Time to learn a bit more about the unique method of checking the signal quality. If you missed my previous article, be sure to read it before applying the filter.
Today we’ll look at several examples that show how to apply the 5 candlesticks method to trading. Since this is a universal system, we’ll discuss two approaches - price action and indicator trading.
Price Action Trading
According to statistics, this method of trading is the most effective one. Let's begin here. Trading on price action shows the best results precisely on higher timeframes, since there is the least market noise there. This means that the signals are more accurate.
However, many day traders prefer hourly charts. Fortunately for them, the “5 candlesticks” filter works great on any timeframe.
Let's take a look at a few examples of the most popular candlestick patterns - reversal.
"5 candlesticks" filter on a chart
- In the first example, you see the "Rails" pattern (1a). It consists of two solid candles of almost the same size. In this case, the second candle is directed in the opposite direction. If the pattern is formed at the local price level, then it gives a clear signal for a reversal. Experienced traders enter the trade immediately after the closure of the pattern’s second candle. The fifth candlestick after entering the trade closed at a loss - 1b. This makes it clear that the signal did not work as it should. If you don't exit the trade right now, you will lose even more.
- The second example also shows the Rails pattern - 2a. This time it gave a sell signal. The fifth candlestick after entering the trade brought profit (2b) which confirmed the correctness of the signal.
- The third example (3a) shows one of the brightest reversal signals - the pin bar. In our case, the pattern gives a signal to open a long position. However, after the fifth candlestick closes, the position makes a loss (3b). There can be many reasons for this, both a change in the mood of retail traders and the intervention of market makers. In any case, the best solution here is to fix the losses and wait for the next signal.
- In the last example (4a), the market touches the price level (resistance) and forms a large downward candlestick. As a rule, this gives a signal to open a short position. However, on the fifth candlestick we see that the price has corrected upward. The signal didn’t work out. If you don’t want to keep losing money, the position should be closed.
Indicator Trading
The main problem when trading on indicators is signal lag. Experienced traders are able to adjust the work of assistants by changing the settings. However, this is not available to everyone.
Fortunately, the “5 candlesticks” filter works just fine when trading on indicators. If after closing the fifth candle your position is at loss then it is better to close it. The signal is most likely to be false either by itself or due to the failure of your indicator.
Of course, in some cases the chart can reverse after the fifth losing candle and bring the long-awaited profit. But practice shows that this rarely happens. One of the main skills of a successful trader is a timely exit from a losing position. The “5 candlesticks” filter will help you identify such trades quickly and easily. Good luck!