Technical Analysis

Support and Resistance

Support and resistance is one of the most widely used concepts in trading. Strangely enough, everyone seems to have their own idea on how you should measure support and resistance.

Let's take a look at the basics first.

Look at the diagram above. As you can see, this zigzag pattern is making its way up (bull market). When the market moves up and then pulls back, the highest point reached before it pulled back is now resistance.

As the market continues up again, the lowest point reached before it started back is now support. In this way resistance and support are continually formed as the market oscillates over time. The reverse is true for the downtrend.

Plotting Support and Resistance

One thing to remember is that support and resistance levels are not exact numbers.

Often times you will see a support or resistance level that appears broken, but soon after find out that the market was just testing it. With candlestick charts, these "tests" of support and resistance are usually represented by the candlestick shadows.

Notice how the shadows of the candles tested the 1.4700 support level. At those times it seemed like the market was "breaking" support. In hindsight we can see that the market was merely testing that level.

So how do we truly know if support and resistance was broken?

There is no definite answer to this question. Some argue that a support or resistance level is broken if the market can actually close past that level. However, you will find that this is not always the case.

Let's take our same example from above and see what happened when the price actually closed past the 1.4700 support level.

In this case, price had closed below the 1.4700 support level but ended up rising back up above it.

If you had believed that this was a real breakout and sold this pair, you would've been seriously hurtin'!

Looking at the chart now, you can visually see and come to the conclusion that the support was not actually broken; it is still very much intact and now even stronger.

To help you filter out these false breakouts, you should think of support and resistance more of as "zones" rather than concrete numbers.

One way to help you find these zones is to plot support and resistance on a line chart rather than a candlestick chart. The reason is that line charts only show you the closing price while candlesticks add the extreme highs and lows to the picture.

These highs and lows can be misleading because often times they are just the "knee-jerk" reactions of the market. It's like when someone is doing something really strange, but when asked about it, he or she simply replies, "Sorry, it's just a reflex."

When plotting support and resistance, you don't want the reflexes of the market. You only want to plot its intentional movements.

Looking at the line chart, you want to plot your support and resistance lines around areas where you can see the price forming several peaks or valleys.

Other interesting tidbits about support and resistance:

• When the price passes through resistance, that resistance could potentially become support.
• The more often price tests a level of resistance or support without breaking it, the stronger the area of resistance or support is.
• When a support or resistance level breaks, the strength of the follow-through move depends on how strongly the broken support or resistance had been holding.

With a little practice, you'll be able to spot potential support and resistance areas easily. In the next lesson, we'll teach you how to trade diagonal support and resistance lines, otherwise known as trend lines.

Candlestick

The best way to explain is by using a picture:

Candlesticks can be used for any time frame, whether it be one day, one hour, 30-minutes, 15-minutes, 5-minutes - whatever you want! Candlesticks are used to describe the price action during the given time frame.

Candlesticks are formed using the open, high, low, and close of the chosen time period. 

-If the close is above the open, then a hollow candlestick (usually displayed as Green) is drawn.
-If the close is below the open, then a filled candlestick (usually displayed as Red) is drawn.
-The hollow or filled section of the candlestick is called the "real body" or body.
-The thin lines poking above and below the body display the high/low range and are called shadows.

• -The top of the upper shadow is the "high".

-The bottom of the lower shadow is the "low".

Different Bodies

Just like humans, candlesticks have different body sizes. And when it comes to forex trading, there's nothing naughtier than checking out the bodies of candlesticks!

Long bodies indicate strong buying or selling. The longer the body is, the more intense the buying or selling pressure. This means that either buyers or sellers were stronger and took control.

Short bodies imply very little buying or-selling activity. In street forex lingo, bulls mean buyers and bears mean sellers.

Long white (or Green Colour) candlesticks show strong buying pressure. The longer the white candlestick, the further the close is above the open. This indicates that prices increased considerably from open to close and buyers were aggressive. In other words, the bulls are kicking the bears' butts big time!

Long black (or Red colour) candlesticks show strong selling pressure. The longer the black candlestick, the further the close is below the open. This indicates that prices fell a great deal from the open and sellers were aggressive. In other words, the bears were grabbing the bulls by their horns and body-slamming them.

Mysterious Shadows

The upper and lower shadows on candlesticks provide important clues about the trading session.

Upper shadows signify the session high. Lower shadows signify the session low.

Candlesticks with long shadows show that trading action occurred well past the open and close.

Candlesticks with short shadows indicate that most of the trading action was confined near the open and close.

If a candlestick has a long upper shadow and short lower shadow, this means that buyers flexed their muscles and bid prices higher, but for one reason or another, sellers came in and drove prices back down to end the session back near its open price.

If a candlestick has a long lower shadow and short upper shadow, this means that sellers flashed their washboard abs and forced price lower, but for one reason or another, buyers came in and drove prices back up to end the session back near its open price.

Basic Candlestick Patterns

Spinning Tops

Candlesticks with a long upper shadow, long lower shadow and small real bodies are called spinning tops. The color of the real body is not very important.

The pattern indicates the indecision between the buyers and sellers.

The small real body (whether hollow or filled) shows little movement from open to close, and the shadows indicate that both buyers and sellers were fighting but nobody could gain the upper hand.

Even though the session opened and closed with little change, prices moved significantly higher and lower in the meantime. Neither buyers nor sellers could gain the upper hand, and the result was a standoff.

If a spinning top forms during an uptrend, this usually means there aren't many buyers left and a possible reversal in direction could occur.

If a spinning top forms during a downtrend, this usually means there aren't many sellers left and a possible reversal in direction could occur.

Marubozu

Sounds like some kind of voodoo magic, huh? "I will cast the evil spell of the Marubozu on you!" Fortunately, that's not what it means. Marubozu means there are no shadows from the bodies. Depending on whether the candlestick's body is filled or hollow, the high and low are the same as its open or close. Check out the two types of Marubozus in the picture below.

A White Marubozu contains a long white body with no shadows. The open price equals the low price and the close price equals the high price. This is a very bullish candle as it shows that buyers were in control the entire session. It usually becomes the first part of a bullish continuation or a bullish reversal pattern.

A Black Marubozu contains a long black body with no shadows. The open equals the high and the close equals the low. This is a very bearish candle as it shows that sellers controlled the price action the entire session. It usually implies bearish continuation or bearish reversal.

Doji

Doji candlesticks have the same open and close price or at least their bodies are extremely short. A doji should have a very small body that appears as a thin line.

Doji candles suggest indecision or a struggle for turf positioning between buyers and sellers. Prices move above and below the open price during the session, but close at or very near the open price.

Neither buyers nor sellers were able to gain control and the result was essentially a draw.

There are four special types of Doji candlesticks. The length of the upper and lower shadows can vary and the resulting candlestick looks like a cross, inverted cross or plus sign. The word "Doji" refers to both the singular and plural form.

When a Doji forms on your chart, pay special attention to the preceding candlesticks.

If a Doji forms after a series of candlesticks with long hollow bodies (like White Marubozus), the Doji signals that the buyers are becoming exhausted and weakening. In order for price to continue rising, more buyers are needed but there aren't anymore! Sellers are licking their chops and are looking to come in and drive the price back down.

If a Doji forms after a series of candlesticks with long filled bodies (like Black Marubozus), the Doji signals that sellers are becoming exhausted and weak. In order for price to continue falling, more sellers are needed but sellers are all tapped out! Buyers are foaming in the mouth for a chance to get in cheap.

While the decline is sputtering due to lack of new sellers, further buying strength is required to confirm any reversal. Look for a white candlestick to close above the long black candlestick's open.

In the next following sections, we will take a look at specific candlestick formations and what they are telling us. Hopefully, by the end of this lesson on candlesticks, you would know how to recognize candlestick patterns and make sound trading decisions based on them.

Lone Rangers - Single Candlestick Patterns

Hammer and Hanging Man

The hammer and hanging man look exactly alike but have totally different meanings depending on past price action. Both have cute little bodies (black or white), long lower shadows, and short or absent upper shadows.

The hammer is a bullish reversal pattern that forms during a downtrend. It is named because the market is hammering out a bottom.

When price is falling, hammers signal that the bottom is near and price will start rising again. The long lower shadow indicates that sellers pushed prices lower, but buyers were able to overcome this selling pressure and closed near the open.

Just because you see a hammer form in a downtrend doesn't mean you automatically place a buy order! More bullish confirmation is needed before it's safe to pull the trigger.

A typical example of confirmation would be to wait for a white candlestick to close above the open to the right side of the hammer.

Recognition Criteria:

• The long shadow is about two or three times of the real body.
• Little or no upper shadow.
• The real body is at the upper end of the trading range.
• The color of the real body is not important.

The hanging man is a bearish reversal pattern that can also mark a top or strong resistance level. When price is rising, the formation of a hanging man indicates that sellers are beginning to outnumber buyers.

The long lower shadow shows that sellers pushed prices lower during the session. Buyers were able to push the price back up some but only near the open.

This should set off alarms since this tells us that there are no buyers left to provide the necessary momentum to keep raising the price.

Recognition Criteria:

• A long lower shadow which is about two or three times of the real body.
• Little or no upper shadow.
• The real body is at the upper end of the trading range.
• The color of the body is not important, though a black body is more bearish than a white body.

Inverted Hammer and Shooting Star

The inverted hammer and shooting star also look identical. The only difference between them is whether you're in a downtrend or uptrend. Both candlesticks have petite little bodies (filled or hollow), long upper shadows, and small or absent lower shadows.

The inverted hammer occurs when price has been falling suggests the possibility of a reversal. Its long upper shadow shows that buyers tried to bid the price higher.

However, sellers saw what the buyers were doing, said "Oh heck no" and attempted to push the price back down.

Fortunately, the buyers had eaten enough of their Wheaties for breakfast and still managed to close the session near the open.

Since the sellers weren't able to close the price any lower, this is a good indication that everybody who wants to sell has already sold. And if there are no more sellers, who is left? Buyers.

The shooting star is a bearish reversal pattern that looks identical to the inverted hammer but occurs when price has been rising. Its shape indicates that the price opened at its low, rallied, but pulled back to the bottom.

This means that buyers attempted to push the price up, but sellers came in and overpowered them. This is a definite bearish sign since there are no more buyers left because they've all been murdered.

Double Trouble - Dual Candlestick Patterns

Engulfing Candles

The bullish engulfing pattern is a two candle stick pattern that signals a strong up move may be coming. It happens when a bearish candle is immediately followed by a larger bullish candle.

This second candle "engulfs" the bearish candle. This means buyers are flexing their muscles and that there could be a strong up move after a recent downtrend or a period of consolidation.

On the other hand, the bearish engulfing pattern is the opposite of the bullish pattern. This type of pattern occurs when bullish candle is immediately followed by a bearish candle that completely "engulfs" it. This means that sellers overpowered the buyers and that a strong move down could happen.

Tweezer Bottoms and Tops

The tweezers are dual candlestick reversal patterns. This type of candlestick pattern could usually be spotted after an extended up trend or downtrend, indicating that a reversal will soon occur.

Notice how the candlestick formation looks just like a pair of tweezers!

Amazing!

The most effective tweezers have the following characteristics:

• The first candle is the same as the overall trend. If price is moving up, then the first candle should be bullish.
• The second candle is opposite the overall trend. If price is moving up, then the second candle should be bearish.
• The shadows of the candles should be of equal length. Tweezer tops should have the same highs, while tweezer bottoms should have the same lows.

Legal disclaimer and risk disclosure

This overview can be used only for informational purposes. Fx Mudra and Its people are not responsible for any losses arising from any investment based on any recommendation, forecast or other information herein contained.