One way of using candlestick is to put it together with trend or momentum indicator such as MACD. MACD is an indicator derived from 12 day and 26 exponential moving averages of a stock price.
A candlestick pattern that is of interest to traders is the inside day bar. Inside day bar occurs when the current price bar is completely engulfed within the range of the previous price bar.
Let’s do a case study on Ferro China, a company listed in Singapore. I will consider the short selling strategy for this study. Data is from May 19 2005 to Feb 14 2008.
Entry
1. High of current day < High of previous day
2. Low of current day > Low of previous day
3. Open of current day > Close of current day. The current day is a black candle.
4. MACD histogram is < 0
5. If conditions 1 to 4 are true, short sell the next day at price below the current days low.
6. Set the stop loss price to the current day high
7. Set the profit target to 10% above the entry price
Exit
1. Stop loss price has been hit or
2. MACD histogram is > 0 or
3. Profit target has been hit
The following trades were made
5 trades hit the profit target of 10% and there were 3 losing trades. Probability of win is 62%.
One advantage of using the inside day bar to set entry and exit point is that the risk is usually small compared to the potential upside.
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