5 vital signs to read in candlestick charts

I used to love watching ER – I don’t mean the reality ones with drunk people being scraped off the pavement in Benidorm, I mean the old one, with George Clooney coming through the sliding doors, knocking the Chicago snow off his gloves.

It’s one of those shows that introduced us ordinary folk to a whole new vocabulary as they wheeled patients on trolleys shouting out their ‘vital signs’ and a load of numbers – I had no idea what they meant, but it sounded really exciting!

The ‘vital signs’ they’re interested in are stuff like your heart rate, blood pressure, respiratory rate, temperature … things that give an instant picture of your health.

So, what if we could use a similar system to give us an instant picture of the markets?

When you fire up your charts, you’re faced with a load of candlesticks … it can be tough to build a picture from this. A spike here or there might catch our attention … a trend up … a trend down … sometimes it just looks like a mess … so how can we gather the information from a chart that really matters?

Whether you’re new to reading candlestick charts or not, we can all do with a system for reading ‘vital signs’ on them. That way you can have an instant picture of the market health.

1. Basic anatomy

First off, I’ll just cover the basics of how to read a candle. If you’re familiar with candlestick charts, this will be familiar to you. But please bear with me …

Every candlestick on your chart represents a period of time. If you’re looking at a daily chart – each candlestick is a day. If you’re looking at a 5-minute chart, each candlestick represents 5 minutes … and so on.

Within that candlestick, you can find information about where the price stood at the beginning of that time period … where it stood at the end of that time period … and any extreme highs or lows it reached during that period …

Sounds simple enough … but when we’re faced with a screen showing a hundred of these candles, it can be hard to know what they’re telling up …

2. Big picture

The first thing to do when you’re looking at a candlestick chart, whatever timeframe you’re trading is to look at a longer timeframe.

For example, if you’re a day trader who normally trades 10-minute charts – look at a daily chart.

What this does is give us a reminder of the bigger picture. It’s easy to feel bogged down by a chart that looks like this …

But when you view it in context (the day’s trading shown above is in the candlestick marked with the red arrow), you see that the price has taken a pause in an uptrend …

Immediately we have an idea of where prices might be going and forces that might be limiting them.

3. Key levels

While you’re still in the longer timeframe, mark off a few key levels that might be relevant to today’s trading – are we near any historical levels of support and resistance?

In the chart above, for example, there’s support at the upward sloping trendline – we expect prices to bounce upwards if they hit this level.

Or in the following chart we can see the key levels that we expect today’s prices to turn at, as they struggle to move through resistance levels or bounce upwards from support levels …

 4. Pattern recognition

Some people’s brains are just better at spotting patterns than others. Apparently it’s to do with our visual perception and is linked to why I can never find the car keys, but my wife can find exactly the piece of paper she’s looking for under a mound of junk on her desk.

But fortunately candlestick patterns aren’t as well hidden as my car keys usually are … so, with a little practice, it’s easy to pick out the important ones.

The patterns we want to spot instantly are the consolidations. These are the ‘breather’ periods – when prices are trending upwards or downwards, they don’t just chug along in a straight line. Instead, they move upwards, then they’ll consolidate – this could be a period or sideways movement or a pullback – then they resume their trend.

It’s a very common pattern that we can spot all over charts. Consolidation patterns come in various guises: rectangles, pennants, flags, triangles … but the basic thing we’re looking for is the price bouncing between two tight lines (the lines are either parallel or moving closer together) …

I don’t want to get too hung up on identifying what kind of pattern we’ve found or how we can trade it – remember this is just our ‘vital signs’ check …

Other main patterns to watch out for are important reversal patterns, like a double top or a head and shoulders. Bear in mind that prices are trending and consolidating most of the time, and really don’t reverse so often. But when these do appear, or if they look like they might be forming, you should be aware of them …

5. And now for the close up

Finally we can zoom in on individual candlesticks that offer important clues about what’s going to have next. There’s a reason this comes last – candlestick reading is all about context. In isolation it’s impossible to read candles – they need to be see within a trend, or at a reversal, on with a breakout of a consolidation period …

Hammers and shooting stars have small bodies and long wicks. When found in a downtrend, a hammer is a bullish signal. When found in an uptrend, a shooting star is a bearish signal.

Engulfing patterns consist of two candles, where the second has a different colour to the first and is larger, engulfing the entire body of the first candle.

There are lots more candlestick patterns you can be looking for, but these two are, in my opinion, the easiest to spot – and the most useful.

It’s always worth flicking back to ‘big picture’ charts – if the last daily candle was an engulfing one, what clues does that give us about tomorrow’s prices?

Once you get used to looking at charts this way, it’ll soon become second nature. And, at a glance, you’ll be able to say something like … vital signs are consolidation pattern within an uptrend, engulfing pattern suggests we should look for breakout at 1376 with a target at 1426 and support at 1315 …

George Clooney eat your heart out.

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