Red is Green

One of the most common areas of confusion for the new trader is chart reading. For example, I had a trader who had been trading for years, but he did not know the difference between the two types of candlestick charts. As we were going through the technical analysis material, it was clear that he understood the basic candlestick concept, but nothing more.

Figure 1

So, how can that be possible? There must be something wrong with the TradeStation data feed, right? No, there is something wrong with those who do not know how to drive a stick-shift. They are too focused on just putting it into gear, applying the gas pedal to the metal and expecting acceleration. They are completely unaware of the fact that the engine usually makes a certain sound with the speed increase as the gears are automatically changing. Meanwhile, those who know how to drive a stick-shift remember that as the engine struggles to change gears from, let’s say third into fourth, that is the precise moment when the driver should release the gas pedal and temporarily step on the clutch pedal just to shift the gear from 3rd to 4th. This whole experience of shifting gears and being aware of what the engine is doing is also obvious on the right chart.

Comparatively, 4th gear is the current trading session, and 3rd gear was the previous one. How did the transition take place? Was it smooth (meaning no gaps)? Was it bumpy with push and pull because the clutch was too suddenly released? On the chart, the transition can be observed by looking at the close of the previous bar versus the opening of the current one. For example, the candle before the one with the blue arrow was nothing else but a doji. On the left it is a green spinning-top doji, while on the right chart it is a hollow white candle outlined in red. The approximate closing price on the doji was around $128. The very next day (candles with the blue arrows), the opening price gapped up almost to $129. It then closed lower for that candle.

The answer to that question is not either/or, but both. So, a more intelligent inquiry needs to be made and that would ask the following question: Which of these two charts is more accurate? The chart that gives more information – Candlestick with the trend – is the more accurate. After all, when trading, the most important piece of information is: Where did the price action close relative to yesterday’s close? In the case of the red candle (left chart), it appears to be a red day. But in fact when compared to the previous session’s close, it was a green day. This is obvious in the case of the green candle (right chart) because the fact that the candle is green means that it closed higher than the previous day’s close, even though it is filled in signifying that it closed lower than its own open. See Figure 1 for the explanation of how to read the candles on the candlesticks with trend charts.

In conclusion, one could argue that candlesticks are the best way to look at the charts. Yet all of those who have skipped studying the Western bars are virtually short-changed. They completely miss the trend unless they specifically change the settings on their platforms to the candlestick with trend. More info is better than mere oversimplification.

Josip Causic can be contacted at The Online Trading Academy

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