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One of the most commonly used technical indicators across all markets is the Relative Strength Index or RSI. Developed by an American technical analyst named J. Welles Wilder, the RSI is a momentum oscillator (whereby oscillators are the most common type of a technical indicator) used primarily by traders to identify the speed and change of price action. The standard setting for the RSI is the 14-period average that oscillates between 70 (cross above is the overbought region) and 30 (cross below is the oversold region). RSI can be used in any timeframe relative to your trading objective.

For those who are puzzled as to what the RSI is, a simple analogy for it is a car’s speedometer. Say you’re driving down South Luzon Expressway (SLEX), the minimum and maximum speed for a car is 60kph and 100kph, respectively. Let’s consider the minimum and maximum speed limit as oversold and overbought. When you go over the speed limit of SLEX, say you’re going 160kph, you’d still be able to go from point a to point b, but the risk of getting apprehended or a vehicular accident is now doubled, if not tripled. Same goes on with RSI, when you entered/bought stock in the overbought region, say in the 90 levels of the RSI, the odds of the stock pulling back is high (meaning it will depreciate in price value due to profit-taking overwhelming buying). So, it’s more likely that you’ll end up in a loss rather than a gain.

The RSI is often used for the following reasons:

• To identify overbought and oversold conditions
• To spot classic and hidden divergences (bullish and bearish)
• To serve as a leading indicator to generate buy and sell signals

Overbought/Oversold Conditions

The chart below shows you the overbought and oversold levels of the RSI (14-period). A stock can proceed to go lower than the oversold line (30) or higher than the overbought line (70) depending on the speed of the movement of price.

The RSI readings below show that a stock can proceed to go over or under overbought and oversold regions and still go into the same direction.

Overbought conditions can be used as a signal to trim down your shares when you are in gain to cash-in some of your profits. It can also be used as a possible signal that a pullback is about to impend. So if you’re the type of trader who’s good at pullback setups, then this may be of use to you.

Oversold conditions, meanwhile, can indicate a possible exhaustion in selling. This is where traders who trade bounce plays sometimes look at when they identify their trading setups.

Note that it would be unwise to passively buy stocks just because they’re oversold or to automatically sell all your position when it’s overbought. Always be systematic when buying or selling so that you won’t let greed, fear, or hope, take over your trading.

Divergences

A divergence indicates a possible change or reversal in the underlying trend. It happens when price is not “in-sync” with momentum. Divergence is not limited only to the RSI as this could also be seen in other indicators such as Moving Average Convergence/Divergence (MACD) and the Commodity Channel Index (CCI), to name a few. When divergence is found in a higher timeframe (like weekly, monthly), it’ll give a much stronger signal.

There are two types of divergences: the bullish and the bearish. When looking for the latter, search for lows. For the former, look at the highs.

Bullish Divergence

A bullish divergence (positive divergence) happens when price makes a lower low whereas the momentum indicator makes a higher low. This means that there is a high probability that selling-pressure is weakening and buying (demand) could soon take over.

After Metro Pacific Investments Corporation (MPI) generated a bullish divergence using the RSI (14) in the 1-hour timeframe, it went on to break the previous high around 4.65/sh and then created a higher high around 4.75/sh. It also created a higher low in the few candlesticks. The bullish divergence signified the change in trend, from a downtrend to an uptrend, for MPI.

Below are a few more examples:

Bearish Divergence

A bearish divergence (sometimes called as negative divergence) happens when price makes a higher high but the momentum indicator makes a lower high which means that the buying momentum was not strong enough to warrant a new high. It could be an indication that buying is waning down, and profit-taking is imminent.

Divergence can be as subtle as the one you can see below. The angle of the slope line may not be as angled as the previous charts you saw. But if you observe closely, the exact RSI reading of the high on the left (RSI = 92.3651) from the high on the right (RSI = 91.4676), it would show that it indeed made a lower high. And as you can see on the right side of the chart, the stock went on to start a downtrend (series of lower lows and lower highs).

Hidden Divergences

Hidden divergences are different from classic divergences. The latter indicates that there could be a reversal (uptrend to downtrend or downtrend to uptrend) to the underlying trend, whereas the former could sign as a continuation in the current trend. The theory of “buying the dips, selling the rallies” may be utilized here.

Hidden Bullish Divergence

Hidden Bullish Divergence often found during retracements in an uptrend. As you can see in the chart below, San Miguel Corporation (SMC) is in an uptrend when the hidden divergence is spotted during the pullback in price action. The concept of “buying the dips” can be used here.

Hidden Bearish Divergence

This type of divergence tells us that there is a strong likelihood that an underlying downtrend will continue. Holcim Philippines, Inc. (HLCM) shows us how this works. We can see that price action made lower highs whereas the RSI created a higher high, an indication of a continuation of the downtrend. The concept of “selling the rallies” can be used in this regard.

Potential Buy and Sell Signals

The RSI can be used to generate entry and exit signals if coupled with other indicators such as the MACD or even just price action itself. If you backtest the divergences above and have a proper grasp of candlestick patterns and support and resistance, then you may utilize the RSI in your favor. It will help you craft your trading techniques so that you would be able to develop your own system to trade the market.

If confused, always remember:

• A bullish divergence (price action gives a lower low, momentum indicator shows a higher low) indicates a reversal from a downtrend. Look for the lows here.
• A bearish divergence (price action makes a higher high, but momentum indicator creates a lower high) indicates a reversal from an uptrend. Search for the highs here.
• A hidden bullish divergence signifies a continuation in an uptrend. Observe the lows here.
• A hidden bearish divergence suggests a continuation in a downtrend. Spot for the highs here.
• Classic divergences are a possible reversal of the underlying trend.
• Hidden divergences are a possible continuation of the underlying trend.

In conclusion

At first, it would be difficult to understand the RSI especially the signals it gives off. It is essential to train your eyes as you progress in technical analysis because it will help you handle future market opportunities, so there’s no reason to rush and get impatient. You won’t be able to memorize all these jargons in one read, so take notes, backtest, and be patient.

Trust in the process as trading is a journey! ?

In the stock market, there are only two certain outcomes: The possibility of making a profit and the opposite. However, almost all new beginners in the stock market wrongly think of it as something that could only give them positive returns or capital gains a.k.a. reward (cue that cash register sound) without the thoughts of uncertainty and volatility. Most of them have it even planned out already the night before or the moment they put up their bid. “The moment I earn X amount of money I’ll be able to afford this and that!” They get blinded by the huge gains they could possibly earn. They approach the market the same way they expect a gift from their godparents during Christmas and mesmerized at the likelihood that their empty, skinny wallets will eventually get filled with crunchy new cash.

The truth is, the market is inevitable, and every great trader who was once an amateur also made losses in the past. There are many reasons why a trader ends up losing money, but the main reason for such cases is the inability of managing risk. The partner outcome of any closed trade is the risk and this is what professional traders and even successful poker players think of prior to the reward. They understand that trading is a game of probabilities. They either win and gain or lose money. As Mark Douglas puts it: “Learn to accept the risk. When you accept the risk, you won’t perceive anything that the market can do as threatening”.

How to combine RISK and REWARD with trading?

One of the most basic yet indispensable part in trading is: RRR or what we call the ‘Risk-Reward Ratio.’ One of the most popular RRR for starting traders is 1:2 risk/reward which means that your trade should earn twice the amount of money you’re willing to risk.

For instance, trader A has finished screening and found a stock that meets his system’s parameters, his Target Price (TP) should be twice the value of what his set cut loss’ value is. So if his cut loss value is worth P1,000, then his TP should reward him the value of P2,000. In this way, if he ever incurs three consecutive losing trades, it would only need him two winning trades to recover his losses and turn a profit.

How to use the risk/reward ratio in InvestaChart?

1. In InvestaChart, select the 7th button from the leftmost part of the chart. It should read “Long Position” when you hover your mouse over it.

2. Determine the area where you will place your entry, stop, and target price. In this case, there’s a candlestick pattern for a pivot low play on the right part of the chart. So let’s set the entry at 2-3 fluctuations above the high of the last candle and set the stop to 5 fluctuations below its low.

3. Here’s how it should look like. This trade will net you a whopping risk/reward ratio of 4.42 if it materializes! Do note that the amount here is relative to your account size and risk.

4. Here’s how the trade played out.

Luckily, the second candle did not hit the set stop loss and it was followed by consecutive bullish candles, hitting exactly our target price.

Conclusion

Understand that risk should always precede reward when trading. Why? Because trading is a business riddled with uncertainty and should be approached with the utmost discipline you can master. In trading, especially when you are first starting out, it is normal to incur more streaks of losses than winners. With the proper use of the risk/reward ratio, you should be able to recover your losses and grow your portfolio in the long run with sound risk management. By properly utilizing the risk/reward on every trade you take, you are approaching the market the right way.

Always remember that trading is a marathon, not a sprint. The risk/reward ratio is your toll to achieve longevity in the stock market.

One of the most fundamental concepts any trader should learn in the stock market is finding the support and resistance levels in a chart. The beauty of these areas or zones is that it will help you identify where the supply and demand are – the two major forces that move the market. Knowing these two validates your points of entry and exit when entering a trade.

Whenever the market needs to accumulate and distribute shares at different price levels, the stock goes to unprecedented price levels (upwards or downwards), and new support and resistance will be formed. On the other hand, if a stock is moving sideways, then the price will gravitate towards to as it waits for a breakdown of support or breakout of resistance.

Identifying Support and Resistance:

Support

The support area is where the market prevents the stock from declining further. The market psychology behind this is that the buying power is strong enough to hold a price. During market movement, the price declines and moves towards these levels where the buyers (bulls) acquire a stock price at the same area and eventually overcome the selling pressure made by the bears (sellers). In short, buyers look at support levels as a buying opportunity.

The chart below shows you how support prevented the stock from declining further on numerous occasions, forming a “floor” of support.

Support can also be identified while the stock is trending upwards or downwards and based on the chart below, buyers supported the stock from reversing from its uptrend. As the stock created dips or retracements, buyers saw this as an opportunity to ride the trend or to add shares to their current positions. These collective market decisions continually overwhelmed all the profit taking and selling pressure from the bears that helped sustain the uptrend.

Alternatively, the support depicted here in the next chart below suffered a different fate compared to the previous one. Buyers here tried and tried again to prevent the stock from trending lower, but the selling pressure was overwhelming enough that it created a downtrend or a series of lower lows and lower highs, breaking down each newly formed support.

Resistance

The area or level that prevents a stock from moving upwards is called resistance. This is mainly because the majority of the sellers are selling at a certain price level of a stock that ultimately overpowers buying pressure.

The chart below showed how the resistance is formed during April acted as resistance again during the last week of August and early October. It went on to become the stock’s ‘roof’ where price keeps getting rejected to move up way pass the current resistance levels. One possible reason is that the investors who bought during the high in April continually sold their positions during the highs of August and October as they break even and exit.

During downtrends, resistances can be seen in a descending trend distinguished by lower highs and lower lows where buyers are not strong enough to overpower the sellers.

Meanwhile in uptrends, because of the underlying buying pressure from the bulls, resistances keep on forming higher highs as they become more willing to pay a higher price for the stock.

Here are the things that you need to take note whenever you look at the support and resistance levels:

– Support and resistance occur in all timeframes.
– In general, the more often an area is ‘touched’ and not broken, the stronger the area is.
– Support becomes resistance: If the price falls below a support line, then the demand for that price wasn’t strong enough to keep the support line intact and the traders who bought at this levels are now stuck in positions at a (possible) loss.
– Resistance becomes support: if the price is broken way pass the resistance line, then the resistance level is now considered as new support.
– The common notion for traders: Buy low (support) and sell high (resistance).

Helpful Indicators:

The indicators below are just a few from a plethora that adds additional support and resistance. Further research about these two indicators is highly recommended before incorporating it into your trading system.

Fibonacci Retracement (FIBO)

This indicator provides support and resistance from its formulated ratios. Simply put, if the FIBO plotted from swing high to swing low, it will identify possible resistance levels. If the chart is plotted from swing low to swing high, it will display possible support levels as a stock retraces from its high which is useful for a bounce on support traders.

Moving Average (MA)

The moving average approach sometimes serves as dynamic support and resistance utilized by some traders. They’re called dynamic because they move along price movements. The chart below shows how the 50-day moving average served as resistance for several times for this stock.

Summary

Support and resistance can be subjective at times mainly because some traders plot them at wicks while others plot at the body of a candlestick. Some traders use the indicators above to find confluence in support and resistance levels/areas while others prefer a more straightforward approach by only plotting them in their structural form. It is also essential to examine how a candlestick closes at a support or resistance level and/or whether it closes above or below it.

Major market players (institutions and fund managers) influence the direction greater than retail traders. There will be times where they could “dictate” support and resistance levels as they significantly provide the supply and demand in the market. They would sometimes trigger breakout traders to buy at the break of resistance only to sell hard on them, creating a liquidity pool to distribute their shares. They may also trigger some traders to exit their positions as their stops are hit below support only to close above support again as these major market players needed the former’s shares in order to allocate more.

As the market trends upward, resistances will be tested. As it trends lower, support will be tested. The market volatility can make or break traders as they look for their preferred setups and trading decisions will be are made at these levels – whether in buying or in selling, in entries and exits and from trigger prices to cut loss levels. That’s why understanding the support and resistance levels of the stock you’re trading is more important than knowing how to click the buy and sell button.

Safe investing!

At first, reading stock charts can be daunting and confusing. Some beginners just focus on the zigzag pattern a chart displays and rely on their hunches and gut feels whenever they feel like the market is about to turn in (or against) their favor. Although it may earn them a few gains or so in the beginning (assuming luck is on their side), it won’t be good for them in the long run. Speculation is wishful thinking, and betting on a stock without proper knowledge of trading is very risky as it may cause a person to lose all his hard-earned money in no time.

There was a time when I was charting during office breaks and one of my colleagues asked me whether it would be good to buy the stock I’m looking at since it seems like it’s about to go up and ‘to the moon’ (a trading term which means that a stock is on top of the all-time high).

Unbeknownst to her, the stock was not really a “stock” because what she was referring to is the chart of the Philippine Stock Exchange Index (PSEi). She told me later on that she bought shares from First Metro Philippine Equity Exchange Traded Fund (FMETF) which is akin to the chart of the PSEi.

I told her that based on the price action (candlestick formations) of the chart, there was a high probability that this would be bearish in the coming days because of the evening star (bearish abandoned baby, shooting star or pivot high in some books) candlestick pattern in confluence with the bearish divergence from my RSI’s setting. Unfortunately, she did not consider my honest analysis and went on to heed the post from a Facebook Group recommendation that she joined recently.

Today, she’s in a dilemma because she’s seeing red amounts in her portfolio (she’s losing her money). Why? Because she bought somewhere in the 9,000 levels of PSEi equivalent of the index fund she bought even after a new calendar year. In hindsight, maybe if she knew how to read candlesticks then perhaps she wouldn’t have had bought then, right?

The above story is one of the precedents as to why a beginner or newbie investor should consider studying technical analysis, especially how to read candlesticks.

This is what the article is about – the foundation of technical analysis: CANDLESTICKS. Learning candlestick patterns bolsters our ability to trade the market more successfully.

Here are five reasons why learning how to read and interpret candlesticks will help you tenfold:

1. It will teach you how to think in probabilities.
2. It greatly improves your odds for a winning trade.
3. You will learn how to come up with your own analysis.
4. You will know who’s winning: buyers (bulls) vs sellers (bears).
5. This will be the “blueprint” for most of the trading setups you’ll trade.

Open, high, low, close, body – the parts of a candlestick

When looking at a candlestick, it is important that you know the open, close, high, low, as well as what the body and even the range is. For the following examples, we will use green (when the candle is trading or closes above its open or commonly known as Bullish Candle) and red (when the candle closes or is trading below its open or the Bearish Candle) colored candlesticks.

Open

This represents the first price bought of the timeframe of your candle. If the succeeding transactions are higher than the open, then the candlestick will become color green, but if the next trades after the open are below the open, then the candlestick will turn red.

High Price

This shows the highest price traded during the period/timeframe of the candle. This is represented by the upper wick/shadow. If ever there’s no wick/shadow, then the open or close price is the highest price.

Low Price

This displays the lowest price traded during the period/timeframe of the candle. Same as what you see in the high price, there should be a wick/shadow but in this case it’s in the lower part of the candle. No wick/shadow means that the close price is the lowest price.

Close

This is the last price sold or the last transaction of the timeframe of the candle. This will ultimately determine the color of the candle. If the last traded price closes above the open, then the candlestick should be color green. Meanwhile, if the last price closes below the open, then the candlestick should be of red color. It is the most important part of the candle as this determines whether the bulls (buyers) or bears (sellers) won.

Wicks/Shadows

These are simply the lines that represents the high and the low price. The upper wicks/shadows represent the high price whilst the lower wicks/shadows depict the low price. Wicks can be long or short depending on volatility.

Range

This is the difference between the high and the low of the candlestick. The bigger the range, the more volatile the candlestick traded during its timeframe as the buying pressure battles with selling pressure. The smaller the range, the less volatile it was (could also represent as consolidation). The formula to compute this is: Range = High – Low.

Body

This is the color-filled section of the candlestick. The color of the body gives us the clue as to where the course or the bias of the candlestick is headed (either upwards or downwards). If a candlestick closed well above its high without lower and upper wicks, you can expect that buying pressure will carry over somehow on the next candle.

In InvestaChart, the open, high, low, and close is conspicuous. It can easily be seen on the right side of the stock’s name just by pointing your mouse over a candlestick.

Here are a few examples of basic candlesticks. The following interpretations are also indicated:Some examples of candlestick patterns:

Bullish Engulfing

The candlestick pattern within the blue box in the middle of the chart is called a “Bullish Engulfing”. A bullish engulfing is a two-candle bullish reversal pattern. It happens when a candle’s body fully engulfs the body of the previous candle after a declining trend. It tells you that there’s a high chance that selling is waning down and that the buyers are now present. The next candles after the pattern shows that the buyers were indeed present.

Evening Star

What you see here is the “Evening Star” bearish reversal pattern. It’s a three-candle stick pattern that involves a prior uptrend. The first candle should be strong and bullish, the middle shows weakness in the trend, while the third and last candle gaps down, making strong selling pressure felt.

Harami

Another candlestick pattern is called “Harami” whereby the pattern will contain two candles and the second candle is smaller than the first one. The smaller candle (second) stays alongside the midriff of the larger candle (first). Note that only the body needs to be inside the first candle, the wicks are irrelevant. Generally, the Harami pattern is a sign of a changing trend and can either be bullish or bearish.

“Never invest in a business you cannot understand.” ~ Warren Buffett

There are plenty of other patterns you can trade out of candlestick formations. This can help you get in and out of your trades with confidence and prudence. Combine candlestick reading with learning how to draw support and resistances, reading trends, use momentum indicators, screen stocks, utilize a few indicators, journaling, and risk management, then you’ll be ready come up with your own trading system. Afterwards, you should be ready to trade after doing proper back testing of your setups or strategy.

Once you have trained your eyes on how to read candlesticks, charting will not be such a mundane task as before. You’ll come to the market well prepared and ready to face probabilities. And remember, always be responsible for the results of your market-related decisions and do your own due diligence.

Best of luck!