While a single candlestick helps us identify the strength of a price move, a group of candlesticks helps us understand the context of that price move.
Allow me to illustrate this with a question:
If we look at this single candlestick, we might say that the market is bullish.
However, if we take a step back and look at the candle before it…
… then we might come to a different conclusion.
This is essentially what relative candlestick analysis is about. It shows us how current prices are moving in relation to past price movements.
As seen in this example, a single bullish candle doesn’t necessarily mean the market is bullish. To make a better judgement, we’ll have to take a look at the bigger picture. This is why single candlestick analysis is not enough — we have to learn about relative candlesticks too.
Remember how we talked about momentum before?
The same principle can be applied to a cluster of candlesticks.
Let’s assume that we see a candle with strong bullish momentum, and enter a ‘buy’ trade:
Some time later, prices continued moving in the direction of the bullish momentum:
At this point, the bullish momentum remains strong, as the upward movement is relatively steep.
Eventually though, we will see a slowing of this momentum. The market price will not continue moving with strong momentum forever.
To identity weakening momentum, we’ll be looking out for the following signs:
• the price move becomes less and less steep; and/or
• the candlestick real bodies get smaller
Let see what this looks like…
When an ongoing trade is sitting on a paper profit, slowing momentum is the first signal for us to consider closing (at least) a portion of the trade, and booking some profits.
Why? Because there is now a higher chance of prices reversing from there.
Next, we see what looks like a price reversal.
If we didn’t notice the slowing down of momentum and closed our trade earlier, we would have lost a big portion of our profits by now!
Now, in the chart above we can see that the most recent candlestick is showing strong momentum to the downside, so we know there’s a higher chance of a complete reversal (rather than for prices to bounce back up from here).
And if we did not close the ‘buy’ trade earlier, this would be the time to do so. Now take a few moments to go through the example again. There are a number of things going on at the same time and you want to make sure you thoroughly understand the concept of relative momentum before moving on.