Seeing into the future sort of

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The goal of charting and technical analysis isn't to see what's happened in the past, but to attempt to predict the future. Basically, if you can predict the future for a majority of the time, you should be able to profit nicely through wise investing and trading. Because candlestick charts are chock-full of info, they aid a trader as she works to predict and profit from future price moves.

For example, a trader may study old candlestick charts and notice that when a security's closing price is much higher than its opening price, it seems to open higher the next day — a situation commonly referred to as a gap opening. That trader can buy the security on the close of the day and place an order to sell the next day, thus making a profit. Figure 2-3 provides a clear visual example of a gap opening.

Just by studying past price action on old candlestick charts, the trader in this section's example is able to predict a small piece of the future and use it to turn a profit. History does repeat itself in markets and trading, and you can use this repetition to your advantage by considering past candlestick charts, which can be a cinch to read. But always keep in mind that as with all aspects of technical analysis and investing, past results do not ensure future returns.

At the very least, be sure to pay attention to price gaps, because they indicate an increase in volatility in the price of a security. When there's an increase in volatility, there's an increase in trading opportunity. Many other types of patterns, including those that incorporate candlesticks, reappear and may be profited from.

Open

Open

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Figure 2-3:

Two candles showing a classic gap opening.

Recognizing patterns on candlestick charts is easy, and you can combine two or more candlestick charts to flesh out a reliable pattern that can lead you to profitable trading. For example, a common price pattern that serves as a good sell signal is depicted in Figure 2-4.

The pattern is a two-day pattern, and the third day is a common reaction to the first two days. Here's the typical progression:

1. The first day is a strong open-to-close day.

The closing price is considerably higher than the opening price. The first day is a victory for the bulls.

2. The second day reveals very little price action because the close is very near the open.

The second day is a wash because higher prices entice more bears to be sellers.

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