This is a Forex Guest Post provided by Richard Cox:
Many expert traders will argue that the best way of making money in the market is to buy assets that have become overly cheap and to sell assets that have become overly expensive. There is a wide variety of ways to determine whether or not the price of an asset is too high or too low. One example is to use traditional chart indicators like the MACD or RSI, as these can give traders an idea of whether prices have become overbought or oversold. But there are also ways of doing this by using the asset prices themselves, as Japanese candlestick charts can show us how market prices are behaving under specific circumstances.
In order for investors to buy low and sell high, it must be possible to identify situations where the predominant trend is ready to change. From the historical perspective, we can see that trend changes tend to be preceded by periods of market indecision. On the charts themselves, one of the best ways to visualize market indecision can be found when a Doji formation is present.
Consider the chart graphic below:
Here, we can see the basic structure of the Doji candlestick pattern. Generally speaking, Doji patterns will be characterized by opening and closing prices that are relatively similar. This creates a very small “body” within the candlestick. Some Doji patterns have long wicks, while others have very short wicks. But the main point here is that markets are unable to decided whether to push prices significantly in one direction or the other.
For this reason, prices will close very close to where the began at the open of the charting period. This is very important because it ultimately suggests that market participants are no longer sure where trend direction is headed next. So, if prices were highly bullish previously, this is a good indication that a bearish reversal is starting to build. If prices were heavily bearish previously, there is a strong suggestion that markets are preparing for a major rally going forward.
Savvy traders can capitalize on this information because broad indecision in the market solidifies arguments that call for trend reversal. In uptrends, these events will usually occur near the highs. This allows traders to establish short positions and ultimately “sell at the highs.” In downtrends, these periods of indecision tend to occur near the lows. This allows traders to establish long positions and “buy at the lows.” In this way, market traders can use chart activity to find the most ideal positions for establishing long or short exposure in the market.
To many, it might seem as though it is impossible to identify situations where market sentiment is turning and this can make it very difficult to maximize gains by buying low and selling high. But when traders utilize candlestick charts to spot Doji patterns and periods of indecision in the market, this type of approach becomes much easier to accomplish. Using the price structure outlined above, traders can look at real-time charts and quickly identify instances where trend activity might be ending. These scenarios are ideal in terms of the ways they can open the way for investors to get a jump on the rest of the market and establish contrarian positions before the majority of the investment community is aware of the coming price changes.