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In the first half of this book I covered two of the three elements of my own personal trading approach to the forex markets, namely relational and fundamental analysis. Now, I would like to bring in the third strand which is technical analysis. This final element completes the three dimensional approach which, I believe, delivers a true understanding of market behaviour. From this all trading and investing decisions then flow.

This is the principal reason I wrote this book, to share this trading approach with you. It is the one I believe will offer you the tools and techniques to succeed in this market.

However, I do accept it is possible to trade using just one of the elements in isolation. Moreover, many new and existing traders do just that, with the majority focusing on technical analysis alone. In addition, there are many successful fundamental traders. However, once traders begin to realise the forex market in particular is the most complex of all the capital markets, any single linear approach may simply not be enough to ensure long term, consistent profits.

This is the realisation I arrived at some years ago, since when I have been using this three dimensional approach, of which technical analysis is the third and final aspect. However, please don’t misunderstand, appearances can be deceptive, the foreign exchange market is the most multi layered of all the four capital markets. It is also driven by powerful, self interested forces whose sole motivation is survival. It is Darwinian in nature and very much red in tooth and claw.

There is a great deal to learn, but in reading this book I believe you will have the foundation in place to build your own successful trading career.

But, what is technical analysis, and how does it fit within this three dimensional trading model? The explanation generally given is technical analysis is based on the underlying philosophy that all market sentiment is contained within a simple price chart. That a price chart encapsulates the views of every market participant at a given point in time. Moreover, technical analysis is simply price analysis, and that traders can forecast the future direction of price by analysing and studying where it has been in the past.

This is the core belief of traders who use a purely technical approach to forex trading, and is the explanation most often used. However, I find this view very misleading and will give you my own definition shortly. However, regardless of the definition used, analysing a chart in isolation without any reference to the complex web of fundamental and relational issues which may also be influencing and affecting the price, is both blinkered and restrictive. Furthermore, I hope from reading thus far, you can understand why. The forex market is the most manipulated of all the markets, and this is something we always have to bear in mind, particularly when considering price and price behaviour.

The simple truth is this. If we accept the forex market is manipulated in many different ways, how can we be sure any price move is valid? It is validation of price that holds the key to success in forex trading, more than in any other market. Yes, other markets are manipulated as well, but not by so many diverse and disparate elements. This is what makes price action on a forex chart stand apart from all the other markets, and why I believe validation of price is the lynchpin of trading success in the forex world. In other words, the price action is meaningless without validation.

As a methodology, technical analysis is perfectly genuine, and most traders start with a price chart as their only form of analysis. However, in isolation a price chart cannot make sense of the underlying forces which drive forex and other markets. Fundamental analysis too is a perfectly valid methodology, with many traders taking this approach to trade currencies. However, my belief is that only by using all three elements of market analysis can traders gain a true perspective of what is really driving the price action. After all, the information is there, and if we can understand and interpret it, then why not use it? And as the saying goes: ‘the whole is greater than the sum of its parts’.

Furthermore, as I have already stated: there are only two risks in trading. The first is the financial risk, which is easy to define, quantify and manage, but the second, which is much more difficult to assess and quantify, is the risk on the trade itself. In other words, it is the question traders ask themselves each time they place a trade (or should ask themselves). Is this trade a high, medium or a low risk? Predictably, the answer to this question can be answered in different ways, not least by considering the fundamental and relational aspects, coupled with the price action on the chart. Furthermore, there are various techniques in trading which help reduce the risk still further, which I will be covering in other books which deal with trading strategies, but this is the starting point, the top level for assessing risk. So, to use any of the three approaches in isolation is simply foolhardy. If the information is there, as we have seen in previous chapters, why ignore it?

Nevertheless, I do accept there are many traders who only look at the technical picture when trading, and I hope they are successful. However, I do have my doubts since two traders can look at the same chart and reach very different conclusions about the future direction of the price. Furthermore, both could also be right in their analysis and trade.

This brings me to the issue of time, which again I will cover in more detail later, but let me give you a quick example of what I mean here. Imagine we have two forex traders looking at a chart, one of whom is an intraday scalping trader and the other a longer term trend or swing trader. The scalping trader believes a currency pair is bullish, and likely to move higher, whilst the swing trader believes the currency pair is bearish and moving lower. Both are proved right and take successful trades.

The reason this is possible is very straightforward. In the case of the intraday trader the currency pair moves higher in a matter hours so the scalping trader makes a profit and closes his or her position later in the day. At this stage, the swing trader has a potential loss. However, over the next few days the currency pair moves lower and the trend trader closes his or her position at a profit. So, both traders are right and both have made a profit on the trade. It has simply been a question of the time, and in the case of the swing trader also requires sufficient trading capital to hold the position open long enough for the trade to develop. In any case, unlike a stock, a currency pair never goes to zero, and will eventually turn. The turn could even take several years to move from loss to profit, but it will eventually happen, it is just a question of time (and money). So, in many ways with forex trading, if you have enough money you can never be wrong.

In reality, no one trades this way. I simply wanted to make the point that two traders looking at the same chart can have very different views and both take successful trades. It’s simply a question of time and timing. The perspective or time horizon if you like.

Taking these examples it could be said technical analysis is about price action over time, and what it can tell traders about the future price action, over time. Now, in the introduction to the book I explained how the markets are driven by people and money. In technical analysis it is the people element which is the focus, and provides the core belief system on which technical analysis is built, but there is a twofold argument for this belief system.

The first argument is this:- if people have behaved in a certain way in the past, they are likely to behave in same way in the future. The second argument is:- if all traders are looking at the same chart, then technical analysis could be considered to be a self fulfilling prophecy. And, if most are using a purely technical approach, the market is likely to react accordingly, thereby reinforcing the reaction further.

But just how true are these arguments? Well, like many things in trading they are both true and false.

First, as we have already seen, two traders can look at the same chart and arrive at very different conclusions, depending on their time horizons. Second and perhaps more importantly, the market has seen a huge rise in high frequency, computer driven trading where trading decisions are entirely automated, using pre-set levels and price pattern recognition. These robots trade in the markets thousands of times a minute, and with no human intervention whatsoever, are becoming an increasing problem in all aspects of trading, not just forex. Indeed, the regulatory authorities are now considering putting a speed limit on this type of trading.

As a result, the concept of traders making discretionary trading decisions on a price chart are outdated with small retail traders very much in the minority, in this respect. Perhaps not so much in terms of the numbers of traders, but certainly in terms of the percentage of trades executed manually, as opposed to software generated trades based on sophisticated algorithms trading billions of dollars every week.

This reason alone makes it even more crucial you consider taking a three dimensional approach to the market, and not rely on just one method of analysis.

This issue notwithstanding, technical analysis is perfectly valid, and when we start to explore the power of candlesticks and candlestick patterns, even more so. However, when it is used in conjunction with both relational and fundamental techniques it becomes all the more powerful. But, and this is a big but, only when the price action is validated. After all, if the price is moving higher on the chart, how can we be sure this a true move higher, or a false one? Is this price move being driven by the market, or by external forces? In other words, is the price move genuine or false.

As I said earlier, this is the one question we simply have to answer when using technical analysis in this market. Without it, the approach is flawed, but don’t worry, I do explain how shortly. In addition, I have also recently written another book on the subject, which explains this approach in more detail and exclusively for trading forex, so help is at hand.

In many ways technical analysis is the glue which binds the other two analytical approaches together. Whilst fundamental and relational analysis are perhaps more 'scientific', technical analysis is much more of an 'art than a science'. It takes practice to develop the skills needed, but once learnt they are never forgotten.

As technical trading continues to grow in popularity so do the number of indicators and analytical techniques, thereby making this branch of analysis very confusing for the novice or inexperienced trader. My task here is to try to point you in the right direction, and highlight what I believe are the strengths and weaknesses of each. But I do have some strong views.

At this point let me just try to summarise where we are.

Technical trading is based on the principle future price trends can be forecast by looking at previous price action on a price time chart. Onto this simple display, traders can then add an array of technical indicators which can help to identify patterns, trends and turning points on the chart.

However, technical indicators are nothing more than tools for traders to use. They have not been designed to give entry and exit signals. Instead, they should be viewed as providing traders with information which would otherwise be difficult, if not impossible, to calculate manually and quickly. The analogy I use here is from the DIY market, and it is this – drilling a hole in a wall is easier and faster with an electric drill than doing the same job with an old fashioned manual drill. Both tools achieve the same result, a hole in the wall, but the electric drill just makes it easier, and a great deal quicker.

This is my philosophy in using technical indicators in trading. Almost all could be replaced with a manual system, but it would be slow, laborious and time consuming, even though we would arrive at the same conclusion, eventually. However, by the time all the calculations have been done the market would have probably moved on and any trading opportunities lost.

My philosophy is this. In viewing technical indicators, if they can reveal something of value quickly, they are worth using, but as a tool to provide information that would be impossible to produce as fast using manual methods. In the end, all a technical indicator is doing is completing some complex calculations and then presenting the result in an easy, visual format on a chart.

This is all they are, tools to help traders analyse the markets quickly, whilst giving detailed information and perspectives which would be impossible to achieve in the same time using manual methods.

Technical indicators are also there to give traders the confidence to take the plunge. They are like the water wings and floats which are used to teach someone to swim. Eventually, they become redundant, and for traders this will mean using price action with just one or two key tools. As technical analysis becomes ever more popular, so do the number of indicators and analytical approaches that are developed and applied, all promising to provide traders with the magic bullet to trading success.

The key is to keep things as simple as possible. The risk with not keeping it simple is traders end up with cluttered charts and 'analysis paralysis'. In other words, there is too much information so traders are unable to make a decision. This is the curse many traders ultimately suffer, believing that having 'more is better' will help them in their decision making.

As a methodology, technical analysis can be broken down into three broad categories. First, there is simple chart analysis, used to identify various price trends in various time scales. Second, there is pattern recognition, which is the study of different price patterns on a chart which are often repeated and can represent significant price levels.

Finally, there is momentum and trend analysis which looks at the rate of change of prices for clues as to changes in market sentiment. It is within these three broad groupings traders can find a plethora of technical indicators, graphical price presentation methods and techniques, all of which have their own advocates and passionate followers.

However, this raises three questions in relation to the forex markets.

First, is a technical trading approach valid for the forex market, given it is a market which is so heavily manipulated? Second, does it provide a reliable method for predicting future price action? And third, why is technical analysis so popular with forex traders?

In order to answer these three questions I want to consider the history of technical analysis which has its roots in the 16th and 17th century rice markets of Japan. However, it is Charles Dow who is generally credited with its introduction to Western financial markets in the late 19th century. At the same time Dow also developed a number of stock indices, all underpinned by his work which later became known as Dow Theory.

In essence, Dow Theory categorised market moves as primary trends or minor secondary trends, and this work formed the basis for a number of financial theorists who subsequently followed. These included Ralph Nelson Elliott, who developed the Elliott Wave Theory. The work of WD Gann and Richard Wyckoff was also heavily influenced by Charles Dow, with Richard Ney developing the ideas further in a series of books and publications in the 1960's.

All of these legendary traders and financial analysts had two things in common. First, their work was based either on the stock or commodities markets, but secondly, and of primary importance to us, is they all used volume as a key indicator in their theory and analysis. Moreover, it is in their original work you will come across the concepts of accumulation and distribution, as this refers to the buying and selling volumes by traders and market makers across the markets.

Here we have a group of iconic traders, who built their fortunes on one simple principle. That price, when validated using volume holds the key to forecasting future price action. These traders succeeded using pencils and graph paper, and a simple ticker tape which printed out the price movements and associated trading volumes. Using these simple tools, vast fortunes were built. Therefore, would it not make sense for us as traders to follow their lead?

Naturally, it goes without saying that the foreign exchange markets simply did not exist at the time, so technical analysis as an analytical tool was developed almost exclusively based on the price movements in equity and commodity markets. Price movements which, when coupled with volume, generally reflect the true balance of supply and demand. This analytical methodology was developed using the equity and commodity markets, with the price volume relationship at its heart. Furthermore, it was also premised on the belief that equities were bought and sold primarily as investments.

This is a world away from the complex foreign exchange model that exists in today’s modern world, and perhaps also begs the question as to how this method fits into the forex market.

After all, there is no volume in forex as there is no central exchange - or is there? Second, whilst the forex market is changing with currencies now growing in popularity as an asset class, in general it is still primarily a market of speculation and corporate money flows. Third, the forex market is probably the most manipulated of all the capital markets, and most definitely not a level playing field.

The question therefore is whether this increasingly popular analytical approach, with no foundation in foreign exchange is suitable or even valid for such a dynamically changing market. For an answer to this question I would like to consider price and price action in a little more detail.

Just as I have tried to explain my own three dimensional approach to trading, price action itself is generally viewed by many traders in a one dimensional way. Indeed, some of you reading this may remember a popular game show in the 1980’s which involved guessing the price of a well known item. The winner was the contestant who came closest to the actual retail price, without exceeding it. And in some ways, this is how many traders view price action on a chart. In reality, price is created through two parties agreeing to disagree, and I often make this point when I am contacted with regard to one of my market forecasts. This is my view, yours may be very different. We agree to disagree. Without it, there would be no market price action.

In other words, price is the fulcrum on which all market opinion is balanced, tilting backwards and forwards on each release of news, data, and geopolitical event which, are first absorbed, and then reflected in the price on a chart.

It could be said price is the basic building block of every chart. Without the price, there is no measure of market sentiment, and no sense of where the fulcrum of the market is at any given time. Price contains all this information in one simple bar, embracing, as it does, the views, news, hopes and aspirations of traders and speculators around the world, all of whom are driven by two primary emotions, namely fear and greed. Without the fulcrum of price, these twin emotions would simply wither and die. It is price which feeds a trader’s emotional responses, which is displayed in one simple bar, on one simple chart. Price distils everything to one single fulcrum, where it balances for a split second, before moving on.

Price is the DNA of the market and contains all of this collective information in one single number. As Wyckoff himself used to tell his students“.....prices are made by the minds of men....”

Each price bar on a chart is composed of four elements: the open, the high, the low and the close. Of these, one element is key when considering any analysis of price and that's the open, because it sets the fulcrum for the trading session ahead. The open represents the starting point, regardless of time frame. It is the benchmark against which all other price action is then measured, whether on a one minute chart or a yearly chart.

The high is the highest point the market traded during any session. It is the price at which the buyers were no longer prepared to go any higher, from which the price fulcrum began to tilt lower. The low is the lowest point the market traded during any trading session, and is the price at which the selling was exhausted with the buyers seeing an opportunity to profit from a bargain.

The close is the last price agreed between buyers and sellers, at the end of the trading session. It is an important piece of information as it defines the market’s final evaluation of the session. It draws a line under the price action for the session, before moving on to repeat the process.

At its simplest, a single bar on a single chart will show the open, high, low and close with all these points clearly defined. In addition, this single bar is also revealing a history of market sentiment during a point in the trading session. In an up bar the closing price will be higher than the open as the balance of market sentiment throughout the session was positive. This single item of information will not, of course, reveal where the price is likely to go next as any subsequent bars could be either up or down.

Price alone can only reveal where the market has been at a particular point in time. Much like the rear view mirror in a car, it can show where it has been, but not where it's going.

In order to compensate for this many traders turn to technical indicators based on an historical view of price of what has gone before. Such indicators are known as ‘lagging indicators’ and this is where their problems start.

For example, imagine a chart where there have been ten consecutive, rising bars. Does this mean the next bar will also rise? The answer is no one can be sure. However, one thing is certain that any indicator based on historical price action will almost always suggest the next bar will be an up bar. The reason for this conclusion is straightforward, the indicator has nothing else on which to base its decision, other than what has already happened in the recent past. And the forecast will be that the price will rise. The indicator has arrived at this conclusion through no analysis. The conclusion is based solely on historical data.

In many ways, this type of indicator is no better than a system which claims to be able to predict where the little white ball on the roulette wheel will land, based on where it has been in the past. However, no one can ever know and no system or methodology can ever forecast such a thing. Moreover, any system which claims to be able to do so could simply not be taken seriously.

Yet, this is what traders are being asked to believe and place their faith in whenever they use ‘lagging indicators’, or systems which include these indicators. The clue is in the word ‘lagging’. They are lagged, and will always lag the live market price action to a greater or lesser degree. As with the analogy mentioned earlier, driving a car using a rear view mirror can only have one outcome. Sooner or later the driver of the car will crash. It is not a question of if, but when.

Unfortunately for traders, there are literally hundreds of such indicators and most can be found, for free on all broker platforms.

Lagging indicators fall into two broad categories, trend following and oscillating. The most popular are moving averages, MACD, Stochastics, Bollinger Bands, and Elliott Wave, to name but a few. And all, without exception, have two things in common. They lag the market and look great in hindsight.

It is one reason why so many traders struggle with trading and fail to achieve their potential. Furthermore, many traders do not appreciate their failure to succeed is not necessarily their fault. It is simply they are working with signals and indicators which are based on historic data and therefore virtually useless at predicting future price direction.

The above notwithstanding I firmly believe a technical trading approach in terms of pure price action is valid for the forex market, but only when the price action is validated. And not just for forex but also for stocks, bonds and commodities and for all instruments, because only price can reflect market sentiment at a given moment in time. It is the only indicator which can do so. Price action is price action, whether on a currency chart, a stock chart or a futures chart. It will always be a leading indicator, revealing as it does in real time the market’s moods, hopes and fears millisecond by millisecond.

However, as to whether a technical approach can provide forex traders with a reliable method for predicting future price action - the second question - here the answer is most definitely no, unless that price can be validated. And this is the key.

First, when traders consider and scrutinise price charts what they are actually looking for is validation of the price action. Therefore, they try to use a variety of tools and techniques to achieve this, as price on its own reveals very little about the future direction of the market. It is only when price behaviour is validated can it then become a powerful predictor of the future direction of the market.

Second, as explained earlier validation of the price action cannot happen with ‘lagging indicators’ alone.

Third, validation of price can be done in many ways in terms of patterns, trends, price bar formation and from other indicators (which I will explain later). Only then can price become a powerful predictor for the future direction of the trend.

When analysing price action we can use a wide variety of techniques. These may include using indicators and price behaviour to confirm the analysis, which in turn will reveal significant price levels or price points which become trading targets. If these targets are met, they confirm the analysis, and from there the process starts all over again.

So, whilst technical analysis primarily focuses on price action, it is the interpretation of the price action that is key, and even more so in the forex market. This is why I have an issue with those who claim technical analysis is about forecasting price. It is not. Technical analysis is about understanding how to validate price action. If the price is validated, traders can forecast with confidence where the price is likely to go in the future. Without validation, there is no forecast.

My third question was why technical analysis is so popular with forex traders, and the answer is probably because of its simplicity. Walk onto any trading floor in New York, Tokyo, London or Singapore and the first thing most traders do is pull up a chart and start looking for trading opportunities. The same is true for retail traders.

The reason for this is straightforward. A price chart removes all the complexities of the market which can often appear random and chaotic. A further reason is a price chart provides a simple, visual image of the market and requires almost no effort on behalf of the trader. In addition, many retail traders may not have the time (or motivation) to learn the approach and techniques advocated in this book.

So what's the answer? And in case you hadn’t guessed already, it's volume. There are only two leading indicators on a price chart. One is price, the other is volume. It really is that simple, and is the essence of technical analysis and forecasting price behaviour.

As I mentioned earlier, all the iconic traders of the past understood the power of volume and used it in their own trading. The great traders I am referring to here include W D Gann, R N Elliot, Jesse Livermore, Richard Wyckoff and Richard Ney. Richard Ney is a particular favourite of mine. His books are sadly out of print, but they still offer some great insights and quotes about the markets and trading. Fortunately, we can still buy secondhand copies.

However, just like price, volume on its own tells us little. In isolation, it is a weak indicator and reveals very little that is helpful. For example, if 1 million Google shares are traded during a session, this information fails to give any sense of what is happening to the price. There is no context and there is no clue as to where the price is heading in the future.

Let's suppose in the same session the Google share price rose $5 on the day, does this extra detail make any difference? The answer is still no.

However, what if over the previous 5 days the volume in each trading session had been averaging 500,000, and on each of these days, the price had been rising 50 cents on average? Now a picture starts to form which can be put into context and analysed. In other words, we have a benchmark against which to compare the volume against the price.

This is the power of the price volume relationship. Individually, price and volume reveal little about the future. Put them together, and they react like two chemicals, and from that chemical reaction the power of price and volume combine to give us the market’s only true leading methodology which then reveals where the market is likely to be heading. For the iconic traders of the past, it was the ticker tape which printed price and volume, for us it is an electronic chart. But the two elements are identical.

This is what I meant when I said price has to be validated, and volume is the only indicator that can do this. For example, if the price moves higher with rising volume, this is a valid reaction, and traders can be confident in any analysis. It is at this point all the other analytical techniques of price patterns, price bars, trend and momentum can be applied to give a picture of how far and fast the price action is likely to run.

Volume and price are the twin pillars on which technical analysis is built. However, with no central exchange for the spot forex market, how can traders overcome this problem and still use volume and price for their trading?

The answer is simple. Traders can use tick data as a proxy for interpreting volume, which in various studies over the years has proved to be over 90% accurate in representing the volume activity in the market. After all, tick data is essentially activity in the form of a change in price, and if the price is changing rapidly, it is a perfectly valid argument to interpret this 'activity' of buying and selling as a representation of volume. So, until there is a central exchange this is the best there is. It works perfectly, even on the free platforms many forex traders use, such as the Metatrader MT4 and MT5, and freely available with most broker accounts.

In summary, price and volume co-exist together. Each is mutually dependent on the other. In isolation they are weak. Together they are strong with each validating and confirming the other. When combined with all our other technical indicators and analytical techniques, traders have the ultimate tool to analyse price action in the most complex market of all – foreign exchange.

Finally, there is one other element, and just like my own three dimensional approach to trading, the approach you will discover here for technical analysis, also has its own three tiered approach. After all volume and price work in tandem, and reveal the truth about market behaviour. Price is validated by volume, and volume validates the price, but there is a third, and equally important element, and that’s time. The relationship that underpins all others in technical analysis is the Price/Volume/Time relationship, and it is one I will return to again and again in the next few chapters. To put this into context for you, it was Wyckoff, one of the greatest exponents of volume price analysis, who proposed in his second rule, the concept of ‘cause and effect’. In other words, the greater the cause (the time element), the greater the effect (the associated price move). Put simply, the longer the time element the greater would be the associated price movement. Wyckoff was the first person to codify volume price analysis into his three classical laws.

To summarise all this for you.

Many forex traders struggle to succeed, as they have never appreciated the significance of volume, or its power. The forex market is the most manipulated of all, making it even more important to validate any price move. Without it, you will never know, and never be sure.

This is the only approach I believe works for all the reasons I have outlined in this introduction. Too many traders come to the market relying on lagging indicators which reveal little of value. Learning to interpret volume and price takes time and effort, but imagine the advantages we have over those iconic traders who only used used pencil and paper.

All the analysis is done for us. Volume appears instantly on our charts, and tells us immediately whether a move is genuine or false. It really is that simple. As I mentioned earlier I have recently written another book which explains this approach in detail, and if you would like to learn more, simply visit my personal site for further details - www.annacoulling.com - or take a quick look on Amazon, where all my latest books are published. You will also find all the details in the back of this book.

Here however, I propose to introduce the basic concepts to help you get started, and if you would like to take your knowledge to the next level, the second book and subsequent books with worked examples, will help you to understand more.

At this point I would like to take a closer look at how price action is represented on a chart, before moving on to consider all the other analytical techniques used to examine price behaviour.

Speak to any trader in any market and it is highly likely a candle chart will be the price chart of choice. Candle charts are becoming the ‘de facto’ standard for representing price action, with only the humble bar chart still in widespread use. Candle charts are now also dominating the retail market and it is these charts that I too use exclusively, in all my trading and market analysis. Hence the reason for devoting this section of the book to candle charts.

But there is one other, perhaps even more compelling reason, which is this. When candlestick charts are coupled with volume and price analysis, this brings the entire concept to life. Many exponents of volume and price analysis, use simple bar charts, which is a mystery to me. Bar charts, as you will see shortly, reveal very little about the price action. Candlesticks on the other hand, reveal everything in graphic and unequivocal terms, and when analysed with volume, reveal the truth behind the price action. I would not say this approach is unique to me, it probably isn’t, but it was the way I started, and is the method I have used ever since.

Combining candlesticks, volume and price are equivalent to mixing Saltpeter, Charcoal and Sulphur, your charts will explode into life. And in case you didn’t know, mix the above together in the correct quantities and you get - gunpowder. If the old time traders had been aware of candlesticks, they would have used them too, and no doubt made even more money. Which I guess also confirms the power of volume. After all, they were using bar charts. You have the additional power of candlestick charts. There really isn’t any more I can say.

The components of a price candle are very simple. The upper and lower 'tails' are called wicks, with either an upper wick or a lower wick, and the solid, coloured part of the candle is called the body. This can be any colour. The open price, the high, the low and the close are clearly defined, and it is the colour of the body which defines whether the candle was an up candle, with prices closing higher, or a down candle, with prices closing lower. See Fig 17.10.

A bar chart is the simplest way to present price action and many forex traders use this style for their price plots as it is very clean and removes much of the noise from the market. The bar is often referred to as an 'ohlc' bar as this denotes the Open, High, Low and Close of the bar. The price action in the time period is created as a simple line or bar with the opening price designated by a small horizontal line to the left and the closing designated by a small horizontal line to the right.

Although many traders use bar charts, I prefer candlestick charts for reasons that will become obvious in the remainder of this chapter. I have used them for over 20 years and have never found any other representation of price that comes close to communicating so much and so quickly on a chart. For me, they are the lynch pin of price analysis and have served traders well for over 400 years.

Candlesticks originated from the Japanese rice traders of the seventeenth century, and have been widely adopted by Western chartists since the mid 1990's.

Most traders also consider price action easier and quicker to analyse on a candlestick chart. They are visually more appealing, and offer traders a plethora of different candle patterns, formations and types to signal market sentiment and potential changes in market direction. Many of these still retain their Japanese names. For me, they are the ‘de facto’ standard when analysing a chart using volume. There is no other representation of price that conveys the message of the volume price relationship more clearly.

The candle is formed with a solid body created by the opening and closing prices, and the high and low are then designated with 'wicks' or 'shadows' to the top and bottom of this solid body as shown in Fig 17.10. I prefer to call them wicks as shown in the annotated chart.

The body is then coloured red (generally) to represent price action that has closed lower during the period, and blue (generally) to show price action that has closed higher during the period. There are literally hundreds of different candles and candle patterns which have been developed over the last twenty years, but of these there are only a handful which I have found to work, and more importantly to work consistently in the forex markets. From my experience I know the candles to watch, and the ones to ignore, as well as the patterns which are important and those which have less significance.

In a moment I’m going to explain my three top candles, what they are, what they tell us and why they are so powerful. These are the candles traders can learn quickly and spot instantly on any chart and in any time frame so they become second nature. Furthermore, these candles are not based on some vague theoretical approach to trading, they are the ones I use and are based on my own trading experience. I know they work and work consistently, particularly when used in conjunction with the other analytical tools which I'll cover in the next chapter. Moreover, when the candles are used with relational and fundamental analysis they can provide powerful trigger signals for market positions.

The candle is the first step, it is the first signal of a potential change in price. The signal then has to be validated by other analytical tools and techniques.

One final point, before moving to the candles and candle patterns. The significance of a candle will change depending on where it appears in the price action or trend and there are always two factors to consider. The first is the candle shape itself, and the second is where the candle appears in the cycle or trend.

Finally, as we get started on our candlestick journey, remember candles and candle patterns work in all time frames from a tick chart to any time based chart. The signals they send are the same, whether, as a trader you are looking at a 1 minute chart, a daily chart, or a 500 tick chart. Their meaning and interpretation using volume and price analysis will be identical.

The following are my three top candles. They are not in order of importance, as they are all equally important.

The first is the ‘hammer’ which appears at the bottom of a bearish trend when prices have been falling in a series of down candles as the market moves lower. The hammer candle appears at the end of this ‘waterfall‘. Here is a classic example in Fig 17.12

Then something changed, buyers suddenly started to appear, preventing the price from falling further. It is their action which took the price back higher to recover close to the opening price of the candle. It is possible to visualise this action in the following way. Imagine every candle as a battle between the buyers and the sellers, rather like an old fashioned 'tug of war'. If the candle is a down candle, the sellers are in control. If the candle is an up candle the buyers are in control. If the candle is neither up nor down there is an equal battle for control. This is the fundamental principle of price action in the markets, ignoring the issue of price manipulation for the time being.

In the case of the hammer candle, initially the sellers are in control, pushing the price lower, but then the buyers come into the market and slowly they begin to outnumber the sellers with prices rising to close near the open. This simple candle is therefore signalling a potential change in market sentiment and direction.

However, please note the word 'potential' – because this is all it is at this stage. It is the first sign the downwards trend is possibly coming to an end and the first sign of a potentially new trend beginning. For traders it is an opportunity to enter the market, which is why this candle is so powerful.

The perfect hammer candle is one where the open and close are identical, or as close as possible, whilst the tail of the candle should be as long as possible, so here are my rules to help you define a true hammer candle. Many analysts become too focused on the depth of the body, suggesting it has to be a certain percentage of the overall price action, but I am not so pedantic. My rules are more relaxed.

First, if the hammer candle has a small body, this can be either blue or red. It doesn’t matter. If the close is above the open with a blue body or the open is above the close with a red body, either is fine. Furthermore, in my opinion the colour of the body has no particular relevance.

However, what is important is the length of the lower wick. This should be at least three times as long as the body and, as a general rule, the longer the better.

Finally, the candle should have no, or only a very small upper wick to the top of the candle, as shown in the Fig 17.12 example.

No upper wick is better.

The hammer candle when formed, looks exactly like a hammer in profile, and the reason it is often referred to as a hammer is twofold. First it looks like a hammer and, second this candle is considered as 'hammering out' a bottom to the market. In other words a potential reversal from bearish to bullish.

However, the hammer candle says nothing about how long this reversal may last, or indeed whether it is a major or minor reversal. Indeed, the candle may simply be signalling a minor pull back in the longer term downwards trend. At this stage nothing is certain. What is known simply from the construction of the candle, is that bearish sentiment has dissipated, to be replaced with bullish sentiment, which could be a temporary change, or the start of a longer term trend reversal. This is where other techniques and indicators are deployed to confirm and validate the likely extent of any reversal of the trend.

The other key point is that when a hammer candle appears as the first signal of a possible change in sentiment and trend, it does not necessarily mean this will occur immediately. This was one of the first lessons I had to learn when I started trading. As a new trader I expected to see the price turn instantly and start to reverse higher. What I soon learnt was that patience is required, particularly when looking at longer term time frames.

The reason is simple. Markets take time to turn, they do not just turn on a dime. Typically, once a hammer candle appears, the market pauses and consolidates at this price level before moving higher.

To recap the hammer candle. The market has moved lower, with sellers in the ascendancy and the hammer candle appears as the buyers have decided the price is now cheap, so have entered the market, buying into the market and stopping the price from falling further. It is this action which results in the price starting to rise, forming our hammer candle. However, this initial rally from the buyers may not have absorbed all the selling, since the trend lower has been in place for several bars. As a result, there are sellers still in the market who continue to sell, only for the buyers to continue buying at this level and support the price as a result. This 'mopping up' operation of buyers may go on for several bars, until all the selling has been absorbed and the buyers are now in control, and can then take the market higher into the new trend.

At this point the market may not be ready to move higher as validation is required so patience is the watchword. The hammer is merely an early warning signal of a ‘potential change’ in sentiment and trend. It's not an entry signal. Indeed, this applies to all the candles and candle patterns mentioned here. They are not entry or exit signals, but simply an early warning of a possible change in the price action.

Validation of the candle comes from other tools and techniques because price on its own tells us very little about the future. It is only when it is validated with volume that it becomes all powerful.

Of equal importance to the hammer is its opposite, sometimes called the upthrust or shooting star candle which gives traders a potential signal of the market turning from bullish to bearish.

In the case of the shooting star, this candle appears after a rally or up trend in prices, with the market having moved steadily higher with the buyers in control. However, within the shooting star candle the buyers continue to push the market higher, but at some point during the formation of the candle, the sellers enter the market, overcoming the buyers and taking control. As the price moves lower, the selling pressure increases, with the market finally closing at or near the opening price.

The shooting star candle sits at the top of an uptrend, and is characterised by a long upper wick and no, or only a very small body. It is the exact opposite of the hammer. In the formation of a shooting star it is the bulls who have driven the market higher, to a point where it can no longer sustain higher prices. In the forex market this point is referred to ‘overbought’. It is at this point that sellers appear. The analogy I like to use here is of a market stall.

In this example the stall holder sells watches, which retail at a higher price in the shopping arcade. The stall holder begins selling at a lower price, and there is demand from the buyers, who see this as a bargain. Every day the stall holder gradually increases the price, and buyers continue to see the price as attractive. However, as the price nears the shopping arcade price, buyers lose interest so the stall holder has to drop the price lower in order to continue to attract the buyers. In other words, the price has found a resistance point, at which buyers are no longer interested, so the price has to be lowered. This, in essence, is what is happening with the shooting star. The buyers have been overwhelmed by the sellers and the price has been forced lower and back to where it started.

Once again, as with the hammer, it is only the first signal of a potential change in trend and possible reversal in the price action. It does not say anything about how long any reversal may last, only that there is the potential for a change. Nothing more, nothing less at this stage.

The same rules apply as for the hammer candle. The body can be either red or blue, and the upper wick must be at least three times the length of the body. Finally, there should be no shadow, or very little to the lower body of the candle, and the longer the wick in relation to the upper body the stronger the signal.

The shooting star is an immensely powerful reversal signal of a market 'running out of steam' and possibly turning lower, and once validated by other indicators, is an excellent candle to watch for.

In all my years of trading these two candles have probably contributed the most to my trading and investing success. The hammer and shooting star candles are so powerful in giving traders an early warning to an impending change in sentiment or trend. Once they appear on a price chart they are saying ‘sit up and take notice, there may be a change coming, so pay attention’.

The third candle I now want to consider is called the ‘doji’ which in Japanese means ‘the same price level’ and, in this case in particular the long legged doji.

The chief characteristic of the doji candle is that, irrespective of where it appears on the price chart, trend or cycle it is a visual representation of the battle between the buyers and the sellers. It represents a tug of war between these two groups or teams. Each team pulling on the price rope with a white marker in the middle. First, the rope is pulled one way, and then the other, before finally the white marker moves back to the middle as the referee blows the whistle and both teams stop pulling with the result declared as a draw.

In essence, this is what happens with a doji candle. First, one group is in control, then the other take control only to lose control once more before the first group take the initiative once again. All this 'to and fro' is reflected in the doji candle, with the opening and closing price ending virtually the same and with long deep wicks both above and below.

What the doji candle represents and, the long legged candle even more so, is market indecision or a lack of direction. Therefore once again it is warning traders of a potential turning point. In this case the candle is found in both up trends and down trends. Again, it is extremely powerful and in the example in Fig 17.14 there were two consecutive long legged dojis, as the markets waited for news which never came.

The two candles represent the final price action on a Friday evening, as the markets closed waiting for news of a key piece of legislation to be agreed by the US Congress. When no agreement was forthcoming, and with no release to the market before the weekend, this indecision was captured by these two classic candles.

Doji candles are so descriptive, it is unbelievable so few forex traders pay attention to them on the chart. The market is clearly signalling indecision. This indecision may be the prelude to a reversal or simply warning of weakness to come and further indecision and a congestion phase. However, there is one certainty and that is the trend, in whichever direction it had been travelling in before the doji candle(s) appeared, has temporarily paused, and is waiting. The trend has run out of energy. The buyers and sellers are in the market in equal measure and traders now have to be patient, and wait for the market to signal its intent. Once again, this is an early warning signal of a potential change, as the trend has lost some of its momentum.

Doji candles come in all shapes and sizes. They appear in all time frames and many times during the trading day in the shorter term charts. However, the doji candle to look out for is the long legged doji which resembles a ‘daddy long legs’ - one of those creepy crawlies which fly around at night.

The reason the long legged doji is so much more powerful than regular doji candles, which appear all the time, is by virtue of the length of the wicks. And the rationale is this. In addition to indicating a market lacking in direction and therefore at a potential turning point, the long wicks to the upper and lower body are also clearly signalling extreme market volatility. This suggests a tug of war on a grand scale between the buyers and the sellers and, is therefore a much stronger signal of market indecision and a possible longer term pause point developing and the possibility of a reversal in due course. Furthermore, long legged doji candles often follow major economic news releases, announcements or statements as market participants absorb the news and battle for supremacy.

The rules for the construction of a long legged doji are much the same as for the hammer and shooting star. First, the body can be either positive or negative and in the example in Fig 17.14 there are both. However, the key is that the body of the doji should be as small as possible, ideally with the open and close identical or virtually identical, thereby creating a single horizontal line rather than any solid body. Again, this is not precise. As I said at the start of this chapter, technical analysis is an art, not a science. The two long legged doji candles in Fig 17.14 are perfect and would have alerted all traders.

Second, the length of the legs should be extreme and at least five times the length of any body. Third and finally the length of the leg or shadow to both top and bottom should be the same length, or as close as possible. If one is much shorter than the other, the signal strength is reduced accordingly. The examples I have chosen here are almost perfect.

The long legged doji is another early warning signal of a potential reversal which can appear in both an up trend or a down trend. Therefore, it can signal a reversal from bullish to bearish after a long rally higher, or a reversal from bearish to bullish after a long trend lower. In many ways, it signals the final battle between the buyers and the sellers for control of the market. This is why the length of the legs is so important as it marks the extent of the volatility in the market. The longer the legs the more volatile the price action and the more fierce the battle. The more fierce the battle, the stronger the signal of an impending change. This candle is also telling traders to pay attention. However, please note, patience is required, as this could simply be a pause point in the longer term trend. The long legged doji is not sending the same message as a hammer or a shooting star, and so we have to wait for confirming signals to follow. Remember, this may simply be associated with a news release, and once the dust has settled, 'normal service' has been resumed. So patience, patience, and more patience. Wait for price and volume to confirm the direction, once it is established or re-established.

These are the three most important candles in the forex world which appear across all charts and time frames. They warn all traders, from short term scalpers to position traders, market sentiment is about to change or is indecisive.

However, they are not trading signals to enter or exit the market. They are only red flag warnings of a potential change and as with all signals need to be validated by other analytical tools and methods.

Finally, two other important points before moving on.

First, the technical element from the three dimensional approach applies equally to all other markets. These candles are just as powerful and can signal possible reversals in equities, futures, commodities and bonds.

Second, the power of these candles becomes even more potent, once volume is added into any analysis.

Just as these candles appear on currency charts they are equally important in other markets and charts and can also be validated using relational analysis. For example, if a shooting star appears on a chart for a particular currency pair while a hammer candle appears in a related market which moves inversely, this is doubly powerful and a strong sign a reversal may be imminent. This is a simple example of using these primary candles across related markets to analyse and validate price action.

All the candles and candles patterns in this book are applicable to all the four capital markets and to all time frames. As soon as they appear they are strong signals which should prompt further attention and analysis.

Finally, I am often asked whether these three candles fall into any hierarchy of importance or reliability. My answer has always been the hammer and shooting star are on an equal footing for giving traders an early warning of a reversal, whilst the long legged doji may sometimes simply be signalling a pause, followed by a continuation of trend.

However, they are all strong signals in their own right and, if traders just focused on these three any price analysis would be easier, consistent and more successful. In addition, they force traders to be patient, a virtue which many lack.

There are, of course, many many other candles and candle patterns, but for the purposes of this book I wanted to highlight what I believe are the most powerful to get started.

There are also many excellent books on this topic and I mention my own personal favourites in the resource section of this book. It is a huge subject in its own right, and all I am attempting to teach here, are the 'major' candles and patterns to look out for. They are the strongest and most powerful. These are the candles and candle patterns to use to validate price action and which can help you achieve consistent trading success.

Now I would like to consider my top three reversal candle patterns. This is where two candles combine to give traders a potential reversal signal, and the first of these is the bearish engulfing candle pattern. This is created at the top of an up trend and is when an up candle is followed immediately afterward by a down candle, which ‘engulfs’ it completely, as shown in Fig 17.15

Fig 17.15 is a one minute currency chart and a good example. The important element here is the second candle which is a down candle, must engulf the preceding candle which is an up candle. In other words, the price action of the down candle must overwhelm entirely the price action in the up candle. This produces the 'bearish engulfing' signal which is again a red flag warning that the market may be about to turn lower after a bull rally.

The price action of a bearish engulfing candle pattern is in fact a shooting star. If the two candles were merged, the effect would create a shooting star, but spread over two candles. This pattern is also referred to as a two bar reversal for that reason and once again makes the case for using multiple timeframes. Overlaying two candles is easy as shown here. Overlaying several is almost impossible.

In the first candle, the buyers have been in control for some time with the market moving higher as a result. At some point the sellers come into the market, over powering the buyers and creating the second candle. This candle engulfs the buyers, and changes market sentiment from bullish to bearish, thus creating a potential reversal signal.

The difference here is the price action happens over two candles as opposed to the shooting star where the action is in one candle.

The key rules for this pattern are as follows. First, the down candle must engulf all of the price action of the previous candle, including any wicks to the top and bottom, so the whole of the previous price action is contained within the down candle, or as closely as possible.

Second, the down candle should have no wicks, or at least only very small wicks to the top and bottom of the body of the candle. The relative size of both the up and down candles is irrelevant. What is important is the up candle is completely swallowed up or engulfed by the second.

The price action which precedes this candle pattern is fairly straightforward. As we can see in Fig 17.15, following the reversal from bearish to bullish, the price action delivered two wide spread up candles, as the market moved firmly higher. Then a pause with the small doji candle, but still the market managed to struggle a little higher. The struggle higher is reflected in the spread of the up candle which is narrow. If the market were moving strongly this candle would be much wider and closer to the earlier ones.

At this point in the price action the market is looking a little weak, when it is suddenly engulfed by a wave of selling. It is like someone standing on a beach, knee deep, and being knocked over by a large wave. The narrow spread up candle was the last heave higher, and to return to the tug of war analogy with two teams pulling on a rope, this is equivalent to one team, the buyers, putting in one final big effort which just manages to pull the white marker in their direction, before they are hauled back by the sellers on the other end of the rope. Urged on by their coach, the sellers give an almighty, determined and prolonged heave, collapsing the buyers who capitulate exhausted in a heap. The sellers have won the battle and regained control or, at least for the time being, and until the next time.

For this candle pattern to have additional strength the last up candle should have a nice wide body, at least two to three times times the norm. The engulfing candle should, of course completely overwhelm it. In the example chart in Fig 17.15 I deliberately selected a pattern that was far from perfect as it helped to explain the price action.

However, for a bearish engulfing candle pattern to qualify as a two bar reversal both candles need to have a wide spread, and when merged, would result in a classic shooting star with a narrow body. Furthermore, if both candles have a wide spread this means there is momentum and volatility associated with the price action. In other words, what traders want to see is a sharp move up, followed by an equally sharp move down. This type of action increases the validity of the signal and increases the prospect of an extended move lower. In the example shown in Fig 17.15 a reversal did take place, and lasted for some time with the market drifting lower over the next hour. However, whilst the signal here was perfectly valid, the more volatile the two bar reversal the more likely an extended trend will develop, backed by momentum and based on a strong reversal in price.

Once again the bearish engulfing candle pattern can be found across all the capital markets. It appears in all time frames and is a powerful signal.

Its 'celestial twin' is the bullish engulfing candle, and occurs in reverse at the end of a trend lower.

The example I have selected to illustrate the bullish engulfing candle pattern is not perfect, but I have done so to reinforce the point technical analysis is not a science, but an art. In watching these candle patterns form, traders have to be flexible in any analysis, and even more so on currency charts, as gaps in the price action are rare. They do occur, but only infrequently.

Therefore, as one bar closes the next bar opens at the same price, so it is unusual to find perfect examples of 'engulfing' patterns. In other words, forex traders have to allow the engulfing candle a little leeway. In markets and instruments with gaps, textbook examples of engulfing candles are much easier to find.

As long as the engulfing candle encloses the preceding one this will be enough. In many ways a flexible attitude applies to all candlestick analysis and all markets.

In this case, the market had been selling off over a couple of days, before the down candle is engulfed by the bullish up candle. The body of the up candle completely engulfs the body of the down candle, after which the price action moves sideways for three periods as the market consolidates at this level. During this consolidation period the market absorbs the remnants of selling, as it prepares to move higher.

In the tug of war example it is the sellers who have put in one last huge effort before being overcome by the buyers who respond, with their coach urging them on and heaving the rope back as the sellers collapse in a heap on the ground. Once again, this price action can be imagined as a hammer candle, which is created in two time frames with the sellers moving the price lower in the first time frame followed by the buyers moving the market higher in the second time frame. This would be the case if viewed on an eight hour chart.

An overlay of one candle on the other produces the familiar hammer candle which, in this case would have an up body.

The same rules apply to the bullish engulfing pattern as for the bearish engulfing. The primary rule is the up candle must engulf the preceding one down, but again these rules need to be applied with common sense. The key is the engulfing candle should swallow the body of the previous candle, which should have minimal wicks.

Bullish and bearish engulfing candle patterns are once again great signals, which traders should pay attention to. The market is speaking and indicating a potential reversal. Traders need to validate the signal with other tools and techniques before deciding to take a position in the market.

To complete this section on my top three reversal candle patterns I want to end with ones called tweezers. Like the engulfing candle patterns tweezers come in two varieties, namely tweezer tops and tweezer bottoms, and again they signal potential reversal points on the price chart.

However, there is one key difference which is they only apply to the forex markets and fast timeframes and the reason is as follows.

As the name suggests, tweezers are a 'precision tool' designed with precision in mind. They are the weapon of choice for ultra fast scalping in the market. I suspect (and this is purely my own opinion) their power comes from the rapid rise in HFT (high frequency trading) which triggers buy and sell orders based on short term support and resistance. The concept of support and resistance is explained later in this chapter.

Moreover, tweezers are not suitable for trading longer term. However, they are most definitely a pattern for the scalping trader and should only be used on very fast time or tick charts. Whilst it is impossible to give a hard and fast rule here, I would suggest that a 5 minute chart is the maximum timeframe in terms of 'time based' charts, and for tick charts, somewhere between 50 and 100 ticks. Tweezers are a precision tool, and this pattern is designed to identify fast scalping opportunities.

To reiterate, please don’t use tweezers in other markets, but for forex they are a great candle pattern for short term trading.

The reason it is called a tweezer pattern is the name is derived from the shape they form on the chart. In the example in Fig 17.17 which is from a one minute chart it is easy to get a sense of the speed of the moves using these patterns.

The key point for this pattern is the high of the candle on each bar is identical, or as close to identical as possible, creating as it does a pair of tweezers. However, some flexibility is required. In this example the high of the second candle is marginally above the first, but that's fine, it is close enough to qualify as a tweezer top. What is also interesting in this example is the second candle is our old friend, the shooting star, so here we have a 'double confirmation' if you like. The tweezer pattern with the second leg of the tweezers being a shooting star, so adding a further element of confirmation to the pattern.

The significance of this pattern and what it reveals about market sentiment, is fairly straightforward. At a tweezer top the market has moved higher, with the buyers firmly in control. Ideally, the first candle in the tweezer top has to form with an up body and, preferably a long body with a nice wide wick to the top of the candle, as we have here.

The following candle in the pattern should also have a strong wick to the top of the candle and a long body as well, although this is not essential as we can see in this example. The reason for the deep wick is this is an additional sign of weakness. The market has run higher, but fallen back quickly. Then tried to run higher again before failing once more. All of this is signalled in the depth of the upper wick, and just like the shooting star and the hammer candle, the length of the wick is a key component to the strength of the signal. I cannot stress too strongly these patterns need to look like tweezers. Other candlestick books will suggest this is not important. This is not the case. The upper wicks must be long on both candles if traders are going to use this pattern for fast scalping.

What is interesting about tweezers is the second candle in the pattern can be either an up or a down candle, it doesn’t matter. The important point is the price has stalled at the same level. In other words, the market has hit and stalled at a 'resistance level' as though there is an obstacle in the way.

The buyers are now struggling to break above this price point which the sellers are defending. The sellers have created a barrier or wall and there is now an obstacle to any further move higher. This is one of the many analytical techniques used when considering price in terms of price patterns, namely support and resistance areas created by previous price history. What is happening here, in a very short time frame, is the price action has reached a short term barrier, from which the market reverses, before taking another run at this level some time later.

The tweezer pattern so created suggests weakness and is therefore a potential reversal point, as a result. Therefore, whilst the rules for a tweezer top pattern are relatively flexible, the key points are as follows.

First, the high price of both candles must be identical or as close as possible that visually they look identical. Second, the candles must have deep wicks to the upper bodies in order to create a true tweezer top.

Third, the first candle must be the same colour as the trend, but the second candle can be either up or down. And finally, the bodies of both candles should be long if possible which adds strength to the signal.

This then is the tweezer top, and the tweezer bottom is identical except it appears at the bottom of a fall and marks a potential reversal from a bearish trend to a bullish trend. Once again, it is an early warning to traders to pay attention. The same rules apply, with the key being the low of the two candles which must be close or identical.

In addition, the candles should have long bodies and deep wicks to the lower body. In a tweezer bottom the first candle should have a body which reflects the trend, but the second candle can have either an up or down body.

Here is a typical example in Fig 17.18. As the rules for tweezer bottoms are exactly the same as for tweezer tops I won't repeat them. However, it is essential that the lower wicks to both candles must be long, otherwise the strength of the signal is diminished.

Once again, the example in Fig 17.18 is from a one minute currency chart, where as you can see reaction to the tweezer pattern lasted for over 20 minutes, so this gives a sense of the short term nature of this pattern

These are my three top candles and candle patterns – the premier patterns and signals to watch. However, there are many others and in the next section I am going to look at several more which I consider both valid and useful. There are many others but, in over 20 years of trading and investing, I have found trying to follow too many is simply counterproductive. These candles and patterns are the ones which can be relied on to work consistently. Now let’s take a look at what I call secondary candles and patterns, which are less powerful, but work well in either validating those we have just looked at, or in providing alerts to pause points in trend.

The first one in this supplemental list is the ‘hanging man’. It has the same shape as the hammer, and is only known as a hanging man when it does not appear at the bottom of a trend.

The hammer only appears at the bottom of a trend, following a fall in the market and is therefore a possible reversal from bearish to bullish. When the hanging man appears at the top of a trend it is signalling the opposite. It is a bearish signal and is a potential reversal from bullish to bearish sentiment.

This is one of the characteristics of candles. Two candles with identical shapes can have completely different significance depending on where they appear on the chart or in the context of its place in a trend.

Here in Fig 17.19 is an example of an hourly chart where we have the same candle appearing at different points of the price action. The first hanging man appeared and was followed by a second several bars later, confirming the weakness in the market at this price level.

The market had been rising steadily with the buyers in control and the hanging man candle begins to form as the sellers come into the market. This drives the market lower, but the buyers aren’t finished yet and fight back pushing the market higher once more, before finally closing at or near the opening price. However, this is the first signal the sellers might be about to take control of the market. Despite having been repelled by the buyers on this occasion, it is a clear initial sign of potential weakness.

The sellers continue to build up strength, which may eventually overpower the buyers, thus ending the trend and creating a reversal in due course. In this particular example, immediately following the hanging man, comes another sign of weakness, namely, a shooting star. Now there are two consecutive signs of weakness, one after the other.

The price action moves sideways and remember what I said earlier, markets rarely turn on a dime, they take time to absorb any residual selling or buying pressure before changing trend. In this case, there were a further five candles of sideways price action, before finally on the sixth candle following the shooting star, a second hanging man candle appears, adding further negative sentiment at this level. Clearly the market is struggling at this price level, and following this third bearish signal, finally starts to trend lower and move into a bearish phase.

Although the hanging man is a secondary signal, when it is validated by a premier candle or candle pattern, its significance increases exponentially. It is only an early warning signal of a potential change in sentiment, but it has to be validated. In this case, part of the validation process was provided by the subsequent candles that developed on the chart.

The key points for this candle are the same as for the hammer. First, if the hanging man candle has a small body this can be either up or down, it doesn’t matter. The close can either be above the open or below the close. In this case, the open and close were identical creating the 'perfect' hanging man.

Second, the lower wick or shadow to the underside of the candle should be at least three times as long as the body and, as a general rule the longer the better. Finally, the candle should have no upper wick or almost no wick for the candle to qualify as a hanging man.

Another pattern I look for on a chart is called an 'inside day',as it can be an early warning signal. However, unlike the other patterns mentioned, an inside day can also signal a pause before the continuation of the trend, or it can be a reversal. In addition, and just to clarify, although the candle pattern is referred to as ‘inside day’, the pattern is perfectly valid across all time frames.

The key as to whether the signal is a reversal or a continuation of the trend depends on how the candles immediately following are created and for novice traders I would suggest this pattern is only used to confirm the continuation of a trend.

In this example in Fig 17.20, the market reached a top several bars earlier, before starting to sell off, moving lower in even candles. However, following the formation of the fourth candle, buyers entered the market, as evidenced by a narrow spread up candle. This buying is all contained within the spread of the previous candle, creating the 'inside' price pattern, where the price action on the small up candle is completely contained within the price action of the previous down candle. This is followed by an even weaker signal of bullish intent, before the market breaks to the down side again, confirming the original trend.

What is happening in this example is the market is in a strong down trend, but buyers have come into the market, attempting to take control. However, they have been swamped by the selling pressure. The initial bullish bar is weak with the buyers contained within the spread of the down candle. The buyers have been contained with the spread of the selling bar maintaining the integrity of the trend. The following bar is even weaker with a narrow spread up candle sending a clear signal. Finally the next candle breaks lower, and confirms the sellers are still in control.

This candle pattern has two uses. First, for traders who have not taken a position in the market, it is confirming the trend and is therefore an opportunity to enter a new position, once the market has broken below the inside day candle. Or, if a position has been taken in the market it is giving traders the confidence to hold that position and stay with the trend.

The principle of an 'inside' candle is that of market indecision. The market has paused and may reverse but, if it continues, as in this case, a move below the candle is confirming the trend remains strong. The key point here, like all candles, is to wait for validation and in this case, part of the validation process comes from the subsequent price action.

However, if the candle is not validated by a continuation of the trend, a potential reversal is in place. Just like the doji candle, this is signalling indecision and a possible turn in the market.

The chart in Fig 17.21 shows an example of both a continuation and reversal of trend. The market is moving lower and the first inside candle is validated as a continuation of the trend by the wide spread down candle which appears two candles later. However, after a further two candles, we see another inside day pattern, with the narrow spread bullish candle contained within the narrow spread down candle. The subsequent candle is a wide spread up candle, sending a strong signal this is a potential reversal of the trend, which duly develops into a strong move higher.

There is a degree of controversy surrounding this candle pattern and a continuing debate between what is considered to be the 'Western' view of this pattern and the pure Japanese description. To be honest, my own view is I simply apply the bullish and bearish engulfing principles we looked at earlier which constitute an 'outside day' candle pattern arrangement.

These then are my top candle and candle patterns which I refer to all the time when trading. They have all become second nature to me. Each candle and candle pattern tells its own unique story which is validated in ways I am going to cover shortly. As I said earlier, there are literally hundreds of other candle and candle patterns but, for me, these are the ones I have found useful in all my trading and investing, regardless of the timeframe on the chart.

To round off this chapter, I would like to devote the next few paragraphs introducing you to the concept of time in trading, which may sound rather obvious and perhaps even irrelevant. However, please bear with me, as it is absolutely fundamental to the way I trade using a technical approach, and one I hope more traders will adopt, not only because it works, but also because it is so powerful and just makes sense.

Imagine for a moment the forex market is like a pond and a typical trader is sitting in a boat somewhere in the middle. The trader drops a pebble over the side, and the ripples gradually move out across the pond until they finally reach the edge. This simple analogy is how I explain the concept of price action in the market and how it ripples out across the price charts.

Now imagine having 5 charts open, starting with a 5 minute chart, followed by a 15 minute, then a 30 minute, a 60 minute and finally a four hour chart. Suppose one of the red flag economic indicators mentioned earlier is released to the markets which reacts with a change in trend. Where is this reaction likely to be seen first in terms of the trend change?

The first reaction will appear and be seen on the 5 minute chart. If a trend starts to develop it then gradually begins to appear on the 15 minute chart and, as the market absorbs the data further this soon starts to ripple through to the 30 minute and, ultimately to the hourly chart before finally appearing on the four hour chart. By the time this reaction has appeared on the four hour chart, the trend is extremely well developed in the faster time frames and is just starting to take effect in the four hour chart. At this point this trend may even develop further and move out into the daily chart and beyond.

In this scenario, if a trader’s preferred time frame is the 15 min chart the change in sentiment will first appear on the five minute chart, before filtering onto the 15 minute chart, at which point a position can be taken in the market.

The change in sentiment then appears in the 30 minute chart and the trader continues to hold the position as the ripples extend further, finally reaching the 1 hour chart and, ultimately the four hour chart. By this time the trader is a holding a very strong position in the market, having ridden the trend higher, watching the lower time frame charts for signs of any pullbacks or reversals, and the higher time frame charts for signals the trend is continuing to build and extend in these slower charts.

What I have described here is the core principle full time traders adopt for trading any market. It is the approach I employ in every market either speculatively or for longer term investing. All that changes is the timeframes of the charts I consider. For speculative trading it’s minutes and hours, for investing its days weeks and months.

The principles are very simple and based on the concept that if you are trading with the dominant trend in a slower time frame, the risk on the trade is that much lower and the probability of success that much higher. After all, a long position on a 15 minute chart, which coincides with a bullish dominant trend on the 30 minute charts means trading with the trend and not against it. In other words, swimming with the current. Of course, there is nothing wrong in trading against the dominant trend, it simply means the risk on the position is higher and any trade is unlikely to last very long.

In the same way that relational, fundamental and technical analysis gives you a three dimensional view of the market, so this approach to the charts, gives you a three dimensional view of the price action. Long gone are the days when a trader could simply watch one chart. This simply does not work. There are too many forces, too much volatility and too many complexities for such a simplistic approach to produce consistent profits week in and week out.

The combination I use is as described above. In other words, three charts, using the middle chart as my entry, and the two charts either side as my view on what is happening in the faster and slower time frames. If I have a position and the trend does not develop on my slower time frame chart, and my faster time frame chart seems to be confirming this view, I exit. If the trend does develop in the slower time frame chart, this gives me the confidence to hold the position. Even more so if I am trading in the direction of the dominant trend on the slower time frame. And, as I said earlier, I take exactly the same approach when trading using tick charts. The principle is identical with three charts, slow, medium and fast, taking any positions in the middle lane and watching for signals on either side.

Finally, this approach not only gives us a powerful methodology for trading, but also trading with increased confidence as we are trading with the trend and not against it.

Furthermore, it also gives us another powerful weapon to validate price action. After all, if a signal appears in one time frame, which is then validated with a confirming signal in a slower time frame, this is yet another powerful analytical tool. In this case, it is price validating price and, whilst there are many other tools and indicators, this is one of the simplest, yet under utilised of all trading techniques.

Consider this as a simple example.

On a fast time frame chart a shooting star candle appears suggesting a reversal which is duly confirmed on the medium time frame chart with a similar candle, and a position is taken. Finally, on the slow time frame chart, perhaps a bearish engulfing pattern appears, adding further confidence and confirmation the trade is with the trend and the market is now turning bearish. A simple example perhaps, but one which I hope starts to paint a picture for you. I cannot stress how powerful this approach is to understanding market behaviour.

If it is a technique you have never used before, it will revolutionise your trading. It is simple, powerful and effective and will give you that three dimensional view of price action. This is underpinned by using the relational and fundamental analysis explained earlier in the book. This gives us a complete picture of the market.

There is also one other immensely powerful reason for adopting this approach, and that’s in exits. If there is one area of trading which virtually all traders struggle with, it is in getting out of the market once in. Getting in is the easy part, and as you will see in the next chapter, when we combine the power of the candles and candle patterns with volume I have described here, this is simple. But when to exit? This is always the problem and perhaps the one area of speculative trading that requires a great deal more research.

Full time traders like myself are generally discretionary traders in terms of exits, and these are often dictated by price congestion region, changes in the volume and price relationships at various levels, and sometimes just on trading experience and instinct. This is hard to teach and is only learnt through years of experience and studying charts and price behaviour. However, this is where multiple time frames help enormously and make the job easier.

Well put simply - they are once again giving you a three dimensional view of the world. A three dimensional view of the price action. If the market is perhaps running into resistance on a 30 minute chart and you are trading on a 15 minute chart, then perhaps this is time to close the position, and take your profit off the table.

This is what trading in multiple time frames gives you, not just the opportunity to see a trend developing, but also, and perhaps more importantly to see when a current trend is running out of steam. As I said earlier, getting in is easy, getting out is the hard part, and using multiple time frame charts will help you enormously.