlestick patterns and what they mean when looked at in the context of recent price action in the market.
The Spinning Top
When a candlestick with a short body in the middle of two long wicks forms in the market this is indicative of a situation where neither the buyers nor the sellers have won for that time period as the market has closed relatively unchanged from where it opened. The upper and lower long wicks however tell us that both the buyers and the sellers had the upper hand at some point during the time period the candle represents. When you see this type of candlestick form after a runup or run down in the market it can be an indication of a pending reversal as the indescision in the market is representative of the buyers loosing momentum when this occurs after an uptrend and the sellers loosing momentum after a downtrend.
Spinning top After a Trend
The Doji
Like the Spinning Top the Doji Represents indecision in the market but is normally considered a stronger signal because unlike the spinning top the open and the close that form the Doji Candle are at the same level. If a Doji forms in sideways market action this is not significant as the sideways market action is already indicative of indecision in the market. If the Doji forms in an uptrend or downtrend this is normally seen as significant as this is a signal that the buyers are loosing conviction when formed in an uptrend and a signal that sellers are loosing conviction if seen in a downtrend. Most traders will place greater significance on the Doji when it forms in a market that is in overbought or oversold territory.
Doji After a Trend
Other Links from Around the Web to Help You Learn About Spinning Tops and Dojis
Candlesticker by Americanbulls.com - White Spinning Top Pattern
Candlesticker by Americanbulls.com - Black Spinning Top Pattern
Spinning Top Candlestick chart Pattern
Doji Candlesticks -- Technical Analysis Education
Learning How to Read Stock Charts Using the Doji
Doji - Wikipedia, the free encyclopedia
That completes our lesson for today. In our next lesson we are going to look at several more candlestick formations known as the Bullish and Bearish Engulfing Candlestick Patterns and how traders use these in their trading strategies so we hope to see you in that lesson. As always if you have any questions or comments please feel free to leave them in the comments section below so we can all learn to trade together, and have a great day!
The Spinning Top
When a candlestick with a short body in the middle of two long wicks forms in the market this is indicative of a situation where neither the buyers nor the sellers have won for that time period as the market has closed relatively unchanged from where it opened. The upper and lower long wicks however tell us that both the buyers and the sellers had the upper hand at some point during the time period the candle represents. When you see this type of candlestick form after a runup or run down in the market it can be an indication of a pending reversal as the indescision in the market is representative of the buyers loosing momentum when this occurs after an uptrend and the sellers loosing momentum after a downtrend.
Spinning top After a Trend
The Doji
Like the Spinning Top the Doji Represents indecision in the market but is normally considered a stronger signal because unlike the spinning top the open and the close that form the Doji Candle are at the same level. If a Doji forms in sideways market action this is not significant as the sideways market action is already indicative of indecision in the market. If the Doji forms in an uptrend or downtrend this is normally seen as significant as this is a signal that the buyers are loosing conviction when formed in an uptrend and a signal that sellers are loosing conviction if seen in a downtrend. Most traders will place greater significance on the Doji when it forms in a market that is in overbought or oversold territory.
Doji After a Trend
Other Links from Around the Web to Help You Learn About Spinning Tops and Dojis
Candlesticker by Americanbulls.com - White Spinning Top Pattern
Candlesticker by Americanbulls.com - Black Spinning Top Pattern
Spinning Top Candlestick chart Pattern
Doji Candlesticks -- Technical Analysis Education
Learning How to Read Stock Charts Using the Doji
Doji - Wikipedia, the free encyclopedia
That completes our lesson for today. In our next lesson we are going to look at several more candlestick formations known as the Bullish and Bearish Engulfing Candlestick Patterns and how traders use these in their trading strategies so we hope to see you in that lesson. As always if you have any questions or comments please feel free to leave them in the comments section below so we can all learn to trade together, and have a great day!
An Introduction to Candlesticks
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In our last lesson we finished up our series on technical indicators with a look at the Parabolic SAR. In today's lesson we are going to start a new series on Candlestick chart formations by looking at some of the most common candlestick patterns in the market.
As you should remember from our lesson on the basics of trading charts, candlestick charts display the open, high, low, and close of an instrument and shade the "candle" portion white if the close of the period is greater than the open of the period, and black if the close for the period is less than the open. The high and the low of the period are then connected by a thin line which is referred to as the wick.
Example:
At their most basic candlestick charts give us a picture of how volatile a particular period was and whether buyers or sellers won the trading period the candlestick represents. If a candle is long and white, this tells us that the period started with buyers in control and remained that way as they drove prices higher throughout the period. If a candle is long and black this is an indication of a volatile period where sellers won out over buyers. The less of a wick there is on a long candle the greater the control of either the buyers or the sellers depending on the color of the candle.
Example
Candlesticks which have long wicks and short bodies indicate periods where there was a lot of action pushing the market either higher or lower but where it ended up closing right near the open.
If there is a long part of the wick on the upper part of the candle means that buyers initially ran the market up against the sellers but then the sellers pushed the market back against the buyers to close the period right where it opened. Conversely if the long part of the wick is below the candle this means that sellers initially pushed the market against the buyers but buyers then pushed back successfully against the sellers to close the period near its opening.
Example
Short candlesticks represent periods in the market where the market closed near its open for the period and can represent either periods of little market activity or periods of activity where neither buyers nor sellers gained much ground.
Example
That concludes our lesson on the basics of candlesticks. In our next lesson we are going to look at two candlestick patterns called The Doji and The Spinning Top and what they can tell us about the supply demand situation in the market so we hope to see you in that lesson.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
Other Links to Help You Learn About Candlesticks
On InformedTrades
Candlestick Patterns - InformedTrades
InformedTrades - Threads Tagged with candlestick patterns
InformedTrades - Threads Tagged with candlesticks
InformedTrades - Blog Entries
Elsewhere on the Web
StockCharts' Introduction to Candlesticks
TradingDay.com Introduction to Candlesticks
Japanese Candlesticks | ThePitMaster.com
The Parabolic SAR
In our last lesson we learned about the Average Directional Index (ADX)
an indicator which helps traders determine the strength of trends in
the market. In today’s lesson we are going to look at another indicator
called the Parabolic Stop and Reversal (Parabolic SAR), which helps
traders enter and manage positions when trading those trends.
The Parabolic SAR is an indicator that, like Bollinger Bands is plotted on price, the general idea of which is to buy into up trends when the indicator is below price, and sell into down trends when the indicator is above price. Once traders are in positions the indicator also assists in managing the position by providing guidance as to how one should trail their stop.
Example of the Parabolic SAR
While this is an indicator that works very well in trending markets, as you can see from the below chart simply following the basic be long when the indicator is below price and be short when the indicator is above price will lead to many whipsaws in range bound markets.
Example of Whipsaws in Range Bound Markets
To combat this problem the developer of the indicator J. Welles Wilder (who also developed the RSI and ADX) recommended establishing the strength and direction of the trend first through the use of things such as the ADX, and then using the Parabolic SAR to trade that trend. As mentioned above although the Parabolic SAR is used for both entering and managing positions, it is used far more to set stops once in a position.
As with the other indicators we have covered in past lessons it is recommended to use this indicator in conjunction with other methods of analysis for confirmation not only on trade entry but also on trade exit.
Example:
Other Links to Help You Learn About Parabolic SAR
Parabolic SAR - Wikipedia, the free encyclopedia
Parabolic SAR - Technical Analysis
Yahoo! Finance Charts User Guide - Parabolic SAR
Parabolic SAR
That’s our lesson for today. While my lessons are by no means exhaustive on the subject this also concludes my series on technical indicators. If you are interested in learning more about the indicators that we have studies as well as some of the other indicators that traders use, I encourage you to visit the technical indicators section of informedtrades.com.
In our next lesson we will begin a new series by taking a deeper look at candlestick chart patterns and how one can use these in their trading.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
The Average Directional Index
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In our last lesson we went over Bollinger Bands, an indicator which helps traders gauge the volatility in the market as well as how high or low current prices are relative to historical prices. In this lesson we are going to learn about the Average directional Index (ADX), an indicator which helps traders determine when the market is trending, how strong or weak a trend is, and when a trend may be about to start or reverse.
Example of the Average Directional Index (ADX)
I am not going to go into the formulas for the Indicator here however you do need to know that:
- The +DI Line is representative of how strong or weak the uptrend in the market is.
- The –DI line is representative of how strong or weak the downtrend in the market is.
- As the ADX line is comprised of both the +DI Line and the –DI Line, it does not indicate whether the trend is up or down, but simply the strength of the overall trend in the market.
As the ADX Line is Non Directional, it does not tell you whether the market is in an uptrend or a downtrend (you must look to price or the +DI/-DI Lines for this) but simply how strong or weak the trend in the financial instrument you are analyzing is. When the ADX line is above 40 and rising this is indicative of a strong trend, and when the ADX line is below 20 and falling this is indicative of a ranging market.
Example
So one of the first ways traders will use the ADX in their trading is as a confirmation of whether or not a financial instrument is trending, and to avoid choppy periods in the market where many find it harder to make money. In addition to a situation where the ADX line trending below 20, the developer of the indicator recommends not trading a trend based strategy when the ADX line is below both the +DI Line and the –DI Line.
Example
Another way that traders use this indicator is to identify the potential start of a new trend in the market. Very simply here they will look from below the 20 line to above the 20 line as a signal that the market may be beginning a new trend. The longer the market has been ranging, the greater the weight that most traders will give this signal
Example
Another way traders use the ADX is as a signal of trend reversals. When the ADX is trading above both the +DI line and the –DI line and then turns lower this is often a signal that the current trend in the market is reversing and traders will position themselves accordingly:
Example
The final example that I am going to cover on how traders use the ADX is to position to trade long when the +DI crosses above the –DI (as this is a sign that the buyers are winning out over the sellers) and to position to trade short when the +DI line crosses below the –DI (as this is a sign that the sellers are winning over the buyers). As with the other crossover strategies that we have covered used alone, the DI crossover is prone to many false signals.
Example
That completes our lesson for today. You should now have a good understanding of the ADX and several different ways that traders use this in their trading. In tomorrow’s lesson we are going to look at a new indicator which is called The Parabolic SAR, which many traders use to set stops when trading trends in the market.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
Other Links to Help You Learn About Average Directional Index (ADX)
On InformedTrades
InformedTrades - Threads Tagged with adx
Elsewhere on the Web
Average Directional Index (ADX) - StockCharts.com
Technical Analysis for beginners: Average Directional Index (ADX):Meaning & Calculation
Interpreting ADX Average Directional Movement Technical Analysis Indicator
ADX Indicator on MarketVolume.com
Bollinger Bands
Bollinger bands trading strategies
PreviousLesson NextLesson
In our last lesson we learned about the Stochastic Oscillator and how traders use this in their trading. In today’s lesson we are going to learn about a technical indicator, which helps traders gauge the volatility and how current prices compare to past prices.
Bollinger Bands are comprised of three bands which are referred to as the upper band, the lower band, and the center band. The middle band is a simple moving average which is normally set at 20 periods, and the upper band and lower band represent chart points that are two standard deviations away from that moving average.
Example of Bollinger Bands
Bollinger Bands Explained
Bolinger bands are a good tool to give traders a feel for what the volatility is in the market and how high or low prices are relative to the recent past. The basic premise of Bollinger bands is that price should normally fall within two standard deviations (represented by the upper and lower band) of the mean which is the center line moving average. If you are unfamiliar with what a standard deviation is you can read about it here. As this is the case trend reversals often occur near the upper and lower bands. As the center line is a moving average which represents the trend in the market, it will also frequently act as support or resistance.
The first way that traders use the Bollinger bands indicator is to identify potential overbought and oversold places in the market. Although some traders will take a close outside the upper or lower bands as buy and sell signals, John Bollinger who developed the indicator recommends that this method should only be traded with the confirmation of other indicators. Outside of the fact that most traders would recommend confirming signals with more than one method, with Bollinger bands prices which stay outside or remain close to the upper or lower band can indicate a strong trend, a situation that you do not want to be trading reversals in. For this reason selling at the upper band and buying at the lower is a technique that is best served in range bound markets.
Example of Buying and Selling at the Upper and Lower Band:
Large breakouts often occur after periods of low volatility when the bands contract. As this is the case traders will often position for a trend trade on a break of the upper or lower Bollinger band after a period of contraction or low volatility. Be careful when using this strategy as the first move is often a fake out. If you are unfamiliar with fakeout, this technical analysis term is described here.
Example of the Bollinger Band Contraction
As Bollinger bands paint a good picture directly on the price chart of how high or low price is relative to historical prices, this is a good indicator to use in conjunction with other methods such as some of the currency chart patterns that we have learned so far and some of the candlestick patterns which we will learn in future lessons.
Bollinger Bands with Multiple Confirmation
As Bollinger Bands are one of the most popular indicators around I have created a special page on InformedTrades.com which lists multiple resources for those looking for more information on Bollinger Bands trading .
Other Links From Around the Web to Help You Learn About Bollinger Bands
Bollinger bands - Wikipedia, the free encyclopedia
Using Bollinger Band "Bands" To Gauge Trends
www.BollingerBands.com: Bollinger Bands Tutorial
www.BollingerOnBollingerBands.com: Home Page
That’s our lesson for today. You should now have a good understanding of Bollinger bands and how traders use these in their trading. In our next lesson we are going to go over the Average Directional Index or ADX, which helps traders identify the strength or weakness of a trend so we hope to see you in that lesson.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
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In our last lesson we learned about the Stochastic Oscillator and how traders use this in their trading. In today’s lesson we are going to learn about a technical indicator, which helps traders gauge the volatility and how current prices compare to past prices.
Bollinger Bands are comprised of three bands which are referred to as the upper band, the lower band, and the center band. The middle band is a simple moving average which is normally set at 20 periods, and the upper band and lower band represent chart points that are two standard deviations away from that moving average.
Example of Bollinger Bands
Bollinger Bands Explained
Bolinger bands are a good tool to give traders a feel for what the volatility is in the market and how high or low prices are relative to the recent past. The basic premise of Bollinger bands is that price should normally fall within two standard deviations (represented by the upper and lower band) of the mean which is the center line moving average. If you are unfamiliar with what a standard deviation is you can read about it here. As this is the case trend reversals often occur near the upper and lower bands. As the center line is a moving average which represents the trend in the market, it will also frequently act as support or resistance.
The first way that traders use the Bollinger bands indicator is to identify potential overbought and oversold places in the market. Although some traders will take a close outside the upper or lower bands as buy and sell signals, John Bollinger who developed the indicator recommends that this method should only be traded with the confirmation of other indicators. Outside of the fact that most traders would recommend confirming signals with more than one method, with Bollinger bands prices which stay outside or remain close to the upper or lower band can indicate a strong trend, a situation that you do not want to be trading reversals in. For this reason selling at the upper band and buying at the lower is a technique that is best served in range bound markets.
Example of Buying and Selling at the Upper and Lower Band:
Large breakouts often occur after periods of low volatility when the bands contract. As this is the case traders will often position for a trend trade on a break of the upper or lower Bollinger band after a period of contraction or low volatility. Be careful when using this strategy as the first move is often a fake out. If you are unfamiliar with fakeout, this technical analysis term is described here.
Example of the Bollinger Band Contraction
As Bollinger bands paint a good picture directly on the price chart of how high or low price is relative to historical prices, this is a good indicator to use in conjunction with other methods such as some of the currency chart patterns that we have learned so far and some of the candlestick patterns which we will learn in future lessons.
Bollinger Bands with Multiple Confirmation
As Bollinger Bands are one of the most popular indicators around I have created a special page on InformedTrades.com which lists multiple resources for those looking for more information on Bollinger Bands trading .
Other Links From Around the Web to Help You Learn About Bollinger Bands
Bollinger bands - Wikipedia, the free encyclopedia
Using Bollinger Band "Bands" To Gauge Trends
www.BollingerBands.com: Bollinger Bands Tutorial
www.BollingerOnBollingerBands.com: Home Page
That’s our lesson for today. You should now have a good understanding of Bollinger bands and how traders use these in their trading. In our next lesson we are going to go over the Average Directional Index or ADX, which helps traders identify the strength or weakness of a trend so we hope to see you in that lesson.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
The Stochastic Oscillator
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In our last lesson we learned about the Relative Strength Index (RSI) indicator and some of the different ways traders of the stock, futures, and forex markets use this in their trading. In today’s lesson we are going to look at another momentum oscillator which is similar to the RSI and is called the Stochastic.
Let me start by saying that there are 3 different types of stochastic oscillators: the fast, slow, and full stochastic. All of them operate in a similar manner however when most traders refer to trading using the stochastic indicator they are referring to the slow stochastic which is going to be the focus of this lesson.
The basic premise of the stochastic is that prices tend to close in the upper end of their trading range when the financial instrument you are analyzing is in an uptrend and in the lower end of their trading range when the financial instrument that you are analyzing is in a downtrend. When prices close in the upper end of their range in an uptrend this is a sign that the momentum of the trend is strong and vice versa for a downtrend.
The Stochastic Oscillator contains two lines which are plotted below the price chart and are known as the %K and %D lines. Like the RSI, the Stochastic is a banded oscillator so the %K and %D lines fluctuate between zero and 100, and has lines plotted at 20 and 80 which represent the high and low ends of the range.
Example of a Stochastic Oscillator
Whatever charting package you use will calculate the lines for you automatically but you should know that the data points which form the %K line are basically a representation of where the market has closed for each period in relation to the trading range for the 14 periods used in the indicator. In simple terms it is a measure of momentum in the market.
The %D line is very simply a 5 period simple moving average of the %K line. Lastly you should know that you can change the inputs for the indicator and use for example a 3 period moving average of the %K line to get faster signals, however as this is an introduction to the indicator and because most traders I know do not change the standard inputs, I do not recommend changing them at this point.
Like the RSI the first way that traders use the stochastic oscillator is to identify overbought and oversold levels in the market. When the lines that make up the indicator are above 80 this represents a market that is potentially overbought and when they are below 20 this represents a market that is potentially oversold. The developer of the indicator George Lane recommended waiting for the %K line to trade back below or above the 80 or 20 line as this gives a better signal that the momentum in the market is reversing.
Example of Overbought and Oversold Trading Signals
The second way that traders use this indicator to generate signals is by watching for a crossover of the %K line and the %D line. When the faster %K line crosses the slower %D line this is a sign that the market may be heading up and when the %K line crosses below the %D line this is a sign that the market may be heading down. As with the RSI however this strategy results in many false signals so most traders will use this strategy only in conjunction with others for confirmation.
Example of the Stochastic Crossover
The third way that traders will use this indicator is to watch for divergences where the Stochastic trends in the opposite direction of price. As with the RSI this is an indication that the momentum in the market is waning and a reversal may be in the making. For further confirmation many traders will wait for the cross below the 80 or above the 20 line before entering a trade on divergence.
Example of Divergence
As the RSI and Stochastic are similar in nature many traders will use them in conjunction with one another to confirm signals.
Links to Help You Learn to Trade the Stochastic Oscillator
Stochastic Oscillator (Fast, Slow, and Full) - StockCharts.com
Stochastic oscillator - Wikipedia, the free encyclopedia
Fast and Slow Stochastics Indicator- Technical Analysis
InformedTrades Archive of Discussions About Stochastics
That’s our lesson for today. You should now have a good understanding of the Stochastic Oscillator and some of the different ways that traders use this in their trading. In tomorrow’s lesson we are going to look at an indicator which allows us to gauge the volatility of a financial instrument over a given time called Bollinger Bands.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
The Relative Strength Index
Relative strength index (RSI) trading
Learn to Trade Using RSI
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In our last lesson we looked at 3 different ways to trade the MACD indicator. In today’s lesson we are going to look at a class of indicators which are known as Oscillators with a look at how to trade one of the more popular Oscillators the Relative Strength Index (RSI).
An oscillator is a leading technical indicator which fluctuates above and below a center line and normally has upper and lower bands which indicate overbought and oversold conditions in the market (an exception to this would be the MACD which is an Oscillator as well). One of the most popular Oscillators outside of the MACD which we have already gone over is the Relative Strength Index (RSI) which is where we will start our discussion.
The RSI is best described as an indicator which represents the momentum in a particular financial instrument as well as when it is reaching extreme levels to the upside (referred to as overbought) or downside (referred to as oversold) and is therefore due for a reversal. The indicator accomplishes this through a formula which compares the size of recent gains for a particular financial instrument to the size of recent losses, the results of which are plotted as a line which fluctuates between 0 and 100. Bands are then placed at 70 which is considered an extreme level to the upside, and 30 which is considered an extreme level to the downside.
Example of the RSI Indicator
The first and most popular way that traders use the RSI is to identify and potentially trade overbought and oversold areas in the market. Because of the way the RSI is constructed a reading of 100 would indicate zero losses in the dataset that you are analyzing, and a reading of zero would indicate zero gains, both of which would be a very rare occurrence. As such James Wilder who developed the indicator chose the levels of 70 to identify overbought conditions and 30 to identify oversold conditions. When the RSI line trades above the 70 line this is seen by traders as a sign the market is becoming overextended to the upside. Conversely when the market trades below the 30 line this is seen by traders as a sign that the market is becoming over extended to the downside. As such traders will look for opportunities to go long when the RSI is below 30 and opportunities to go short when it is above 70. As with all indicators however this is best done when other parts of a trader’s analysis line up with the indicator.
Example of RSI Indicator Showing Overbought and Oversold
A second way that traders look to use the RSI is to look for divergences between the RSI and the financial instrument that they are analyzing, particularly when these divergences occur after overbought or oversold conditions in the market. These divergences can act as a sign that a move is loosing momentum and often occur before reversals in the market. As such traders will watch for divergences as a potential opportunity to trade a reversal in the stock, futures or forex markets or to enter in the direction of a trend on a pullback.
Example of RSI Indicator Divergence
The third way that traders look to use the RSI is to identify bullish and bearish changes in the market by watching the RSI line for when it crosses above or below the center line. Although traders will not normally look to trade the crossover it can be used as confirmation for trades based on other methods. As you can see in the chart below, the RSI crossover was a great confirmation of the head and shoulders top, a pattern which we learned about in previous lessons and that occurred recently in the EUR/USD.
Example of the RSI Indicator Centerline Crossover
Links Around the Web to Help You Learn to Trade the Relative Strength (RSI) Indicator
Relative Strength Index (RSI) - StockCharts.com
TradingMarkets | How to use the 2-Period RSI
Trading RSI Divergence
That’s our lesson for today. You should now have a good understanding of the RSI and how traders use this indicator in their trading. In tomorrows lesson we will look at another Oscillator which is known as the Stochastic Oscillator so we hope to see you in that lesson.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
PreviousLesson NextLesson
In our last lesson we looked at 3 different ways to trade the MACD indicator. In today’s lesson we are going to look at a class of indicators which are known as Oscillators with a look at how to trade one of the more popular Oscillators the Relative Strength Index (RSI).
An oscillator is a leading technical indicator which fluctuates above and below a center line and normally has upper and lower bands which indicate overbought and oversold conditions in the market (an exception to this would be the MACD which is an Oscillator as well). One of the most popular Oscillators outside of the MACD which we have already gone over is the Relative Strength Index (RSI) which is where we will start our discussion.
The RSI is best described as an indicator which represents the momentum in a particular financial instrument as well as when it is reaching extreme levels to the upside (referred to as overbought) or downside (referred to as oversold) and is therefore due for a reversal. The indicator accomplishes this through a formula which compares the size of recent gains for a particular financial instrument to the size of recent losses, the results of which are plotted as a line which fluctuates between 0 and 100. Bands are then placed at 70 which is considered an extreme level to the upside, and 30 which is considered an extreme level to the downside.
Example of the RSI Indicator
The first and most popular way that traders use the RSI is to identify and potentially trade overbought and oversold areas in the market. Because of the way the RSI is constructed a reading of 100 would indicate zero losses in the dataset that you are analyzing, and a reading of zero would indicate zero gains, both of which would be a very rare occurrence. As such James Wilder who developed the indicator chose the levels of 70 to identify overbought conditions and 30 to identify oversold conditions. When the RSI line trades above the 70 line this is seen by traders as a sign the market is becoming overextended to the upside. Conversely when the market trades below the 30 line this is seen by traders as a sign that the market is becoming over extended to the downside. As such traders will look for opportunities to go long when the RSI is below 30 and opportunities to go short when it is above 70. As with all indicators however this is best done when other parts of a trader’s analysis line up with the indicator.
Example of RSI Indicator Showing Overbought and Oversold
A second way that traders look to use the RSI is to look for divergences between the RSI and the financial instrument that they are analyzing, particularly when these divergences occur after overbought or oversold conditions in the market. These divergences can act as a sign that a move is loosing momentum and often occur before reversals in the market. As such traders will watch for divergences as a potential opportunity to trade a reversal in the stock, futures or forex markets or to enter in the direction of a trend on a pullback.
Example of RSI Indicator Divergence
The third way that traders look to use the RSI is to identify bullish and bearish changes in the market by watching the RSI line for when it crosses above or below the center line. Although traders will not normally look to trade the crossover it can be used as confirmation for trades based on other methods. As you can see in the chart below, the RSI crossover was a great confirmation of the head and shoulders top, a pattern which we learned about in previous lessons and that occurred recently in the EUR/USD.
Example of the RSI Indicator Centerline Crossover
Links Around the Web to Help You Learn to Trade the Relative Strength (RSI) Indicator
Relative Strength Index (RSI) - StockCharts.com
TradingMarkets | How to use the 2-Period RSI
Trading RSI Divergence
That’s our lesson for today. You should now have a good understanding of the RSI and how traders use this indicator in their trading. In tomorrows lesson we will look at another Oscillator which is known as the Stochastic Oscillator so we hope to see you in that lesson.
As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!
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