Candlesticks to Find Decisive Moves
01/10/2013 8:30 am EST
It pays to know how candlestick charting can help make you a better forex trader, especially when someone else is doing the work. Huzefa Hamid shows you how.
My guest today is Huzefa Hamid and we're talking about candlestick patterns, specific ones that are good for currency traders but probably all markets as well. Huzefa, talk about the smart reversal pattern.
Hi Tim. Okay the smart reversal pattern is a very simple candlestick setup. It relies on two candles and it's a variation on Steve Nison's engulfing pattern, and Steve Nison, as most people know, was the guy in 1991 who brought out his candlestick charting technique book.
He brought it over to the west when nobody had heard of it. Smart reversal is you want one candle's body to engulf the previous candle's body as the standard engulfing pattern is, but the key difference that we employ is that we have to make sure the wicks are of a certain length, and the reason is a candle with a long wick represents indecision in the market, whereas if you have a candle with a short wick that represents a decisive move.
Whenever we're looking at the market and we're looking at candles or bars we're looking for the meaning behind those candles or bars. It has to have some kind of a context. It has to mean something. It has to represent some kind of sentiment or emotion in the market.
If we have a decisive move we can trade off that. When we see an indecisive move it's confusion essentially and we want to avoid periods of confusion because they're less predictable. What we do is we measure the wicks specifically and the length of the wick has to be a third or 33% or less of the entire candle length.
Now sometimes you can eyeball and you can see it's quite obvious that the very, very short wick that's a decisive move. Sometimes it's not so clear and we've developed a very simple calculator or spreadsheet that you can come to our site and request and it will give you a wick measurement straight away rather than having you sit there with a calculator while the market is live and calculated out.
When we see an engulfing pattern you have, or a smart reversal pattern I should say, you have say a bullish candle one way and then you have a bearish candle another way, which engulfs the previous candle, and if both candles have a wick length that is a third or less that to us is smart reversal quite simply.
Well I've actually never heard about measuring the wick, but it makes perfect sense why you would do that, and so how long does it take then usually? Are we looking at the next bar to be lower right away, or could it take a few bars to happen?
Well, usually you have an initial thrust in the direction of the engulfing. Now we in particular love to try this in the daily time frame because there is a huge consistency with the daily time frame, and you find at the open of the next candle, the third candle, that half your risk is covered 89% of the time. It's a hugely consistent setup, so we're often getting in at the open of the next candle and we sometimes have a second entry at a retrace to gives us a better risk reward.
Alright. You have something kind of a cousin to the pin bar reversal. What is that?
That's right. The pin bar is a one candle pattern. Again it comes from Nison's book and Nison's labeled it a hammer, dozer, a stone. He's got about five or six different names for it depending on where it appears on the chart. We just simply call it a pin bar. A pin bar looks like a pin. It looks like we have a head at the top and a tail at the bottom, or vice versa, you have a head at the bottom and a tail at the top.
The key thing again we employ is we employ the 33% rule where the body is now in the top or bottom third of the candle. This is much easier to spot than a smart reversal being just the one candle.
Okay. Then each of these would be used in different ways or they are both signal and reversals?
They are both signal and reversal. When we look at the smart reversal in dailies we often just trade it by itself. We don't look at any confluence of trend lines or Fib reversals or anything like that, but we trade it by itself on dailies. When you go into lower time frames we need some kind of confluence and with a pin bar you always need some kind of confluence, but it certainly is, we can use it as an entry strategy. You can use it also as an exit, so if you're long on a trade and you see a pin bar it's a signal to move your stops up or to get out of the trade, so on and so forth.