The Only Technical Analysis Course You Will Ever Need
When I started this blog, my sole goal was to focus on topics considered to be more advanced such as Market Profile, Footprint charts or Market Microstructure.
Although I never felt a need to spend much time covering basics that are available all over the internet, I come across this basic trading education almost every day on social media, and I feel like it is only getting worse.
From flashy technical indicator signals posts on Twitter that provide zero context, viral technical patterns posts on TikTok or overpriced courses that teach people basics of technical analysis that build upon perfect hindsight examples that happen once in a blue moon.
This article will be my attempt to explain technical trading to someone with minimal experience in the market. Hopefully, by the end of it, you will be able to form your opinion of what’s trending online and take more educated bets.
I will do it in a way that I believe is the most useful for newer traders to reach profitability without a lot of nonsense presented online.
Because there is quite a lot to go through, and I don’t want this post to repeat things already mentioned on the website before, I will be linking other blog posts in the text, so make sure to read them.
On the other hand, I will also cover things I don’t personally use and present my arguments for or against them.
Of course, if you are already experienced in trading, this might not be precisely for you; therefore, you can skip this one and read other blog posts that cover more complex topics.
If you like this article, read the rest of the blog or join the Tradingriot Bootcamp for a comprehensive video course, access to private discord and regular updates.
If you want to get a free PDF that covers the basics of cryptocurrency orderflow and shows tools and mechanics that I use. Register on Bybit or Binance, make a first deposit and email me at firstname.lastname@example.org to receive it. More info.
Is technical analysis astrology for men?
Does technical analysis even work in the first place?
This is, of course, a valid question.
You go on Twitter, Youtube, Instagram or Tiktok, and you will see all these people posting candlestick charts with all the different patterns, indicators and so on, claiming with certainty that the underlying asset will do this or that, is it that easy?
Of course not.
On the other hand, if you stumble upon the quant or volatility options trading section of the internet, you will be met with strong despite towards technical analysis.
So what is the answer? Is technical analysis completely useless, or does it work, and you will be a millionaire if you put a bunch of indicators on your chart and follow along with the signals it provides?
The answer lies somewhere between; when you use the word “technical analysis” or technical trading, it highly depends on your representation.
You can be using many lagging indicators or price patterns that more intelligent people easily exploit, or you can have an in-depth understanding of the markets and why they move.
If you focus on the latter, you won’t need much on your charts to make educated decisions.
In my opinion, and of course, you can have a different one and tell me I’m wrong; there are only two concepts you need to understand to make technical analysis work.
The auctioning process of supply and demand.
And the ability to see the levels where other market participants will be forced to get out of the trades, which you can use to take your trades.
But I am already getting ahead of myself; let’s talk about why markets move in the first place.
Why Markets Move?
Before learning any trading strategies, it is crucial to understand why the market move in the first place, what is price and why it fluctuates.
If it’s Crypto, Forex, Stocks or futures, you always need buyers and sellers to move the price.
When markets are trending in one direction, you might think there are more buyers than sellers or vice versa.
This isn’t true as you need to have a buyer for every seller (and vice versa).
The markets are trending because demand is overwhelming supply or supply is overwhelming demand.
Like anything else in the world, price movement is a function of supply and demand.
And markets are simply advertising mechanisms.
Supply is the amount sellers are willing to sell at particular prices.
Demand is the amount buyers are willing to buy at particular prices.
As supply and demand dynamics change, prices move.
Let’s imagine you have a food truck where you sell apples.
You set up the price for these apples at $10/each.
The problem is that other vendors sell apples for lower prices.
Looking at the table above, you can see that no one is willing to buy the apples at $10.
If buyers were willing to buy, the price of apples would move even higher as there is increasing demand.
If you have ten apples and you want to sell them at the current market, you won’t be able to do it for $10.
You will sell one for $9, three for $8, one for $7, three for $6 and two for $5.
The same scenario would happen for someone who wants to buy ten apples for $5.
That would not be possible based on the current market condition.
He would buy one apple for $5, two apples for $6, one apple for $7, three for $8 and three for $9.
The financial markets work completely the same; they are just a little faster and more populated.
This dual auction process is fundamental in understanding financial markets or any other market.
With substantial economic growth price of houses rise sharply because there is a great demand for them.
If a seller is selling the house for $100,000 and buyers are desperate to buy the house, the price will rise until no one is willing to bid, and it will go to the highest bidder.
If we are in recession, the seller might list the house for $100,000, but as no one is willing to buy, he has to decrease the price until his supply meets demand.
In the markets, price is a function of supply and demand.
Price rises while demand is greater than supply, while buyers are willing to pay higher prices.
Market stops rising once we run out of buyers or until supply increases sufficiently to absorb all the demand.
Price falls while supply is greater than demand, while sellers are willing to sell at lower prices.
Market stops decreasing once we run out of sellers or until demand increases to the point it absorbs all the supply.
Price movement is a result of supply/demand imbalance. And the supply/demand imbalance is created by the trader’s sense of urgency to transact.
There is always a heated discussion online amongst different types of traders who use technical analysis or fundamental analysis, arguing why their trading approach was the key behind price movement.
The truth is that people always move the market, not technical or fundamental indicators.
Supply and demand trading is a popular term among the traders that draw boxes on charts and call them supply and demand zones.
Sometimes I wonder if these people understand the concepts properly as many of them went their way to rename the ideas and make them more appealing with stories of evil market makers hunting retail traders stop-losses.
I have an article on the blog about Supply and Demand trading that covers these things in greater depth; therefore, if you are new to trading and want to understand the relatively simple concept proven to work overtime, make sure to read the article.
Let’s expand on this topic a little more and talk about the auction process in the financial markets.
As I have already mentioned, markets move due to the available supply and demand.
As you probably know, markets are either trending or ranging. In other words, they are in balance and imbalanced.
When markets are imbalanced, they come into low liquidity (liquidity = available orders in the market) state and tend to move; this is often displayed but very strong directional candlesticks.
One of the common fallacies of newer traders is that they constantly seek trends.
Trying to catch just another bull run that will bring them a fortune.
The truth is that markets spend most of their time in balance; therefore, they range.
You can see it on this H4 Bitcoin chart for approximately two months.
As you can see, the time market spent in balance was always much longer than the time imbalance; this is because once the market finds the fair value, it takes time to find someone willing to step in with enough size and move the market higher or lower.
These shifts are usually affected by fundamental events.
The last chart I want you to look at is this one.
What you see on the chart now is Volume Profile plotted on Y-Axis.
Although it might look complicated, it simply shows how much volume was transacted at different prices.
As you can see, in areas of balance, there are a lot of volumes traded as buyers and sellers are trading back and forth with each other, and in areas of imbalance, there is very little volume traded as liquidity becomes thin.
As you can see, every time market went from a state of balance to imbalance; it moved to the area of previously high executed volumes.
When markets seek fair value, they often find it in the areas where volumes were traded in the past.
This is the concept behind the Auction Market Theory, and it was covered in the post on this website.
These auction market theory principles are one of the key foundations of my trading strategy, which I cover in-depth in the Tradingriot Bootcamp.
What type of trader do you want to be?
No matter what you read online, there is no right or wrong way to make money in the markets.
All of us have different expectations, starting capital, and different schedules, and as we all know, life can often get quite busy due to work, family, and other things.
This is why it is essential to separate different roles and approaches to trading to decide what suits you the best.
Although you can change your “specialisation” at any time, it is not a bad idea to stick to one thing first and try to perfect it.
Once you progress more in your trading journey, you can start focusing on more things and becoming more versatile.
Investing is probably the most straightforward approach to the market.
You have a fundamentally strong belief in the positive future of something, and you are betting on it with a “long-only” approach.
Long-only = Only participating in the financial markets as a buyer.
You usually don’t need to understand the complex mechanics of futures or options markets as you mainly participate in the spot market. It is usually only for hedging purposes when you venture to other markets.
Hedging = Hedging means an opening counter position on the same or correlated instrument to protect yourself.
For example, you have bought 1 Bitcoin at $30,000. Price rises to $60,000, where you think the market will find resistance and move lower because you don’t want to sell your Bitcoin entirely; you will open a short futures position or buy put options. If the price goes down, the value of your spot holding will decrease, but your short position will gain value. If the market proceeds go up, you will lose money on your short hedge, but your spot holding will continue to gain value.
Hedging can be done 1:1 to your spot position or in smaller portions only to have some protection.
Investors always play the long term game; they are not bothered about intraday price moves but focus on the long term outlook of the market.
If you decide to invest in crypto markets, you won’t need much; you just need to make sure you are not risking what you are not willing to lose and never forget to take some profits on the way up.
Many investors apply a dollar-cost averaging strategy that slowly builds their positions over a certain period instead of buying all at once.
Cryptocurrency markets have experienced massive growth in recent years; thanks to that, investing seems like an easy and safe approach to the market.
Those that joined the crypto space at the end of 2017/start of 2018 will tell you otherwise as they saw all their investments de-appreciate almost close to 90% throughout two and a half years.
When it comes to investing or any long term holding, timing is really everything. No matter how up it is, every asset has periods of long-term drawdown.
The best investors know when to get out of their positions and don’t “marry their bags”.
The same goes for the opposite; you need to know when to get profits or protect your downside risk when the price is going in your desired direction.
The best investing is done systematically; therefore, you should apply a set of rules that you will follow throughout your decision making.
Swing traders hold to their positions for days, weeks and sometimes even months.
Same as investors, they operate on higher time frames but trade both sides, long and short.
They use futures or options markets where they open such positions.
Swing trading is a great trading approach for those who work full-time jobs or want to pick up trading as something on the side.
This oftentimes creates an illusion that swing trading is easy as you are only required to look at markets for a couple of hours every day and then do whatever you want.
As swing traders often use leverage and protect their positions with a stop-loss, it can be quite tricky to position yourself well and be protected from intra-week volatility and unexpected news events.
Swing trading requires an extreme amount of patience, and you are constantly waiting for something to happen as you are setting the limit orders and just playing a waiting game if the price reaches your entry.
And the real work begins once you are in the trade.
In the swing position, price often just consolidates around your entry for several days or rally higher only to go back to where you got in the next day.
It is crucial as a swing trader to stick to your trading strategy and follow your plan so emotions won’t get better of you and you pre-maturely exit the trade.
A great example of this would be this Bitcoin trade executed in the H4 timeframe, which took approximately 20 days to reach the target.
Although it looks great in the hindsight, after entering the trade price went into drawdown and almost hit the stop-loss.
After that, it pushed quite a bit towards the target; for most traders this would be an immediate signal to use a breakeven stop.
In this case, they would get taken out.
Those who would stick with the trade would have to stomach another couple of days in drawdown before the market finally went in the desired direction.
When you are new to trading, it is easy to stomach these trades since you are trading with 4-5 figure accounts and you are not risking much on individual trade, but once your account grows and you see large PnL swings, you really need to showcase strong emotional relentless to follow your plans.
Day Trading and Scalping
Daytrading/scalping is the last approach traders choose to tackle the market.
From trading on a 5-minute chart to executing trades on DOM.
DOM = depth of market / price ladder. The most zoomed-in view of the market is where you can see orders resting at different prices.
This type of trading is considered to be the hardest approach to markets.
Being quickly in and out of positions requires a lot of practice and can be very tough on your emotions.
Especially once you start trading with a larger amount of capital, losing hundreds or thousands of dollars within a few minutes/seconds can cause a lot of trauma and urge you to make your losses back as soon as possible.
Because of that day, trading requires an extreme amount of discipline, and you also have to consider other factors such as trading costs in for of fees.
Day Traders also have lower win rates compared to swing traders, which can be hard to manage as you experience several losses in a row, but even at that point, you just need to stick to your strategy and trading plan.
On the other hand, there are some advantages of day trading.
Day traders and scalpers can work on very flexible schedules.
They just can pick a few hours on a day where volatility picks up, trade in and out quickly and be done for the day.
As day traders don’t hold positions overnight and they generally don’t care much about market direction, fundamentals and so on.
This can bring a very unbiased and mechanical approach to trading.
Also, one can argue that predicting what markets are going to do in the next few minutes/hours is actually easier than predicting multi-week moves.
As I already mentioned, there is no right or wrong way to make money in the markets.
The important thing is to find something that works for you, stick to it and do your best to master it.
Risk management and market jargon
You often hear that risk management is the most important part of trading.
Well, that’s not really true; if you don’t know what you are doing, you might be able to manage your downside but still lose money.
Nonetheless, risk management is critical.
With gained knowledge, we always like to think that we can outsmart the market, that our approach or strategy is unique, and that we can bet our whole account to make it big.
This thinking will often lead to disaster.
Proper risk management is the key to the longevity of any trading career, and it separates trading from gambling.
The explanation of risk management here will be fairly brief, but I published quite a long article about it, so make sure to read it here.
Markets are not always playing in our favour.
Especially in crypto markets, it is very easy to start feeling overwhelmed by quickly rising prices, but no matter how good things look, the market can always quickly turn against you.
So what makes good risk management?
Let’s assume you have an edge in the market.
Edge is simply the advantage of knowing that you should come out profitable over a certain period of trades.
This edge is achieved by having a robust trading strategy and overall knowing what you are doing.
For the simplicity of this, let’s say that your edge is that for every 1 unit of risk, you will get two units of reward.
In other words, for every $100 you risk, you will get a $200 reward.
For every $1000 your risk, you get $2000 of reward and so on.
In trading, this is called risk-to-reward to the ratio in short R:R: R or just R.
If you see someone on the internet saying that they are aiming for 3R on a trade, it means that he is aiming at three units of reward for one unit of his risk.
As already mentioned, imagine you trade trading with a fixed 2R strategy that has a 50% success rate.
This can be presented as a simple coin flip.
If you flip a coin 100 times and always bet on heads, the chance of heads is 50% in a coin flip.
You are betting $100 on heads for each coin flip, and because you have a strategy with a fixed risk to reward ratio of 1:2 (for one unit of risk, you gain two units of reward), your gain is $200.
If you flip coin 100 times and 50 of these flips will be heads and 50 tails, you will lose $100 fifty times but get $200 fifty times.
As you can see from the coinflip example, after 100 flips, you will end up with a $5,000 profit as you won $10,000 in 50 flips and lost $5,000 in 50 flips.
Of course, this is not a completely realistic example, as the distribution of coin flips won’t always be 50/50.
If you flip the coin only ten times, it is quite likely that you will only see heads once or twice.
This would result in you losing money, as you made $400 but lost $800.
The edge in trading is very similar to the edge in a coin flip.
Your results over a short period can be quite random; that’s why you will experience losing days, weeks, and sometimes even months, but you should always come up profitable over that 100 or 1000 trade sample.
Here you can see the simulation of the equity curve with this 50% win rate 2:1 risk to reward ratio over 100 trades; as you can see, all equity curves ended up positive.
If we change it to 10 trades only, only half of the equity curves are in the money.
It is very important to remember that the money in trading is not made with one trade in a short period of time but with a lot of trades over a long period of time.
It is quite a cliche to say this as you probably heard it already, but trading is a marathon, not a sprint.
Types of markets
Now let’s have a talk about some of the market jargon you need to know, more in-depth explanation was provided in Market Microstructure and Understanding Futures and options.
At most popular cryptocurrency exchanges, you will encounter two types of markets.
Spot and derivatives market.
If you are operating in the spot market things are pretty simple.
Want to buy one Ethereum, which is priced at $4,000? You need to have $4,000. Once you purchase that one ETH, you own it, can send it to other wallets or put it in cold storage.
If the price of ETH rise to $8,000, your net profit is $4,000.
If the price of ETH fall to $2,000, you lose $2000.
Your unrealised PnL will fluctuate until you decide to sell your ETH back to the market for either profit or loss.
This is quite simple; operating in the spot market is recommended for every long term investor and also beginner traders who want to focus on their strategy rather than worry about the more complex market dynamics they encounter in the derivatives market.
If you move to the derivatives market, things can get a little more complicated.
You will be most likely trading futures as they are offered at every major exchange, some exchanges also offer options, but those are beyond the scope of this article.
If you are trading futures, you can trade on margin with leverage.
This means that your broker is borrowing you money to trade with.
Leverage shows the ratio of borrowed funds compared to real funds you have.
In other words, if you see 1:100 leverage, that means for every $1, you can borrow $100.
Although this sounds great, the risks are exponentially going to increase if you decide to trade with leverage.
Let’s say you are buying Bitcoin at $100,000 on the broker that is offering you 1:100 leverage.
This means that your margin (funds you have on your trading account) only needs to be at $1,000.
So with $1,000, you can buy the whole Bitcoin that is priced at $100,000, pretty sweet, right?
Well, the problem is when the position starts going against you.
Because you are trading with borrowed money and the exchange has to protect its downside, if Bitcoin drops 1% to $99,000, your whole position gets closed, and you will get so-called “liquidated”.
Liquidation – Forceful close of position by exchange due to inefficient funds on the account.
As you probably know by now, a 1% move in Bitcoin is nothing unusual.
Leverage is different with different exchanges, and you can use anything from 1:2 to 1:100 leverage.
If you use 1:20 leverage, the position has to go 5% against you to get liquidated.
If you use 1:5 leverage, the position has to go 20% against you to get liquidated.
You get the point.
Leverage can be useful as it allows traders to open bigger positions and also offset the exchange risk.
Although exchanges always act very friendly on social media towards their customers, at the end of the day they are third party companies holding your funds.
If you, for example, have $100,000 set aside for trading, you don’t need to send all of that to exchange; you can send there only $20,000 and trade with 1:5 leverage.
If the exchange disappears or goes bankrupt (it might sound unrealistic, but it can definitely happen and happened many times in the past), you only lost 1/5th of your account.
It still sucks, but it is better than losing it all.
On the other hand, for most traders that don’t know what they are doing, it is a dangerous tool that will lead them to get liquidated.
The most important thing is that you should never trade with leverage without a proper trading plan and stop-loss.
In general, there are three order types you will see at most exchanges.
In fact, there is plenty more of them, but those are beyond the scope of this article.
Think about the supply and demand apple example again.
You want to buy one apple for $5, but there are 10 other people waiting in line to buy this apple as well that came before you.
You are faced with two options; first one is to get at the end of the line and wait; the issue with that is if there is a limited supply of apples and they will get sold out before your turn, you won’t get it at a price you wanted, on the other hand, if there are enough apples you will be the buyer at $5.
Or you can skip the whole thing and buy apple immediately, not for $5 but for $6.
Of course, this is an extremely simplified version compared to financial markets, but the dynamic is more so the same.
Here you can see the Depth of Market (DOM) for E-mini S&P500 futures which is the most liquid futures market in the world.
In the blue column are buyers willing to buy, and in the red column, sellers are willing to sell.
The current price is 4418.25, and it won’t move until someone is willing to either buy into (long) the 20 contracts or sell into (short) 17 contracts.
Once that happens price will move one tick in either direction.
There is a spread for those who are impatient and want to get into the market immediately.
The thing is that in financial markets, when you see the price of an asset, it doesn’t mean you can buy it or sell it at the exact price.
The spread is the way for brokers and market makers (market makers explained in this article) to make money.
Here you can see the order window for CFD (Contract for difference – derivative offered by most Forex brokers, generally they are cheaper to trade compared to futures but have bigger spreads) of WTI Crude Oil.
As you can see, the spread is currently three ticks.
This is called a bid / ask spread as you buy at the best available bid and sell at the best available ask (sometimes also called offer).
To sum things up, Market orders are the impatient way to enter the market. You will get in immediately, but you will have to pay the spread; also, in crypto markets, there are two types of fees, taker and maker fees.
If you use a market order, you are taking the liquidity (resting orders) from the order book; therefore, you are paying the taker fee, which is higher than the maker fee.
Limit orders are the patient way to get into the market; you are putting order to the order book; hence you are making the market, so you are paying a cheaper maker fee, in some cases, this fee is actually positive and you are getting paid by the exchange.
The downside of the limit orders is that you might not get filled.
If you want to be the buyer, you put the limit order below the market, and if you want to be a seller, you put the limit order above the market.
As I mentioned, there are three types of order, the last one is called the stop order and it has generally two use-cases.
The first one is if you are not in a position and you are anticipating a breakout to happen.
In this case, you can put a buy stop order above the price or a sell stop order blow the price, which will trigger once it is touched.
The breakout trading is not usually the smartest way to do things, I will talk about it more later on.
The second use case for stop orders is to get you out of a losing trade.
This is called a Stop-loss.
If you are a buyer you put a sell stop order below the entry and if you are a seller you put a buy stop order above the entry.
These orders will get you out of the trades if you are wrong.
As markets can be oftentimes unpredictable, you should always trade with a stop-loss order in place.
Although getting stopped out and losing money is never a pleasant experience, it is much better than sitting in a losing trader that can lead to liquidation of your whole trading account.
Trading without a stop-loss is only for seasoned traders or the long time investors who have fundamental beliefs in the asset and working with scaling in strategies (buying every time the price goes against them.)
The take profit order is much more pleasant, if you are going long (buying) you set the take profit order above the price so once the price reaches your target, the take profit order will automatically realize the desired profit.
If you are shorting (selling) you are setting a take profit order below the price.
Setting up a take profit order is not so strict and required as setting the stop-loss order, although it is good not to be greedy, there are a lot of trend-following strategies which are using a trailing stop-loss to get out from the trade instead of a fixed take profit.
Trailing Stop-Loss: Moving a stop-loss behind the price in profitable trade based on a fixed $ amount or technical analysis. Traders use trailing stop-losses to stay in the trade as long as they can and they only get out when the market turns in the opposite direction.
If you are in drawdown you are experiencing some kind of losing streak.
It is never a pleasant experience but it happens to all of us.
If you have an edge with a 55% strike rate, you still have over a 50% chance to experience 5 losses in a row.
This can be psychologically exhausting, but you should always remember to stick to your strategy, not increasing risk and just slowly working towards positive numbers on your account.
Candlestick analysis, Technical Indicators and Chart Patterns – Retail traders nonsense?
The learning curve for most traders usually starts the same way.
Candlestick patterns, technical indicators and chart patterns are what is broadly available online, either free or paid.
These are usually the ones that get a bad reputation when it comes to technical analysis.
This article won’t cover every single indicator, indicator or pattern in-depth; if you seek this type of education, there are plenty of free resources online; there is absolutely no reason to pay for education like this as the internet is full of it.
One of the popular websites to learn how indicator or candlestick patterns work is Babypips.
What I will do in this article is just briefly discuss each category and share my opinion on what is worth and what is not.
There are dozens of indicators that you can plot on your chart: MACD, RSI, Moving averages, Ichimoku cloud, etc.
Although the choice of indicators is huge, they are quite similar as they are calculated by plotting the average of past prices into an indicator.
For example, 100-day simple moving average will simply take an average price for the last 100 days and a plot line on the chart that can be used as the level of support or resistance.
Besides using moving averages as dynamic support and resistance, you can then add a 50-day moving average as your “fast” moving average and watch where these moving averages cross.
If the 50-day moving average is above the 100-day MA gives a buy signal. If it is below it gives a sell signal.
The second types of indicators are so-called oscillators.
Here you can find RSI, MACD or Stochastics.
Once again, they are calculated using different formulas consisting of average prices from the past.
Oscillators are used for two reasons, first one is outright signals; for RSI this is so-called overbought and oversold levels.
The second use of indicators is to seek a divergence; this happens when the price is not in line with the oscillator itself.
Here this is visualised on a simple cheat sheet.
Do technical indicators work or not?
When it comes to indicators, it is fairly simple to actually find out if they work or not.
If you want to use overbought/oversold signals from RSI or Moving average crossovers, just go to the asset you trade, choose the desired timeframe, open the excel sheet and backtest all the signals that were given by indicators and you will see the results of them.
I would say this is a good thing about indicators as they take away a lot of subjectivity in trading.
In my personal opinion, the signals these most known indicators generate will end up with you losing money in the long run as they are too lagging and too easily exploitable by smarter people.
Every indicator has its purpose, moving averages are trend indicators, and they can work out nicely as support and resistance in the trading market but will perform horribly in ranges.
Oscillators are usually the opposite as they give solid signals in ranges but blow out once trends emerge.
If you go back a little bit in this article where I explained why markets move in the first place, there was no mention of the indicators; therefore, heavy use of these things can easily make you lose sight of important things.
In my trading, I still use indicators; if you follow me on Twitter or read any other posts on this website, you will probably know I am a big fan of looking at orderflow and volume therefore, indicators that I use are based on that.
I have published an article about the indicators that I use in the past; although they can be seen as a little more “sophisticated” they are still producing false signals often.
At the end of the day if you want to use indicators in your trading, you should either:
- Run a systematic backtest to find out if they generate profits and then use them in a systematic strategy without any discretion.
- Use them as a confluence for a more complex trading system. (Eg. Using RSI divergence only when the market is trading at a key level of support/resistance, or using MA only if the market breaks from significant consolidation (balance/imbalance example).
- Not use them at all.
There are hundreds if not thousands of candlestick patterns.
This leads to plenty of cheat sheets and videos/articles of “X Candlestick patterns you MUST know in your trading.”
This is a) useless and b) counterproductive thing to do.
When it comes to observing candlesticks, there is basically only one thing you need to understand, and it is not tied to spotting patterns but to volatility,
For those that are completely new, candlesticks are the most popular graphical representation of the price action on the chart.
They originated in the 16th century in Japan; that’s why they are also referred to as Japanese candlesticks sometimes.
The OHLC Bars are the second most popular representation of price; they are completely the same as Japanese candlesticks, just look a little bit different.
Every candlestick has open, high, low and close, and they are either bullish or bearish.
If you dig deep into the topic you will find out that you have one but also several candlestick patterns that come in different shapes and names, before you know it you will be completely lost.
The truth is that markets are rarely perfect like the infographics you see online that consist of highly cherry-picked examples.
Directional Candlestick Patterns
We can separate candlestick patterns into two categories, directional and indecision.
The directional candlesticks tell us that there has been an expansion in volatility and the move is likely to continue if it is set in the right context.
The most popular is called Engulfing candlestick, sometimes referred also as an outside bar.
The rules for engulfing a candle are simple, a bullish engulfing has to trade below the low of the prior candle and close above the highest point.
Oppose to that, a bearish engulfing has to trade above the high of the previous candle but close below the lowest point.
This gives us a clear idea that one side tried to take the direction of trading above the previous high/below the previous low, but another side completely overtook it and was able to close the candlestick at the opposite side.
You will sometimes find a different explanation of engulfing candles online but this one clearly shows strength and one side of the market initiating the move.
The second type of directional candle is often referred to as reversal candles, pin bars, hammers, Doji etc.
It does not really matter how you call them, the key thing is that they should be large candles with long wicks.
As the term “large” can be fairly subjective, you can use something like the ATR (Average true range) indicator that measures the range of the last x periods or measures the candlestick by its volume, which I personally use.
But the highest importance of these candles is where they happen, which is something I will cover a little later on in the article.
Indecision Candlestick Patterns
If we talk about outside days as volatility expansion candlestick patterns, we should also have the ones that tell us that volatility is low; therefore, we can expect a move coming in the near future.
If you want to understand volatility a little bit more, make sure to read an article about Move Contracts.
Inside bars are the type of indecision candlesticks.
They tell us that there was very low activity happening inside this candle.
This is represented by a candlestick that stays completely inside the candlestick on the left.
Once the inside bar closes, we can mark out its high and low and expect a strong breakout.
One thing you need should know is that breaking outside of the inside bar is a very popular strategy that attracts a lot of traders, especially when the inside bar happens on higher timeframes such as daily or weekly.
Because of that, markets often gives a “false” breakout trapping traders who participated in the breakout.
Like I said there are much more patterns, and things can get fairly confusing if you decide to learn “Three White Soldiers” or “Stick Sandwich” patterns; some of these things definitely sound more like adult film scores instead of something related to financial markets.
Same with the indicators you can simply backtest all of these candlestick patterns because they are always the same and decide for yourself.
I personally don’t use candlestick patterns religiously but if you decide to look at higher timeframes such as daily or weekly, you can get a quick idea of what has been going on and what you can expect to happen next.
It is also worth saying that looking at candlestick patterns on something like 5-minute or 1-minute charts is completely useless.
The last portion of conventional wisdom technical analysis are chart patterns.
Head and shoulders, Double tops and bottoms, different triangles, wedges and so on.
These chart patterns present themselves usually when markets are in balance, or in other words, when they are in the accumulation or distribution phase.
This is something that comes from a Wyckoff theory and is in general, a great description of how markets work.
As I mentioned previously, markets do not just go up or down in straight lines but often accumulate (before the move) and distribute (after the move and before reversal).
The issue is with chat patterns themselves and the way how popular they got over the year with very systematic entry rules that usually consist of breakout trading of any given “neckline”.
As I said, these patterns got so popular over the years that they ended up creating a very obvious place in the charts where most traders have their stop losses placed.
More often than not markets take them out before the anticipated move unfolds.
Once again, you absolutely don’t have to believe me and go backtest these patterns yourself.
Read about what conventional wisdom is teaching about them, especially where your stop-loss should be placed.
You will very quickly find out that the market will take you out on the chart pattern trade before the move unfolds.
On the other hand, this kind of knowledge can present you with a certain edge and a better understanding of the markets.
If you learn these patterns and you will be able to realise where and how are other traders positioned once these patterns happen, you might be able to find great opportunities once they are shaken out of their traders.
At the end of the day, over 80% of retail traders lose money in trading, so it couldn’t be all this easy right?
Price action – Simple thing that can work
Markets are moved by people (and, in most cases, their algorithms).
For this article, I will keep things simple and don’t go too in-depth into the orderflow, but you can read more about it in the article here.
But even without fancy Footprint charts, it is not complicated to understand the market context by looking at a naked price action chart accompanied by simple volume indicators.
The conventional wisdom of price action trading
Same as with every other trading concept, you will find a lot of different explanations online.
When you look into price action trading, it is essentially built upon understanding a market structure and support and resistance, either horizontal or diagonal.
Most websites teaching price action will usually describe the market structure in very simple terms, usually infographics that perfectly demonstrate how markets are making higher highs and higher lows in an uptrend and lower highs and lower lows in a downtrend.
All of this is accompanied by perfect retests of support and resistance levels on the way.
It will take you one look at the real market to find out this is something that rarely happens.
Financial markets are messy, and they often find a way to screw up with most participants before any significant move happens.
When it comes to price action, it is no different than with indicators or patterns.
As I already mentioned, the textbook trends rarely happen and when you see a “perfect” example of an uptrend or a downtrend, you should really start paying attention.
Proper understanding of price action
If you take a look at the first part of this trend, you can see a solid up move.
This is can be identified as inefficient price action as the market moves very quickly to one side; this makes a lot of people rush into trades and put their stop-losses into very obvious areas.
Once the trend shifted, you can see all that positioning was whipsawed by only 2 candles.
This is very often the case when you see a perfect trend on a chart, one side is getting very biased, and their stop losses are clustered at the same place; once they are triggered, it will create a cascade, and markets will drop in a strong fashion.
Why do stop losses matter?
I already covered this when I talked about the order types, if you are a buyer your stop-loss order is essentially a sell stop order, therefore, if you are long and you get stopped out you are essentially executing a sell order at market.
If markets hit the level where a lot of stop-losses are resting, this newfound pressure is often hardly met with enough counterparty and markets spike through the levels.
If you have any experience in trading crypto, you know this is often the case, this is because most traders are thought to put their stops at the same place and are able to actually predict and point out at the charts where most people are going to be forced to get out from the market is not that complicated since most of the market participants are using the chart patterns or very simple support and resistance levels.
This is a perfect example of conventional wisdom versus the real markets.
The selloff from resistance didn’t happen before the market spiked above the absolute high resulting in all prior sellers likely to get taken out and then making a complete whipsaw below the level of support where a lot of retail traders are thought to be looking at it at a strong level as it was tested many times in the past.
So why do levels of support and resistance get weaker with every touch?
Above you can see something called a heatmap chart, and before you lose your mind thinking this is some hidden trading alpha, make sure to read more about them in an article about Market Microstructure first.
At every level of support and resistance, there is a certain amount of liquidity.
liquidity = resting orders
If we are looking at the pink box of resistance above you can find there sell limit orders from traders who want to go short and play the reversion lower, as this level gets tested more and more, the resting orders are getting filled and with each touch, there are simply fewer sellers willing to trade that continuation lower.
Why do false breaks happen?
It is important to understand that there is nothing false about false breaks, it is simply a supply and demand dynamic.
Besides traders that are using levels of support and resistance as continuation levels, there are also breakout traders that see those levels as a possible continuation.
As I already mentioned, you can get into the market in two ways, by using limit orders and market orders.
Those traders that are using market orders are often retail traders as they don’t care about paying the spread and they are always first to chase any type of move.
If you are a large institutional trader and you need to execute large size, you need to trade at areas where you will have a significant counterparty to fill your trade as for every buyer there has to be a seller and vice versa.
When the market breaks a resistance and breakout traders start executing market buy orders to chase a breakout, it presents a great opportunity for large passive sellers to fill their orders.
On top of that traders who were already short are getting stopped from their positions which happens also in form of buy market orders, therefore, there is even more liquidity for large players to go short.
This characteristic happens over and over again across all markets and all timeframes, because of that you should be always careful when you are trading levels of support and resistance.
If you sell the level of previous resistance blindly, you can be a victim of a “false break” that you can see on the chart above as the green-up candle signals high relative buying volume, but once the market broke through the level of resistance, there has been lack of follow-through as passive sellers used large limit orders to fill the positions and market sold off shortly after.
Trading smart money concepts (SMC)
One of the price action concepts that seem to be extremely popular these days is Smart Money Concepts by ICT.
This is always funny to me because I have already mentioned ICT and his shenanigans on this blog almost 2 years ago in the Supply and Demand article, but he seems to be finding his way back and getting more and more popular.
The whole idea of “smart money” is based upon the fact that there every market is constantly manipulated by market makers that are engineering liquidity (moving the markets) in order to take out retail traders’ stop-losses.
If you read this you might think that a market maker is some sort of evil entity in the market that really just sits at the desk all day and ruin the fun for all retail traders.
This could not be further from the truth.
The job of market makers is literally to “make markets”, which means providing liquidity so other people are able to trade.
They make money from the spread as they are constantly buying and selling with a goal to be delta neutral (not have directional exposure in underlying assets).
Read more about Market Makers here.
ICT concepts came from the teaching of Chris Lori, which does a great job to explain how you can observe liquidity in naked price charts and see where markets are either efficient or inefficient.
I have covered some of these concepts more in-depth in an article dedicated to Price Action and I also use a lot of these concepts in combination with orderflow and volume profiling in Tradingriot Bootcamp.
To give ICT at least a little bit of credit, markets are definitely manipulated as there have been many reports about it in the past, one of the most known is Forex Scandal.
But it is a very different manipulation than most people think, if you really think that there is someone sitting at the bank trading a 1-minute chart of EUR/USD just to run every possible stop-loss of retail traders it is honestly silly.
Of course, these “concepts” get a lot of clicks and attention as this idea of revealing a big hidden truth behind the financial markets is good marketing.
The areas of support and resistance are often tested and probed because they simply attract a lot of attention.
If you are wondering why markets react and continue from levels of prior consolidations that are called “orderblocks”, “clusters” or “supply and demand zones”.
It is once again not hidden inside evil manipulation but it is due to the memory of orderflow.
You can read this research paper to find out more about this.
To makes things simple the areas of consolidation before the large move provide enough back and forth trading (liquidity) to allow larger players to fill their orders.
In the example above you can see that after this volume buildup (signalled by the point of control on the Volume profile), the market moved higher as the demand overcome supply.
Because large players often have issues filling their orders at once they use these levels to leave resting buy orders for future revisits to complete their fills and also to defend the levels from going in the opposite direction.
As you can see from the example, once the level was revisited there was a large market selling coming into it (red candle) but all the aggressive selling was once again absorbed by passive buying.
I truly hope by showing you these examples of both “false breaks” but also this continuation trades, you will be able to understand how markets dynamics work and you will spend more time trading rather than trying to catch up on some hidden truth with obscure names that simply does not exist.
Finding your “edge” in the market
So now you know the things about technical analysis.
I haven’t talked about Gann, Harmonics or Elliot Waves as I truly believe that is astrology for man and you can just completely skip that to save yourself time and money.
So let’s assume now you are a skilled technical analyst (just don’t put that to your Linkedin bio please) and you are about to tackle the markets.
What you will very quickly find out is not easy to do.
Markets constantly change, they run from periods when every trade works smooth like a knife through the butter, to quickly shifting to periods when everything you do is just wrong.
A fortune in the financial markets is not made in one week or month, it is made over a long period of time by sticking to your trading plan and managing your downside.
People always talk about the “edge” or the “alpha”.
It always tends to bring this mysterious thing as others think that by having an edge in the market you found some money-making formula.
Truth is really different.
The edge is simply by knowing that you will make money after X amount of trades.
To find out if you have an edge you simply must start trading and collecting your statistics.
If you journal 100 trades, you take any Journaling software that will tell you a few key things about your strategy, most importantly your % win rate and average risk/reward ratio.
For example, if your strategy has a 40% win rate with an average 2.7R: R ratio you can plot this equity simulation over 1000 trades to see clearly that after 1000 trades you have an edge and you should be profitable.
But if your win rate would be only 20% the simulation would clearly tell you that there is no reason to continue with the given strategy.
To find out this edge, you need to be true to yourself, and the trades that you take should have systematic aspects which will make them easy to replicate in the future.
This can be often answered by the “IF/THEN” process.
Example: If the market breaks a monthly high on high volume but fails to continue, then I will go short, targeting a monthly low.
Edges can also diminish over time; this is highly probable, especially if you decide to trade very thin or obscure markets.
Example: Buying new altcoins listed on Uniswap will work perfectly in raging bull markets but will be a terrible strategy when whole crypto markets take turns.
Drawing lines on a chart or using indicators is not rocket science, although many people act like it is.
I know many people who make a lot of money in the markets by only using different indicators, but I also know people who only trade by using price action.
The most important thing is to focus on building a robust system to weather changes in market dynamics and be able to execute properly on your strategy without hesitations and with solid risk management.