A practical handbook to getting started in the world of trading – part 2

The world of trading can often be puzzling. Financial markets provide a plethora of knowledge and a dynamic learning environment, from making sense of the complexities of global finance to generating potential profits. However, it's crucial to remember that trading also involves significant risks, and losses will be part of your journey.

The initial hurdle lies in navigating the jargon and discovering a few technical aspects.

We strive to demystify trading concepts, guiding you from confusion to confidence as you take the first steps to start your adventure in the markets.

This second part of our ‘how to get started’ series provides additional vocabulary and some introductory technical analysis knowledge that you will need to learn to start trading and understand market content.

Read also: A practical handbook to getting started in the world of trading – part 1

The candlesticks seen on all trading charts, often featured on finance TV, in journals, and articles, originate from Japanese rice traders in the 18th century and serve as visual guides to spot how prices move from one period to another.

For example, a 1H (1-hour) candle will represent the prices that have traded, let’s say, between 11:00 and 12:00.

Different prices at the open and close will draw the candle boundaries – the body – with price extremes (the lowest and highest prices reached during that hour) highlighted by wicks. Let’s explore some common variations, along with their visual representations.

A green candle (or bullish candle) in trading is a visual representation showing that the price of an asset increased during a specific time period.

• The price opens at the low of the main body of the candle.
• The price closes at the high of the main body of the candle.

For example, assume that the price at 11:00, when the candle opened, was $1 and the candle closed at 12:00 at $2.

The thin lines above and below are the “wicks” – the price extremes mentioned just before. Using the same example, the lowest price traded between 11:00 and 12:00 is $0.50, and the highest price is $2.20.

This simply means the closing price was higher than the opening price, indicating buying pressure and a net price gain for that period.

A red candle (or bearish candle) in trading is a visual representation showing that the price of an asset decreased during a specific time period.

• The price opens at the high of the main body of the candle.
• The price closes at the low of the main body of the candle.

Taking the same example for the following 1H candle, assume that the price at 12:00, when the candle opened, was $2 and the candle closed at 13:00 at $0.30.

This simply means the closing price was lower than the opening price, indicating selling pressure and a price loss for that period.

A Doji candle is a type of Japanese candlestick on a trading chart that looks like a cross or a plus sign.

It forms when the price at which a trading period opened and the price at which it closed are almost the same.

It often suggests that the buyers and sellers are equally matched, leading to indecision and/or balance in the market.

A wick (also known as a shadow) is a thin line that extends from the main body of the candle, as quickly explained through our preceding examples. It represents the highest and lowest prices at which the asset traded during that time period, even if the price quickly moved away from those extremes.

Let’s use a real-life example: Suppose peanut butter sells between $4 and $5, a typical price range. If a wick appears, it means that for a short time, the price was outside that main range — if, for example, a trader sold peanut butter at a high price of $10, or perhaps a sale at a low price of $3, but the session closed at $5, there will be a wick at these extreme prices.

Double bottoms and double tops are trading patterns that most traders recognise.

One of the reasons why they are appreciated in technical analysis is that they offer reversal setups (after prices have moved in one direction continuously). They also present clear areas to place stops.

A double bottom happens when the price tests the same low level twice after a downtrend. It usually means that sellers are exhausted, implying that the downtrend is nearing its end.

It then often forms a bullish reversal, which provides interesting “long” or buying setups.

Double bottoms also provide levels that should not be breached, even on a consequent selloff. This is why it is common to see traders place their stops below the double bottom level.

A double top is the exact reverse of a double bottom. After an uptrend, traders buy an asset and push its prices to test recent highs but fail to break the preceding peak.

It then often forms a bearish reversal, providing interesting “short” setups.

This implies that buyers did not have enough strength to push prices higher and tend to attract sellers, looking to get the most optimal (elevated) price before prices eventually fall lower.

Similarly, a double top should not be breached (and if it is, the pattern is no longer valid), which is why traders tend to place their stops above the double top level.

Support is a price level on a chart where buying interest (demand) is strong enough to prevent the price from falling further.

It acts like a "floor" where the price tends to bounce up from after testing it, often forming from previous lows.

Support and resistance rarely represent a single level, but more often price zones spanning on multiple pips or dollars.

Resistance is a price level on a chart where selling interest (supply) is strong enough to prevent the price from rising further.

It acts like a "ceiling" where the price tends to bounce down from after testing it, often forming from previous highs.

A Break-retest pattern is a setup where the price action confirms that a previous key level (Support or Resistance) has been flipped.

In an upside or “bullish breakout”, what served as price high and resistance will now act as support.

Inversely, on the downside, “bearish breakout” or “breakdown”, what served as price low and support will now act as resistance.

Traders appreciate break-retests as they allow joining trends as elevated or low prices mean-revert to offer better risk-rewards (more on risk-rewards to follow).

Furthermore, traders and investors who are trapped on the wrong side of a new trend will tend to close their trade as it mean-reverts to their offside (losing) entry, which can magnify the Break-retest setup.

Before proceeding with a trade, consider whether you are prepared to risk a portion of your trading account.

Traders should measure their risk (i.e., the amount of money they are willing to lose in the trade) before placing the trade.

Once risk is measured, traders will often consider the reward: the price at which they will take their potential profits if their trade is successful.

Automatic orders can be preset for both risk and reward:

• A stop loss will materialise losses if your trade doesn’t go in the desired direction.
• A take profit will secure the gains, the “reward” incurred, at a pre-determined price.

The reward-to-risk ratio is simply the ratio of how much you will make if your trade goes to your take profit to how much you would lose in case of a loss.

Assuming a $100 maximum potential loss, a 2:1 Risk-reward ratio would also mean that a take profit will occur when the position reaches $200 in potential gains. An essential development to remember is that the higher the risk-reward ratio, the greater the chance of getting stopped out, and the lower the chance that the position reaches your take profit.

Finding your first trade can be a tedious task. But looking at a few elements can help you make your decision. First, you can look at different asset classes, and spot if you want to trade in volatile or less volatile ones.

In general, the two primary reasons for placing trades are changing or continuing fundamentals (fundamental analysis) and/or emerging technical patterns (technical analysis).

An example of a fundamental trade is, for instance, a positive surprise in Canadian Retail Sales data (more on Trading News in our next edition of the series).

With Canadian consumers’ relative strength increasing, a fundamental trade could be to buy CAD against other currencies such as the yen. In short, long CAD/JPY.

Of course, many other fundamental factors can influence such trade, so traders must consider all essential factors to confirm their decision.

On the other hand, a technical trade can be, for example, a double bottom arising in a trading product.

Let’s say that gold has been correcting (i.e, selling) for some time, moving in “lower high, lower low” formation, but the fall stops twice very close to the same price.

A technical trade could then be a long gold as its price starts to rebound, as the double bottom will have generated a technical signal. A stop loss would commonly be placed below the recent price.

Fundamental trades can complement technical trades; hence, with experience, traders can find trades that combine both and also generate a positive risk-reward.

Now that you have started taking the first steps to discover trades, managing your risk-reward ratio, and identifying support and resistance, our next edition will delve into even more technical aspects, allowing you to dive deeper into your trading journey.

This will include how to read and interpret the economic calendar, as well as more trading expressions such as “higher low, higher high” and “lower high, lower low” sequences, price ranges, what happens when trends become extreme – “squeezes”, “dumps”, and much more.

As you continue exploring trading concepts, reading financial articles, news, and charts will become easier and will exponentially enhance your experience in the markets.

While the beginning can be confusing, the learning curve gets smoother as you assimilate the technical names and apply them while you make your own analysis.

There is always more to learn in trading, so keep exploring and discovering this exciting world!