CFD trading strategies: Rejection candlesticks

The basis of this CFD trding strategy is to use the Japanese candlestick pattern to find a price level that has been ‘rejected’ by the market. Learn more…

Definition

A ‘rejection candlestick’ communicates the rejection (or reversal from) higher or lower prices. Naturally, it is found when using Japanese candlestick charts. The candlestick shows that the market has pushed in one direction but then been rejected.

How it looks

The ‘rejection candlestick’ looks exactly like a shooting star bearish reversal candlestick or the hammer reversal candlestick pattern. It is also known as the ‘pin bar’ pattern because it looks like a pin. The main characteristic is the long wick in contrast with a short body.

What distinguishes this strategy from the identical Japanese candlestick pattern is where it happens on the price chart. The rejection must take place at a significant high or low in the market.

In this chart it can be seen that the evening star pattern happens at the previous high in the price. What it shows us is that bulls tried to take the market higher but bears took control and forced the price back down again. The fact that it happened all within one timeframe (whatever timeframe the candle is) shows us that there has been rejection, The previous high in this case shows us that the rejection was of something significant – an attempt by the market to make a higher high.

The point of the above chart is to show what is integral to this trading system. The rejection candle must occur at an area on the chart that is worth rejecting.

NOTE: A common mistake by newbie traders is upon learning a candlestick pattern – is to trade every candlestick pattern they see. A cursory glance at any price chart will quickly show that there are many ‘failed’ candlestick patterns. The point is this – the candlestick reversal pattern will only consistently work at important price levels. This leads us to the next question. What is an ‘important’ price level?

Where will rejections happen?

The list below highlights five areas of the chart in which rejections should happen. So make sure the rejection you are considering as using as a trigger to enter a trade is at one of these areas on the chart in order to increase your overall probability of success.

Round numbers
Previous swing highs and lows
Trendlines
Popular moving averages (50DMA, 200DMA etc)
Fibonacci retracement levels
At the end of a very extended trend

There are other things like pivot points but this strategy is better as KISS (keep it simple stupid!)

Good rejection candle examples

The below chart has been picked at random to give some indication as to how this strategy can be employed, giving examples of each of the above price areas.

The 200 period moving average sees two consecutive long wicks that after some consolidation push the price higher. The up-move gets rejected by the 4^th touch of a falling trendline and price is sent significantly lower to just above the 1.10 round number, where lower prices are rejected and sent back higher again to the moving average, which this time acts as resistance instead of support. The price falls but eventually makes its way back up to the old high where the upmove is rejected and price is sent back down in another large down-leg, which gets very over-extended, which eventually creates a rejection of lower prices and sends the price back higher. The resulting up-move

Bad rejection candle examples

No trading strategy works perfectly – and that’s without consideration of important areas of trading including risk management and trader psychology. But there are some rules of thumb to increase the probability of each trade by avoiding some common pitfalls. When looking at good examples, we focused on finding ‘important areas’ on the price chart in which to take the rejection signals. In the bad examples, we are focusing on some reasons that might increase the probability that the patterns fail in order to decide which rejections to ignore.

The rejection is against the dominant trend
The rejection happens at a level that has recently been rejected
The wick of the candle is too small to be significant
The rejection happens too far away from important areas on the chart

By ignoring trades that meet one of the four previously listed criteria, we can filter out the ‘bad trades’. It’s no mistake that the top of the list is going against the trend. Counter-trend trading is very difficult and typically something that should only be attempted by advanced traders with a very fine-tuned system with very well-defined risk: reward criteria for when to take such trades.