Anticipating candle and chart pattern formations

As traders, we are already warned enough about staying away from predicting the market. However, as traders, we always have to anticipate how far and for how long the market will keep moving in our direction without reversing. As traders, we always expect that our target will come before our stop loss is hit. So let me throw some clarity on how I distinguish between prediction and anticipation, by quoting two thought processes that come to most traders, just before they enter any trade.

"Prices have been going up for a long time, and I feel the top is nearby. If this is true, then the fall will be quick and sharp. Let me take a short position right now, so that I do not miss the trade. I will need a slightly larger stop loss and the wait and risk is worth taking right now."

The above thought process is clearly predictive in nature, and should be avoided at all costs. 

On the other hand, look at the following thought process, which is clearly anticipatory in nature.

"Prices have been moving up for now. But the current hourly candle which is about to close within next 2 or 3 minutes, has a contracting range till now. If the range does not expand within the next two minutes or so, it will most likely form a doji at the top, which could be a reversal pattern. The risk involved is clear as upward range expansion would be evident within the next two minutes and so let me take a short trade taking that risk into consideration for the next 2 minutes."

The above thought process is anticipatory in nature because it considers the possibilities of a favorable pattern forming and identifies what evidence if appears on the screen would shatter those probabilities.

Also as in any other business, and since we are considering trading as our business, we should be able to anticipate opportunities, stock up well in time for en-cashing these opportunities and to be able to identify threats that could be lurking around shattering these opportunities. Luckily, as traders, we always have our stop loss as our plan "B" which enables us to exit quickly.

In this article, we will focus on honing our anticipatory skills by considering a few candle formations and chart patterns.

The first thing to keep in mind before even venturing into anticipation, is that one has to be patient till at least 60% to 80% of time in the life of that candle has elapsed. That means, if you are looking at the 10 minute chart, your anticipation starts only after passage of 6 or better still 8 minutes duration of that candle. On a hourly chart, I always start the anticipation process after the 55th minute. 

Now let us turn our attention at the actual process of anticipation.

Most of us are aware, that a pin bar at the bottom of a chart is a strong indicator of a fresh up move starting. But how many of us are really aware of the fact, that for a pin bar to form, the candle must be a deep red candle before it turns into a pin bar? Typically, these deep red candles go on remaining deep red candles till the very last phase in its life, and then in the very fag end, the prices start moving up, turning this very candle into a pin bar. Most traders join the rally, much after the pin bar is actually formed, and some even wait for confirmation of follow up buying. But a trader who anticipates a deep red candle at the bottom to turn into a pin bar will be in trade already whereas most of these traders who were sucked in by the deep red candle would be exiting their short positions pushing the price further up. In the next candle, if the follow up buying does not emerge, the anticipating trader would be ready to exit with a small profit, while if the follow up buying emerges, he would be ready to ride the trade.

Another similar example is that of the evening star pattern. This pattern involves a set of three candles, the first one being a large green candle, the second one a small candle on top of the first candle, and the third one a large red candle below the second candle. So when on top of the chart I see a huge green candle followed up by a shrinking candle, I am on the lookout for whether a evening star might form. And when the third candle starts trading below the top or close of the first candle, and if not much time is remaining for the close of the third candle, I would take a anticipatory short position with a stop loss above the high of the second candle.

Let me articulate another example. In this example, I am also discussing a time frame which is not much discussed around. Although this is the only time frame in which all indices in the Indian market are traded, it does surprise me that there is almost no discussion which occurs keeping this time frame at the center of the discussion. People always talk about and look at hourly, daily, weekly and monthly time frames, but have you ever heard of a series to series time frame? At least I have not. While all the trades in Nifty and Bank Nifty Futures and their respective options, are done on a series to series time frame.

Following is a chart which depicts the movements of the Nifty Spot from one series to another since June 2013. Each candle here represents one series, starting from the last Friday of the previous month and ending at the last Thursday of the current month.

Looking at the above chart and the last two candles (Jan & Feb 2018) the following facts are evident already

• Prices have been moving up in a upward sloping channel consistently.
• The average range of each candle is about 500 points, whereas the last two candles are having a range of 700 and 900 points already. Range expansion is clearly evident.
• The current candle not only is threatening to violate the support of this channel, there is also a threat of Bearish Engulf pattern to emerge at the top of a good up move.
• The current candle (Feb 2018) is already 10 days through its life with another 8 sessions to go before its close, so it may be time to start the anticipatory process.

Having noted the evidence, now for the anticipation.

• For the Bearish Engulf to sustain, prices need to keep below the open of the Jan 2018 candle which was at 10492 ( say 10500)
• For the Bearish Engulf to get violated, the candle must close above 10500 on 22nd Feb 2018. The first signs of this happening would appear if a daily close is above 10500 and would get confirmed with two consecutive closes above 10500 levels.
• For the upward sloping channel to get violated, prices need to close below the low of the Jan 2018 candle 10408 (say 10400). The first signs of this happening would appear with a daily close below 10400 and would get confirmed with two consecutive daily closes below 10400 levels.
• If the end of candle assertion has to come, it would come in the last 4 days of this series, and if it is a bearish assertion, it could target the lows of previous two candles (Nov and Dec 2017) at 10093 and 10033 respectively.

Considering all the above, the trade setup that emerges is as follow

• Have a Bearish outlook for the current series as of now. 
• Abandon the Bearish outlook if any day closes above 10500. 
• Pyramid the Bearish outlook if any day closes below 10400

A caution also needs to be placed right here, that one should not mix this up with any other lower time frame. So this outlook may not appear consistent to a Intraday trader. One needs to take trading positions according to one's time frame.

Whereas there is no need to point out towards the perils of predicting the markets, it is clear from the above three examples, the skillfully anticipating the chart patterns before they actually appear, can enable us to take trading positions well in time, with much lesser risk and with a much larger reward. 

Happy Trading !!!