Trading commodities, or any actively traded investment medium for that matter, involves the continuous search for the latest angle, tip, or trading gambit that may suddenly provide that necessary mental advantage to create a burst of profitable trades. As technology has enabled the assimilation of mountains of data in an instant, the art of technical analysis has grown in sophistication to the point of intellectual overload. Sorting through the plethora of new “tricks” can be time consuming, and favorable back-testing results do not necessarily convey confidence either.
In times like these, it is often best to take a breather and think back about your early training and what early instructors taught about the simplest signals communicated by forces in the market. One of those early lessons in commodity trading surely concerned candlestick formations, the simple box and line structures embedded in our charts and most likely taken for granted. These little symbols have more significance than meets the eye and have made millions for commodity traders in earlier times.
Technical analysis actually has its roots from centuries ago when commodity traders learned to associate pricing patterns with the changing of the seasons, and, as the story goes, back in the 1700’s Japanese rice dealers invented “candlesticks” to quickly convey the price action for each day’s trading. The simple box structures related opening and closing prices, along with the high and low for the day. The story continues that one particular trader studied repeating patterns over time, and with new technical “weapons” at his side, he soon wreaked havoc in the market and became wealthy over night.
Sounds like a good plan for today’s ambitious trader, and if not that, then it makes for a fun read. Candlesticks have a fascinating history, steeped in Japanese lore during the Tokugawa shogun era with colorful names tied to nature or Samurai battle tactics. The nicknames alone are very interesting, and the degree of study is much deeper than most would think, actually enough to fill books on the topic and provide a world of insights long before computers were available. Recognizable patterns can be for a single candlestick or extend over several trading periods, but the objective is to signal significant reversal points or that the market has stalled in a sideways trend.
The chart below presents a series of actual candlestick formations over roughly sixty trading periods. A variety of typical formations are shown. While we generally think of a candlestick as always having a “box”, either colored or transparent, the most basic daily reversal pattern is actually known as a “doji”, a formation where there is no box. The “shadows” or “wicks” are present, but the opening and closing prices are either equal or so close to being equal that the result is a horizontal line. If the line is near the top or bottom of the shadow, then it becomes a “tombstone doji”, a prevalent reversal pattern.
Over the course of forty-five trading periods, this “tombstone doji” appears seven times, signaling a reversal at each occasion. Additional insights can be gained by studying other familiar patterns and combinations that occur frequently in commodity, stocks, and forex trading markets. One of the basic benefits of technical analysis is its inherent flexibility that allows for its principles to be applied over multiple investment mediums.
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Searching for new trading tips, especially in active markets like commodities, is a never-ending process that enhances our effectiveness as traders. Success requires an inquiring mind and one open to new ideas, even when those ideas are as basic as candlestick formations.
