Technical analysis is the study of actual movements in the price of a financial product. However in my opinion, technical analysis is less about trading and more about the study of mass psychology. We study the way people react in certain situations in the market, which is quite prevalent when identifying and trading using chart patterns.
This is particularly pertinent in one of my favourite candlestick patters – the marubozu. In the image below, you can see a variety of different candlesticks. Here, the extremities of the symbol represent the high and low price, and either end of the body of the candlestick represents the open and the close of each period’s price.
Extending from these candlestick patterns are theoretically an infinite number of possible different patterns. There is extensive material available on different types of patterns and their interpretation.
One of my favourite candlestick patterns is the marubozu. In simple terms, a marubozu can be described as a long candle, relative to other candles in recent past. Its shadow length relative to the body is very small. A perfect marubozu has no shadows although these are quite rare.
A marubozu is shown towards the end of the chart of the British pound (GBPUSD) below showing the pound moving from below 1.28 to near 1.30 within one day. Notice it is by the far the most significant and largest bodied candlestick in that series.
A marubozu is also sometimes referred to as a dominant candlestick or a significant candle as it shows very strong control by either buyers or sellers. There is tremendous momentum in place when a major currency pair moves so far in a short period of time. Obviously, longer candles tend to yield stronger signals.
Having extensively studied client trading information in the past, I can tell you that often the majority of traders trade in the opposite direction of a marubozu. Therefore, after a strong upward marubozu many clients will sell in the expectation that price has extended too far and is likely to fall. This is rarely the case due to the amount of momentum in place.
However, often price doesn’t return to levels prior to the marubozu candle and if it does, it can take some time. Do your own research and draw your own conclusions about the effectiveness of the marubozu candlestick and what you think is most likely to occur after one happens.
Below is another recent example of a marubozu in the Australian dollar (AUDUSD) where the Australian dollar has surged higher, yet price has immediately returned to pre-marubozu levels. Yet traders often trade against these dominant candlesticks.
What the candlestick is representing in the price action, is far more important than demanding perfect candlestick shapes.
In a marubozu candlestick, the fact that the opening and closing prices are so far away from each other means there has been clear dominance by one side of the market – either buyers or sellers. However more importantly if the marubozu range (low to high) is significantly greater than the average, it demonstrates what little opposition there was to the move.
You will see in another example below in the price of gold (XAUUSD), where there is a clear dominant candlestick and price hasn’t gone close to returning all of the gains from that one daily candlestick.
Another interesting thing about marubozu candlesticks is how far price can continue to move in that same direction afterwards. Many would believe that once price has moved so far in a particular direction, that price has exhausted and must return.
In this example below in the US major index, you will notice how strongly the market fell in that one red marubozu candlestick, however the market fell that more than that distance again in the few weeks afterwards. The marubozu candlestick should have been a clear sign as to how much control the sellers had.
An important point to consider when looking for marubozu candlesticks, is that while you may never trade in the same direction as the, you should definitely trade against them. Otherwise you are reasonably likely to be run over as the market continues to move in that direction. Even if it doesn’t continue, history has shown that rarely does price reverse immediately and consume all of the move from the candlestick.
There is no right or wrong way – what is important is you find an approach that you are comfortable with and then stick to it.
There is a well-known saying in trading which says, “trade what you see, not what you believe”. The chart will tell you everything you need to know and marubozu candlesticks can provide us great insight into the interaction between buyers and sellers.
Unfortunately in this environment, what we think and believe counts for nothing. Remain objective and let the chart tell you precisely what is happening.
About Stuart McPhee
Stuart McPhee has traded for over 20 years and is the author of the best selling book Trading in a Nutshell, 4th Edition. He is one of Australia's most compelling speakers on trading and has personally coached high net worth traders all over the world. Since 2001, he has spoken live in front of tens of thousands of fellow traders from Mumbai to New York, Tokyo to London, Melbourne to Beijing, and many places in between. He has helped countless traders improve their performance with his expertise in technical analysis, trading psychology, risk management, the trading process and developing a trading plan.
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