While technical indicators can be a way to gauge market direction and signal potential entry points, many traders make the mistake of believing they offer guaranteed profitability. In reality, they can be extremely misleading, so many traders prefer to trade without any indicators at all. Trading without indicators is called "price action trading." If done correctly, it can be a financially rewarding way to operate in the markets.
Those who trade without technical indicators need an alternative method of interpreting the markets. One of the popular alternative methods involves the use of Japanese candlesticks -- a graphical representation of price over a particular time period. The period that each candlestick represents is dictated by the time frame of the chart you are viewing. For example, if the chart is a one-hour chart, each candlestick will represent one hour's worth of price movements. Japanese candlesticks have a body, a wick and a tail. The size of the body is dictated by the opening and closing prices of the session. The wick and tail are dictated by the high and low, respectively, of the session.
Traders can use the shape of these candlesticks to interpret the balance between buyers and sellers in the market. In turn, they can use the interpretation to predict future price movements. A number of well-known single candlesticks reliably produce profitable signals. Other patterns include two or more candlesticks, and they also produce reliably profitable signals.
The Pin Bar Candlestick
The single candlestick that traders use the most is the pin bar. A pin bar candlestick has a thin body at the top of a long tail, or at the bottom of a long wick. The thin body of the candlestick indicates the session had similar opening and closing prices. The long tail or wick indicates that during the session the price moved substantially in one direction, but then reversed. Traders look to take advantage of this reversal momentum by entering a trade in that direction. Therefore, a pin bar with a long wick is a bearish pin bar. If you see a bearish pin bar, you could look to enter a short trade. A pin bar with a long tail is a bullish pin bar. If you see a bullish pin bar, you could look to enter a long trade.
The Inside Bar Candlestick
One of the most popular multiple-candle patterns is the inside bar candlestick. An inside bar candlestick forms when one candlestick is completely engulfed by the previous candlestick. This pattern indicates indecision in the markets and can precede a large movement. Traders normally look for the price to break through the high or the low of the bigger of the two candles, and then enter on the break. If it breaks the high of the candle, they enter long. If it breaks the low of the candle they enter short.
One way to improve your chances when using candlesticks to enter trades is to look for points of confluence. A point of confluence is a point at which two or more factors indicate a potential price movement. For example, if a bullish pin bar forms at a level of support, it could be considered confluence.
Samuel Rae is an experienced finance journalist whose work has been published across a range of different sites and publications in the financial space including but not limited to Seeking Alpha, Benzinga, iNewp, Trefis and Small Cap Network. He holds a BSc degree in economics.