FOREX TRADING

Price Action
Playbook
How to use candlesticks patterns to read
markets and make smarter trade decisions
2

Contents
Simply click the topic you’d like to read, to go directly to it.

Understanding the Anatomy of a Candlestick 5

1.1 What is a Candlestick? 6
1.2. Anatomy of the Candlestick 7
1.3 Basic Candlesticks  8

Understanding Price Action 11

2.1. Price Action and Candlesticks 12

Understanding Candlestick Setups 14

3.1. Top 3 Single Pattern Candlestick Patterns 15
3.2. Top 3 Double Pattern Candlestick Setups 22
3.3 Top 3 Triple Pattern Candlestick Setups 28

Placing Stop Loss and Take Profit Levels 34

4.1. Support and Resistance Levels 35
4.2. Drawing Support and Resistance Levels 36
4.3. Using Support and Resistance to Stop Loss and Take Profit 37
4.3. Stop Loss and Take Profit in General 40
4.4. Average True Range (ATR) 40

Conclusion 43
3

About the author

Desmond Leong runs the award winning research

firm Everest Fortune Group, a finalist in 2019 and
2020 for Best FX Research and Best Equity Research
in The Technical Analyst Awards.

Boasting a team of CFA, CMT and CFTe

accredited traders who specialize in technical
analysis (particularly Fibonacci, Elliott Waves
and Correlation) and fundamental analysis, they
regularly advise banks, brokers and hedge funds on
where the markets are heading and how better to
navigate them. Desmond also regularly shares his
trading insights and theories on his personal site:
The Forex Army.

Desmond is also known as the “mad coder”. He has

developed several high grade MT4 indicators that
are used to better interpret the markets. Throughout
DESMOND LEONG
this eBook series, you’ll come across indicators
Desmond has agreed to let Axi clients use as part of
a joint collaboration.

DESMOND LEONG
MARKET ANALYST, AXI

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4

Introduction
I’m personally a big fan of price action. It tells a story so well –
almost as if you’re watching a live action film, seeing the bulls
and bears lock horns (and paws) over one, two or even three
candlesticks. The careful observer sits on the fence and monitors
the things carefully, only joining the action when he sees a winning
situation.

It’s worth noting that candlestick charts are the primary choice for
most price action traders. There are many patterns out there but,
honestly, there are only a few worth looking at in depth – especially
in the context of Forex trading. In this eBook, we’ll dive deep into
helping you understand how price action and candlesticks work,
then focus on the practical tips and tricks of how to use them in your
trading strategy.

If oscillators are lagging indicators, and Fibonacci are leading

indicators, price action would be considered the present. It’s the
place where the action is happening. It tells you what’s happening
in real-time as the markets unfold before your eyes. For any good
strategy to work well, you’ll need to combine the past, present and
future together effectively – and that’s why it’s so important to
understand price action.

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 1
Understanding
the Anatomy of
a Candlestick
6 Understanding the Anatomy of a Candlestick

1.1 What is a Candlestick?

Candlesticks, sometimes referred to as Japanese candlesticks, are basically used to describe price
action within a particular time frame, thereby reflecting the market sentiment at the time (i.e. whether
the market is more bullish or bearish as a whole). Within this time period, there will be the opening,
closing, high and low prices – all of which are condensed into a simple candlestick.

Upper shadows

High High

Close Open

BULLISH BODY BODY

BEARISH
CANDLE CANDLE

Open Close

Low Low
Lower shadows

Candlesticks consist of a body and a shadow, which is sometimes referred to as a wick. As you can see
in the above image, the thick, rectangular section of the candlestick is the body, and the thin lines above
and below the body are the upper and lower shadows respectively.

Let’s take a look at the bodies of the two candlesticks above – take particular notice of how the open
and close prices differ from each other.

Notice that the candlestick on the left has the closing price above the opening price. This means the
market closed at a price higher than when it opened in that time period. This is commonly referred to as
a “bullish candle”.

In contrast, the candlestick on the right has the opening price above the closing price. In other words,
the market closed at a price lower than when it opened in that time period. This is commonly referred to
as a “bearish candle”. That is the inherent difference between these two candlesticks.

Traditionally, the body of a bullish candle is white in colour, whereas the body of a bearish candle is
black in colour. On your trading platform, you can edit the colours of the bodies to help you visualise the
market better.

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7 Understanding the Anatomy of a Candlestick

Now, let’s move on to the shadows – the wicks – of our candlesticks. These shadows show us the range
between the high and low prices of that time period. The top of the upper shadow is the high price,
whereas the bottom of the lower shadow is the low price.

By analysing a candlestick’s anatomy – and in conjunction with the candlesticks surrounding it – traders
are able to draw conclusions regarding price action and market sentiment that can help them to make
better trading decisions.

1.2. Anatomy of the Candlestick

The anatomy of a candlestick can tell us a lot about what happened during that time
period, and help us to predict how a price will move in the near future. Let’s have a
look at the different parts of candlesticks and what they tell us about the market.

Bodies
The bodies of candlesticks give us an indicator of the strength of buying and selling pressure at a given
time period.

Long bodies are an indicator of strong buying and

selling pressure. This means that, in the market,
either buyers or sellers took control of the market
and therefore were much stronger. Just remember:
the longer the body, the stronger the buying or
selling pressure in the market. Referring to the above
example, a long white candlestick indicates strong
buying pressure.

As you can see, the close is much further above

the open. This indicates that buyers were highly
aggressive and forced prices up much higher than
when the market opened. In contrast, a long black
candlestick indicates strong selling pressure, where
sellers were more aggressive and forced prices down.
Thus, this results in the close being much further
below the open.

Short bodies, on the other hand, are an indicator of weak buying and selling pressure. This means that,
in the market, there was little buying or selling activity. Remember: the shorter the body is, the weaker
the buying or selling pressure in the market.

As you can see above, a short white candlestick indicates weak buying pressure. The close is not much
further above the open, meaning buyers were not very aggressive and did not bring prices up considerably.
In contrast, a short black candlestick indicates weak selling pressure. The close is not much further below the
open, meaning sellers were not very aggressive and did not force prices down considerably.

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8 Understanding the Anatomy of a Candlestick

Shadows
Recall that the top of the upper shadow indicates
the high price of the session, while the bottom Long upper
of the lower shadow indicates the low price of shadow
the session. Hence, we can see that the length
of these shadows highlight whether most of the
trading action occurred close to or further away
from the open and close.
Long lower
We can view the upper and lower shadows in
shadow
relation to each other in order to draw conclusions
about what happened during the time period of
that particular trading session

For example, if the candlestick shows a long upper and short lower shadow, it says to us that buyers
were able to bid prices higher in the session and force the price up. However, sellers were able to enter
and force the price back down again. On the other hand, if the candlestick has a long lower and short
upper shadow instead, it reveals that the sellers were initially able to bid prices lower in the session, but
buyers were able to force it back up in the end.

1.3 Basic Candlesticks

On any price chart, there will be lots and lots of candlesticks that will be plotted to reflect current price
action. Hence, it’s important to have a solid understanding of candlesticks and what they reveal about
the market. It’s useful to think of them in terms of whether they are potential reversal or continuation
patterns. Reversal patterns indicate a reversal in the direction of price movement (i.e. from up to down,
or vice versa). Continuation patterns indicate a continuation in the direction of price movement (i.e.
continue going up, or continue going down). The following are a few basic candlestick patterns that you
should remember.

Spinning Tops
Recall that the top of the upper shadow
indicates the high price of the session, while the
bottom of the lower shadow indicates the low
price of the session. Hence, we can see that
the length of these shadows highlight whether
most of the trading action occurred close to or
further away from the open and close.

Spinning tops are candlesticks that have long

upper and lower shadows, and short bodies. The
colour of the real body does not really matter.
This pattern reveals indecision between the BULLISH BEARISH
buyers and sellers. SPINNING TOP SPINNING TOP

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9 Understanding the Anatomy of a Candlestick

The small body shows us that there was only a small difference between open and close prices, while
the long upper and lower shadows show us that both buyers and sellers were bidding aggressively but
neither side could gain an advantage over the other.

WHAT DOES THIS SIMPLE CANDLESTICK PATTERN TELL YOU?

Well, if a spinning top forms during an uptrend, this could signal a lack of buyers in the market, thus
hinting at a potential reversal with the price falling soon. Similarly, if it forms during a downtrend, it could
signal a lack of sellers in the market, thus hinting at a potential reversal with the price rising soon.

Of course, this is not a foolproof method of determining future price movements. But by combining it
with further analysis, you can make the most sound trading decision appropriate to you.

Marubozu

Marubozus are candlesticks that have a long body and no shadows at all. In this case, the colour of the
candlestick does matter in showing us what’s happening in the market.

A Bullish Marubozu – or White Marubozu – is a very bullish candle with a long body and no shadows
at all. In this case we can see that the open and low price are equal, while the close and high price are
equal. In other words, the market opened at its lowest price and closed at its highest price.

Evidently, buyers were able to control the market and force prices up to close at the highest price
possible. A White Marubozu is therefore usually seen as the first part of a bullish continuation or a bullish
reversal where prices begin to climb.

On the other hand, a Bearish Marubozu – or Black Marubozu

– is a very bearish candle with a long body and no shadows
at all. In this case, we can see that the open and high price is
equal, while the close and low price is equal. In other words,
the market opened at its highest price and closed at its lowest
price.

Evidently, the sellers were able to control the market this time
round, and forced prices down to close at the lowest price
possible. A Black Marubozu is thus usually viewed as the first
part of a bearish continuation or a bearish reversal, where
prices begin to fall.
BULLISH BEARISH
MARUBOZU MARUBOZU

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10 Understanding the Anatomy of a Candlestick

Doji

Doji candlesticks are candlesticks with extremely short bodies that appear as a thin line. In this case,
we can see that the open and close prices were either the same or extremely close to each other.

There are four special types of doji candlesticks, as can be seen below.

LONG-LEGGED DRAGONFLY GRAVESTONE FOUR PRICE

DOJI DOJI DOJI DOJI

Doji candlesticks indicate high indecision within the market, where neither buyers nor sellers were able
to gain the upper hand and take control of the market. In the event that a Doji appears after a series
of candlesticks showing an apparent trend, it could be signalling an exhaustion of the trend and that a
reversal could be occurring soon.

By now, you will have realised how much information you can glean just from analysing candlesticks on
charts. In later sections, we’ll dissect single, double and triple candlestick patterns in detail and show
you how they can be helpful in predicting future price movements.

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UnderstandingtheAnatomyofaCandlestick

2
Understanding
Price Action
12 Understanding Price Action

Price action is the study of the movement of price over time. You can also
understand price action as the study of the actions of buyers and sellers within the
market, which will ultimately determine the market price. Price action can be useful
as a tool to help you manage your trades, decide the quality of your setup and
determine the percentage of capital to risk on each of your trades.

In simple terms, price action tells you exactly what’s happening in the market at this
moment, or “in the present”.

2.1. Price Action and Candlesticks

Does that sound too complicated for you? Well, there’s no need to worry because you’ve already
engaged in a little analysis in price action in the previous section where we discussed candlesticks!

Candlestick formations that are seen on charts are a form of price action as they show the relevant
open, high, close and low prices of the trading session and give you deeper insight into what buyers and
sellers were able to do in that session. Just recall the analysis we did when discussing the bodies and
shadows of candlesticks, and how they relate to the action of buyers and sellers in the market – using
the information you can get from price action can help you to improve your trading decisions.

For example, you may have determined a suitable point to enter the market with a long position, based
on your analysis. All your indicators and intricate analysis are pointing you in this direction. Just at this
moment, you may see a bullish engulfing candlestick setup being formed, which is a bullish reversal
pattern hinting that a strong move up may be incoming. This can help you to confirm your entry and
build your confidence that this is a long position to buy. As a consequence, you may also decide to risk
slightly more on this trade.

As you can see, using candlesticks to determine current price action can be a useful tool that can
enhance your trading strategies. That being said, you should always be cautious of your trading
practices and drill yourself with proper risk management strategies as well. This includes placing your
stop loss and take profit levels appropriately, which will be discussed in later sections.

Source: TradingView

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UnderstandingPriceAction

3
Understanding
Candlestick
Setups
15 Understanding Candlestick Setups

By now you should have gotten a grasp on what candlesticks are

and how they can benefit you in your trading. In this section we’ll be
exploring different candlestick setups and what they can tell you about
the markets. At the same time, we’ll also be explaining your possible stop
loss and take profit placement levels when you encounter such setups.

Do understand that your placement of the stop loss and take profit levels will ultimately be determined
by your risk appetite on the trade and your tendencies towards risk-taking as a whole. We generally
advocate for proper risk-taking practices and trade management to avoid excessive losses.

Also remember that candlestick setups are only an indicator of future price movements. They are in
no way a confirmation of future price movement and you should not treat them as such. You can and
should always consider reconciling these setups with further analysis.

3.1. Top 3 Single Pattern Candlestick Patterns

As the name suggests, single pattern candlestick setups involve only one candlestick. Here are our 3
favourite single pattern candlestick setups:

1 Hammer and Hanging Man

2 Inverted Hammer and Shooting Star
3 Dragonfly and Gravestone Doji

Hammer and Hanging Man

The Hammer and the Hanging Man are reversal patterns that look almost identical. The key difference
lies in whether they form at the end of an uptrend or downtrend. The colour of the body, in this case,
does not really matter much.

To identify a hammer or a hanging man, here’s what to look for:

 long lower shadow, typically about 2-3 times the

A
length of the body
Short, or even non-existent, shadow
 ody appears at the upper end of the trading range
B
(i.e. between the high and low)
Colour of the body is not as important

Let’s go through the Hammer and the Hanging Man

individually to see how they can be identified and how they
can fit into your trading strategies.

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16 Understanding Candlestick Setups

The Hammer is a bullish reversal pattern that typically forms during a downtrend. What it signifies is
that price is reaching a bottom level soon and may start to reverse. As you can see, the Hammer has a
longer lower shadow, a short or even non-existent upper shadow, and a short body. This means sellers
were able to push prices lower at the beginning, but buyers were able to come in and overcome the
high selling pressure to close near the open.

On the other hand, the Hanging Man is a bearish reversal pattern that typically forms at the end of an
uptrend. What it signifies is that price is reaching a top level soon and may start to reverse. The Hanging
Man has a similar anatomy to the Hammer. This shows us that, as the price continues to rise, the number
of sellers is starting to exceed the number of buyers within the market, and buyers were only able to
push prices back up to near the open, whereas the sellers were able to push prices lower during the
session.

Let’s look at an example involving the Hammer.

Source: TradingView

We can see a clear Hammer setup forming that checks all the boxes we defined earlier: long lower
shadow, non-existent upper shadow, a body in the upper range, and the setup forming at the end of a
downtrend. From here, where do you think the price will go?

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17 Understanding Candlestick Setups

Source: TradingView

If you guessed that price would reverse and go up, you’d be absolutely right!

Given that the Hammer is a bullish reversal, we can expect the price to reverse and move upwards,
making a long position profitable. In this case, the price managed to rise from 1.07554 to 1.09875, by a
total of 232 pips.

Inverted Hammer and Shooting Star

The Inverted Hammer and Shooting Star are also reversal patterns that look identical to each other.
Similar to the Hammer and the Hanging Man, the key difference lies in whether they form in an uptrend
or a downtrend. The colour doesn’t matter much in this single candlestick setup.

To identify an inverted Hammer or Shooting Star, here’s what to look for:

A long upper shadow, typically about 2-3 times the length of the body
Short, or even non-existent, shadow
Body appears at the upper end of the trading range (i.e. between the high and low)
Colour of the body is not as important

Let’s go through the Inverted Hammer and the Shooting

Star individually to see how they can be identified and how
they can fit into your trading strategies.

The Inverted Hammer is a bullish reversal pattern that

typically forms at the end of a downtrend. What it signifies

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18 Understanding Candlestick Setups

is that price is reaching a bottom level soon and may start to reverse. As you can see, the Inverted
Hammer has a long upper shadow, a short or even non-existent lower shadow and a short body. This
indicates that buyers were boosting prices up, but sellers were able to force the price back down to
close. However, since sellers could not close the price any lower and there is a small, even non-existent,
lower shadow, it indicates that those who wanted to sell have already done so, and the buyers could
likely overwhelm the market soon.

On the other hand, the Shooting Star is a bearish reversal pattern typically found at the end of an
uptrend. What it signifies is that price is reaching the top soon and could possibly start to reverse. The
anatomy of the Shooting Star is quite identical to an Inverted Hammer. Thus, we can see that the buyers
boosted the prices up, but sellers were able to come in and overwhelm them to close the session at
a much lower price. This indicates that sellers are beginning to overwhelm the market and a bearish
reversal could be incoming.

Let’s now take a look at an example of the Shooting Star in action.

In the above image, we can see quite a distinct uptrend in the days preceding the formation of the
shooting star, which fits our description of a long upper shadow, no lower shadow and a body near the
lower range. Where do you think price is headed from here?

Source: TradingView

Recall that the shooting star is a bearish reversal setup, hence the price would be expected to fall from
here. In this case, the price fell from 1.1230 to 1.09927, for a total of 220 pips.

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19 Understanding Candlestick Setups

Source: TradingView

Dragonfly and Gravestone Doji

Let’s return to the doji patterns which we have discussed before in basic candlestick patterns. In this
case, we want to highlight the Dragonfly and Gravestone Doji patterns as strong reversal patterns to
take note of.

To identify a Dragonfly or Gravestone Doji pattern:

Bodies are so small that they appear as a thin line

 A
 Dragonfly Doji would have a long lower shadow and non-existent upper shadow, whereas a
Gravestone doji would have a long upper shadow and non-existent lower shadow.

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20 Understanding Candlestick Setups

A Dragonfly Doji is a bullish reversal pattern that is

typically found at the end of a downtrend. What it
shows us is that sellers tried to force prices lower but
there was a strong rejection by buyers in the market,
who then forced prices up to close at, or very near
to, the open price. This gives us a very bullish signal
that price could move up from here.

LONG-LEGGED DRAGONFLY GRAVESTONE

DOJI DOJI DOJI

A Gravestone Doji is a bearish reversal pattern that

is typically found at the end of an uptrend. What it
shows us is that buyers tried to force prices higher
but there was a strong rejection by sellers in the
market, who then forced prices down to close at,
or very near to, the open price. This gives us a very
bearish signal that price could move down from here.
LONG-LEGGED DRAGONFLY GRAVESTONE FOUR PRICE
DOJI DOJI DOJI DOJI

Let’s take a look at a Dragonfly Doji in action.

Source: TradingView

Here, we can see that a Dragonfly Doji formed after a slight downtrend in price. Given that it is a bearish
reversal pattern, where do you think price would be headed from here?

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21 Understanding Candlestick Setups

Source: TradingView

If you guessed that price would rise, you would be right. Price indeed went up after the setup appeared.
In this case, it went up from 1.17098 to 1.18763, by about 166 pips.

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22 Understanding Candlestick Setups

3.2. Top 3 Double Pattern Candlestick Setups

Double pattern candlestick patterns consist of two subsequent candlesticks that are side by side with
each other. Here are our 3 of our favourite double pattern candlestick setups:

1 Engulfing
2 Tweezer Bottoms and Tops
3 Harami

Engulfing
Engulfing candles can be bullish or bearish in nature, and are reversal patterns that you should look out
for. These candlestick patterns show us that sellers are overwhelming buyers in the market for a bearish
reversal, and vice versa for a bullish reversal.

To identify an engulfing pattern:

Second candle has a body much larger than (“engulfs”) the first candle
Second candle is the opposite type when compared to the first candle

The bullish engulfing pattern is a bullish

reversal pattern that’s typically found
at the bottom of a downtrend, thereby
signalling a price movement upwards.
In this pattern, the first candlestick
would be a bearish candle, which is then
immediately followed by a larger bullish
candle. This indicates that the buyers
greatly outnumbered the sellers and
regained control of the market from them.

The bearish engulfing pattern is a bearish

reversal pattern that’s typically found at
the top of an uptrend, thereby signalling
a price movement downwards instead. In
this pattern, the first candlestick would be
a bullish candle, which is then immediately
followed by a larger bearish candle.
This indicates that the sellers greatly
outnumbered the buyers and regained
control of the market from them.

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23 Understanding Candlestick Setups

Let’s have a look at a bearish engulfing setup this time around.

Source: TradingView

As you can see from the above image, the price in the market had been enjoying a steady uptrend in
the past few days. However, we can see that a bearish engulfing pattern appeared near the top of this
uptrend. Clearly, the second bearish candle is “engulfing” the previous bullish one. From here, where
can you expect the price to be headed?

Source: TradingView

If you guessed downwards, you’d be right! The price took a fall as expected after the bearish engulfing
setup, which is a bearish reversal pattern to look out for. In this case, the price fell from 1.19341 to 1.16307
for a total of 303 pips.

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24 Understanding Candlestick Setups

Tweezers
Tweezer bottoms and tops are also reversal patterns that occur after an extended uptrend or
downtrend is observed.

To identify tweezers, here’s what to look for:

 T
 wo consecutive candles with shadows that are of equal length (i.e. bottoms should have equal
lows, tops should have equal highs)
The first candle should be of an opposite type when compared to the second candle

Tweezer bottoms are a bullish reversal

pattern and should be found at the end of a
downtrend, thereby signalling that a change
in price direction upwards is incoming. With
Tweezer bottoms, the first candlestick should
be bearish, following the market sentiment in
a downtrend, whereas the second candlestick
is bullish. Both candlesticks should have the
same lows, with their lower shadows having
the equal length in order to achieve this.

Tweezer tops are a bearish reversal

pattern and should be found at the end
of an uptrend, thereby signalling that a
change in price direction downwards is
incoming soon. However, with Tweezer
tops, the first candlestick should be bullish
in nature to match the current market
sentiment in an uptrend, whereas the
second candlestick should be bearish. Both
candlesticks should have the same highs,
with their upper shadows being of equal
length to achieve this.

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25 Understanding Candlestick Setups

Let’s look at an example of tweezer tops and see what happens.

Source: TradingView

As you can see, the two candlesticks after the extended uptrend had the same highs, with the first being
bullish to reflect the bullish sentiment of the uptrend, and the second being oppositely bearish in nature.
What do you think is likely to happen here?

Source: TradingView

Evidently, since tweezer tops are essentially a bearish reversal pattern, you should see a steady decline
in price from there. This is exactly what happened, as the price fell from 1.19733 to 1.16164 after the
tweezer tops setup appeared, by about 356 pips.

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26 Understanding Candlestick Setups

Harami
The Harami consists of two candlesticks that typically represent indecision in the market amongst
buyers and sellers. Harami setups can be both bullish and bearish in nature, and are traditionally used
to trade “breakouts”. What this means is that price can break out to the top or bottom, and traders will
tend to wait for the next candlestick to give an indication of the next direction in which price is likely to
move towards.

To identify a Harami, here’s what to look for:


First candle is formed within, or smaller than, the range of the second candle, which is the
distance between its high and low prices
If a doji is formed within another candle’s high or low, it’s known as a Harami Cross

A Bullish Harami can be found when a bullish

candlestick is formed within the high to low range of the
previous bearish candle. As we can see, the continuation
to form a new low after the previous bearish candle
has been halted, which represents a level of indecision
in the market. In the event that this is formed in a small
consolidation period after an uptrend, it could mean a
subsequent breakout to continue the uptrend. If it forms
in a downtrend, it could mean a breakout to reverse to
the uptrend instead.

A Bearish Harami can be found when a bearish

candlestick is formed within the high to low range of the
previous bullish candle. As we can see, the continuation
to form a new high after the previous bullish candle has
been halted, which represents a level of indecision in
the market. In the event that this is formed in a small
consolidation period after a downtrend, it could mean
a subsequent breakout to continue the downtrend
soon. If it forms in an uptrend, however, it could mean a

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27 Understanding Candlestick Setups

breakout to reverse to the downtrend instead.

Source: TradingView

Now, let’s have a look at a bullish Harami setup.

As you can see, after the large bearish candlestick, a smaller bullish candle was formed within its high

Source: TradingView

to low range. We know that this indicates some level of indecision in the market. With this bullish setup,
where do you expect price to be headed from here on out?

With your understanding of the harami pattern, you should be able to predict a breakout to the upside
after this setup. In this case, there was indeed a rise in price from 1.0931 to 1.1709, which gives us a total
of about 267 pips.
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28 Understanding Candlestick Setups

3.3 Top 3 Triple Pattern Candlestick Setups

Triple pattern candlestick setups are patterns that consist of three consecutive candlesticks. Here are
our 3 favourite triple pattern candlestick setups:

1 Morning and evening star

2 Three white soldiers and three black crows
3 Three inside up and three inside down

Morning and Evening Star

The morning and evenings stars are candlestick patterns that are typically found at the end of a
downtrend and uptrend respectively. To identify a morning or evening star, look for these characteristics:

 irst candlestick should reflect the nature of the current market sentiment (i.e. bullish in an
F
uptrend, bearish in a downtrend)
 econd candlestick should have a small body, and the color of the candlestick does not matter;
S
this tends to reflect the high level of indecision in the market amongst buyers and sellers
 hird candlestick must close beyond the midpoint of the first candle, and is typically of the
T
opposite type compared to the first candlestick; this acts as a confirmation that a reversal in price
is going to occur.

The morning star pattern is a bullish reversal pattern that

occurs at the end of a downtrend. This should signal to you that
there’s an upcoming change in direction of the price movement
upwards. For the morning star pattern, the first candle should
be bearish, reflecting the sentiment in a downtrend. The
second candle should have a small body, or a straight line
for a body, which is also known as a doji (recall that Dojis
are candlesticks with the same open and close price). This
indicates indecision in the market amongst buyers and sellers.
The third candle should be bullish, to act as a confirmation that
the buyers have taken control and will soon drive price up.

The evening star pattern is, on the flip side, a bearish

reversal pattern, typically occurring at the end of an uptrend.
This should signal to you that there’s an upcoming change in
the direction of price movement downwards. For the evening
star pattern, the first candle should be bullish to reflect the
current sentiment in an uptrend. The second candle will
similarly have a small body — or even be a doji — reflecting
indecision in the market. The third candle should be bearish,
to confirm for us that the sellers have overwhelmed the
buyers and will soon drive price down.

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29 Understanding Candlestick Setups

Let’s have a look at an example of the Evening Star setup.

Source: TradingView

As you can see, the price has been steadily rising in the past few trading sessions. However, at this point
in time, we can see an evening star pattern forming that fulfils the above criteria required to identify it.
Where can we expect the price to go from here?

Source: TradingView

Knowing the evening star is a bearish reversal pattern would have told you that price was likely to fall
after this setup appeared. In this case, we can see that the price indeed fell, from 1.10815 to 1.07769 for
a total of 304 pips.

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30 Understanding Candlestick Setups

Three White Soldiers and Three Black Crows

The three white soldiers and three black crows are a reversal pattern that occurs at the end of a
downtrend and an uptrend respectively. They can also be found after a short period of consolidation
with no clear uptrend or downtrend. Despite its fancy and complicated name, this is a fairly easy pattern
to spot in charts. All three candles that are part of this pattern are of the same type, opposite of the
current trend prevailing in the market at the moment.

To identify the three white soldiers or three black crows, look for these characteristics:

 irst candlestick is also known as the “reversal candle”, which reflects a market sentiment opposite
F
of the prevailing one (i.e. bullish at end of downtrend, bearish at end of uptrend)
 econd candlestick should have a bigger body than the first candlestick. It should also close near
S
its high after a bullish first candle, or near its low after a bearish first candle, thereby giving small
upper and lower shadows respectively.
 hird candlestick should minimally have the same body size as the second candle, with a short
T
shadow or no shadow at all.

The three white soldiers is a bullish

reversal pattern and one of the most
obvious patterns of its type. It forms
after a downtrend and, occasionally, a
short period of consolidation. It consists
of three consecutive bullish candles
fulfilling the above criteria. This should
be a clear signal that price is likely to
rise from now on.

The three black crows, on the other

hand, is a bearish reversal pattern and
is an apparent display of an upcoming
fall in price in the market. It forms after
an uptrend and, occasionally, a short
period of consolidation. It consists of three
consecutive bearish candles fulfilling the
above criteria. This should be a clear signal
that price is likely to fall from now on.

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31 Understanding Candlestick Setups

Let’s have a look at the three white soldiers in action.

Source: TradingView

As you can see, price was on a slight downtrend up until the moment where a strong three white
soldiers pattern appeared. What do you expect to happen with the price from here on?

Source: TradingView

As you can see, price definitely shot up after the three white soldiers appeared. Based on what you know
and understand about candlestick setups thus far, this should not be a surprise and is possibly even a
move you could have taken since this setup indicates a bullish reversal for upward price movement. The
price managed to rise from 1.31860 to 1.36713, which is a whopping 485 pips in total.

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32 Understanding Candlestick Setups

Three Inside Down and Three Inside Up

The three inside up and down patterns are reversal patterns that typically occur at the end of a
downtrend and an uptrend respectively.

To identify a three inside up or down pattern, here’s what to look for:

 irst candlestick should be found at the end of the current trend and should reflect the current
F
market sentiment according to the trend (i.e. long bullish candle at end of uptrend, long bearish
candle at end of uptrend).
Second candlestick should have a body that minimally crosses the midpoint of the first candle.
 hird candlestick must close below the first candle’s low for three inside down, and above the first
T
candle’s high for three inside up.

The three inside down pattern is a bullish

reversal pattern and is typically found at
the end of an uptrend. It consists of three
consecutive candlesticks that specifically
fulfil the above criteria, thereby
signalling to us that the downtrend
has most probably concluded and a
subsequent uptrend is about to begin.

The three inside up pattern is a bearish

reversal pattern and is typically found at
the end of a downtrend. It consists of three
consecutive candlesticks that specifically
fulfil the above criteria, thereby signalling
to us that the uptrend has most probably
concluded and a subsequent downtrend is
about to begin.

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33 Understanding Candlestick Setups

Let’s have a look at the three inside down setup in greater detail.

Source: TradingView

As you can see, the three inside down pattern has clearly formed after a steady upwards trend in price,
which is a bearish reversal pattern. In this case, what do you foresee about upcoming price action?

Source: TradingView

If you thought that price would fall, then you would be absolutely right! The three inside down indeed
marked a point where a bearish reversal occurred, as price dipped sharply right after that from 1.24525
to 1.21812, by a total of 271 pips.

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UnderstandingCandlestickSetups

4
Placing Stop Loss
and Take Profit
Levels
35 Placing your Stop Loss and Take Profit levels

4.1. Support and Resistance Levels

SO WHAT ARE SUPPORT AND RESISTANCE LEVELS?

In simple terms, these are price levels on charts that prevent a price from breaking above or below them
when tested either upwards or downwards. This price behaviour occurs due to the forces of supply and
demand that exist in the market. Think of support and resistance as barriers, through which price may
find challenging to break through.

Resistance

Support

As you can see, support refers to price levels below the current price at which the demand is strong
enough to prevent the price from falling any further beyond it. When price reaches the support level and
tries to test it, it will be difficult to penetrate that level due to the higher demand and lower supply at
that price.

Visualise yourself in the market. When a price falls to such a level (support level), you would naturally be
more inclined to buy instead of sell, since you view the price as “cheap”. Similarly, buyers in the market
would be more likely to buy, sellers would be less willing to sell, thereby forcing the price back up again,
away from the support level.

Similarly, resistance would refer to price levels above the current price at which the supply is strong
enough to stop the price from rising any higher beyond it. When price reaches the resistance level and
tests it, it will be difficult to penetrate that level due to the higher supply and lower demand at that
price.

You can also visualise a similar situation in the market, when price rises to such a level (resistance level).
Naturally, you would feel more inclined to want to sell instead of buy the currency, since you would see
the price as being more “expensive”. Similarly, sellers in the market are more likely to sell, buyers are less
willing to buy, thereby forcing price back down again, away from the resistance level.

As you can see, support and resistance levels are absolutely key levels to watch out for because they
reflect previous price action from the buyers and sellers that highlight the significance of those levels.
This is especially so if the support and resistance levels have been tested multiple times and the price
has still yet to break through them. This could be an indicator of a strong level beyond which price is
likely to bounce off from.

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36 Placing your Stop Loss and Take Profit levels

Source: TradingView

For example, you can see that the horizontal support line at 80.347 has been tested three times, yet the
price was unable to break through it. Similarly, the horizontal resistance line at 80.825 has been tested
four times and still price could not break through. This indicates that these levels are fairly strong and
should be paid close attention when the price approaches them.

It’s important to note that if a price breaks through a support level, it is possible for it to become a
resistance level in the future. Similarly, if price breaks through a resistance level, it is possible for it to
become a support level in the future. This means that we should remain attentive to price action in the
market and constantly update your strategies based on what has happened.

4.2. Drawing Support and Resistance Levels

One of the most common questions we encounter is how to determine a proper support or resistance
level. After all, when you look at a typical price chart, it seems like nearly every level we draw can be an
important level in one way or another.

Simply put, there are many ways to draw support and resistance levels, but some will be more accurate
than others. For example:

 here are ascending/descending lines, which are typically more inaccurate, because the
T
subjective nature of taking the proper levels is too subjective.
 here are also channels, which require at least 2 points on top and 2 points below, and are thus
T
generally more accurate.
 hen there are horizontal support/resistance levels, which are the most accurate because it leaves
T
extremely little room for subjective interpretation.

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37 Placing your Stop Loss and Take Profit levels

4.3. Using Support and Resistance to Stop Loss

and Take Profit

Source: TradingView

Now that you have a basic understanding of how support and resistance levels work, it’s time to put your
newfound knowledge to action! Let’s go back to the first example at the beginning of this playbook,
where we encountered the bullish engulfing candle.

We’ve already identified a bullish engulfing pattern at the end of a downtrend, as highlighted in red in
the above photo. From what you now know, you can tell that it’s a pretty good signal that a reversal to
an uptrend might be well underway. How can you now use your understanding of support and resistance
levels to set up a good trade?

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38 Placing your Stop Loss and Take Profit levels

Source: TradingView

Based on previous price action data, we can find a swing low at 1.16120 that occurred in the past that
acts as our main resistance level, since price has yet to break through it successfully. This resistance
level can act as our stop loss level, giving our trade a good space of about 28 pips to breathe before
the uptrend begins. The good thing is that, since we’ve placed our stop loss at a known resistance level,
we can be fairly certain that the price would be unlikely to break through it, staving off fears of getting
stopped out too early.

Additionally, we can use previous price action data to identify a few take profit levels, at 1.17036, 1.17588
and 1.18393. These are support levels that the price has broken through on the downtrend prior to the
bullish engulfing candlestick setup, hence it’s possible that they may become resistance levels in the
future – though the strength of these resistance levels remains to be seen. Hence, it would make sense
for us to use these levels as take-profit levels, where we can partially close (or “scale out”) our positions
at each level. This allows us to take in profits, should the price reach each of these levels, and scale back
on risk at the same time by not risking the entire position size to only take profit at the highest level of
1.18393.

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39 Placing your Stop Loss and Take Profit levels

Now, let’s look at what happened to the price after this.

Source: TradingView

As you can see, price did go into an uptrend after the bullish engulfing pattern. In fact, it managed to
break through the take-profit levels at 1.17036 and 1.17588 as well and ultimately reached our highest
take-profit level of 1.18393. Thanks to your knowledge on price action, you were able to rake in quite the
profit!

Some of you may ask: why not set only one take-profit level at the highest resistance, which would return
more profits for my initial position? Well, you must understand that price could have done anything
at each of the resistance levels – it could have reversed at the lowest level too! If that had happened,
wouldn’t you have been glad to take in at least some profits first?

Remember, support and resistance levels are not a foolproof method in determining how price can act.
It’s simply a tool with which we can estimate the probability of price action in the future and, as with all
of such tools, it can never be 100% accurate.

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40 Placing your Stop Loss and Take Profit levels

4.3. Stop Loss and Take Profit in General

Whenever you open a position, seriously consider where you want to place your stop loss and take profit
levels.

Generally, you can set your stop loss levels at the extreme low or high of the market structure where the
setup appeared. In other words, for bullish reversals, you can set your stop loss at the lowest low price
in the setup, or at a previous support level that has been proven to be strong. For bearish reversals, you
can set your stop loss at the highest high price in the setup, or at a previous resistance level that has
been proven to be strong. For example, when you encounter a bullish engulfing pattern in the above
example, you can place your stop loss at the lower of the two lows between the two candles. This would
represent the extreme bottom of the market structure. In a bearish engulfing, you can place your stop
loss at the highest high instead, which represents the extreme top of the market structure.

For take-profit levels, a similar principle can be applied. For bullish reversal setups, you can set your
take-profit level at the next resistance level. For bearish reversal setups, you can set them at the next
support level. For multiple take profit levels, you can choose to scale out at each of these levels so as to
take in some profits steadily over a period of time.

4.4. Average True Range (ATR)

Average True Range (ATR) is a technical indicator that shows the volatility of price over a given time
frame. It’s calculated by averaging the price movement over a period, essentially levelling out the spikes
and dips in price to give a more holistic view of what is the “true range” of the price. This indicator is a
favourite amongst traders as it’s adaptable to markets and, best of all, it doesn’t tell you which direction
to go.

Commonly, ATR is calculated with regard to the past 14 periods, or 14 candles, and can be applied
to any time period, be it hourly, daily, weekly or monthly charts. This lets us see the particular chart’s
volatility. This “True Range” is calculated by simply finding the difference between the previous close and
the current price (high or low).

Simply put, a currency pair that has higher ATR would experience a high level of volatility. Conversely, a
currency pair that has lower ATR would experience a low level of volatility.

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41 Placing your Stop Loss and Take Profit levels

Using ATR to Calculate Stop Loss

The ATR can be useful in determining where you can place your stop losses when trading in markets that
have different volatility levels. Since the ATR is quite a good volatility indicator, it can help to preempt
traders for wider price movements, which is a characteristic of highly volatile movements. This would
help traders know how much further away their stop loss needs to be when opening a position.

As a general rule of thumb, when the ATR reading is high, and thus volatility level is high, price
movements will be wider than usual with greater spikes and dips. This gives us the signal to set stop
losses further away from their entry price to avoid getting stopped out too early into the trade.
Conversely, when ATR reading is low, and thus volatility level is low, price movements will be narrower
and a smaller stop loss can be used. This is similar to the function of the Volatility Stop, which is another
common indicator used in technical analysis.

Let’s take a look at an example of how we can use ATR to determine our stop losses.

Source: TradingView

In the image shown above, which shows EURUSD in the daily time frame, the ATR is showing an average
movement of 73.1 pips a day.

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42 Placing your Stop Loss and Take Profit levels

Below, we have an image of the ATR of GBPUSD in the daily time frame which is 123.8 pips.

Source: TradingView

Comparing between EURUSD and GBPUSD, GBPUSD moves 1.6x more than EURUSD. In other words,
GBPUSD is more volatile than EURUSD, thus it’s reasonable to assume we’ll see much wider price
movements. So, using a bigger stop loss for GBPUSD is much wiser when trading this pair as compared
to EURUSD.

Using ATR to Calculate Take Profit

A similar principle can be applied when using ATR to calculate where we should place our take profit
levels.

In a more volatile market with higher ATR readings, we could aim for a larger take profit in order to
maximise this move. This is because you would expect the price to spike or dip more sharply in a more
volatile market, thus you can aim to ride out as much of this change in price as possible.

On the other hand, in a less volatile market with lower ATR readings, it would be better if the take profit
level is adjusted lower. This is because you would not expect such dramatic spikes and dips in the price
as you would if the market was more volatile. In order to catch the smaller rises and falls in price, you
would want to put less of a distance between your entry price and take profit level.

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PlacingyourStopLossandTakeProfitlevels

5
Conclusion
44 Conclusion

As you can see, there are a myriad of different candlestick patterns that can give you greater insight into
the market. Understanding price action and candlestick patterns can allow you to better manage your
trading and make more well-informed decisions on the percentage of risk you want to have on each of
your trades.

Importantly, you should always have a strategy to stick to when placing stop loss and take profit
levels. This will help to regulate your trading activity and rein in your emotions. Beyond the techniques
we’ve discussed above, there are other strategies you can use for placing these critical levels. These
techniques involve the usage of other indicators such as support and resistance levels, Fibonacci
retracement and extension levels and momentum indicators.

Some traders use the percentage method, by tying a trailing stop loss to all the trades pegged at a
certain percentage of losses they are willing to take. There are also traders who use the support method,
which sets hard-fixed stop loss levels at a certain price based on support and resistance levels.

Take profit levels should also be determined in a similar way, by deciding on how much profit you want
to be able to reasonably take away from the trade. Be sure to carefully consider the risk-to-reward ratio
in your trade and always consider what the market structure is telling you in the future. You should not
be trying to overestimate the profits you hope to reap and set your take profit levels too high.

Ultimately, these patterns should not be analysed in isolation, and should instead be viewed in
conjunction with other indicators to give you a more comprehensive view of how best to place your
positions. You should also have proper trade and risk management practices in place, which means you
may not want to risk more than 1-2% of your account on any trades you make.

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45 Conclusion

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