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Candlestick patterns

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Japanese candlesticks serve to demonstrate what is happening on the market for a specified period of time, and can be used as indicators for the market mood. There is a lot that an informed trader can learn from the various types of candlesticks. They are insufficient by themselves, for an overall strategy, but they can be important tools for making trading decisions. Generally speaking, they can be subdivided into: patterns (comprising one to three or four candlesticks) and figures (comprising more candlesticks). Let us take a look at some of the main patterns, starting with those that comprise only one candlestick:1.3

 

Spinning tops are characterized by a small body and long tails. The color of the candlestick is not important. They always stand for indecision. It is possible that such a slowdown transforms itself into a complete shift in the market direction. Quite often, trends come to an end with exactly this kind of candlestick. This is valid both for rising and for falling markets. The long tails and the short body indicate a lack of pressure on the part of market participants, entering the market in the direction of current trending (that is – buyers, when the price is rising, and sellers, when the price is falling).1.2

In the case of Marubozu candlesticks (the name sounds a bit strange, but these are Japanese candlesticks, after all), they don’t have tails. This means that when they are positive, the open equals the lowest point for the period, whereas the close equals the highest. Therefore, if we have a negative Marubozu – the opening price is at the highest point, whereas the close – at the lowest. With these kinds of candlesticks, their color is of utmost importance. They serve as indicators of upcoming movement in the direction of that particular color, irrespective of the dynamic that took place beforehand. The Marubozu candlesticks are thereby able to turn around a trend or to strengthen a pre-existing one.

In practice, a positive Marubozu means that buyers were dominant during the entire period. That can be taken as an indication for the mood of the market participants.

DOJI CANDLESTICKS

1.1

A Doji is a candlestick where the open and the close are equal (or relatively close in value). The principle is similar to the spinning tops, and indicates a lack of confidence in the market. If a Doji candlestick follows immediately after a strong movement or a strong candlestick (such as the Marubozu), it is likely to express the “exhaustion” of the price movement. A reversal is therefore possible.

We will continue the review of candlestick patterns. Here are a few more that comprise a single candle and are significant.

 Hanging Man and Hammerhammer-and-hanging_FINAL

The Hammer candlestick is typically formed at the end of a downtrend. It is a signal that a reversal might occur. As with any other pattern, it is important to remember that the mere presence of a Hammer on the chart does not guarantee anything. It should be used in conjunction with other indicators and types of analysis.

The Hammer candlestick is characterized by:

1. A long shadow, which is two to three times longer than the main body;
2. There is a noticeable lack (or almost a lack) of a tail above the main body;
3. The body is located in the upper part of the candlestick;
4. The color of the candlestick is not important, even though a positive one is recommended.

The Hanging Man candlestick indicates possible market resistance when prices are rising. Its long tail means that the bulls have partially taken control of the market. However, they have not been able to push the price to new highs. This can be taken as a signal for lack of confidence in the market.

The Hanging Man candlestick is characterized by:

1. A long shadow, which is two to three times longer than the main body;
2. There is a noticeable lack (or almost a lack) of a tail above the main body;
3. The body is located in the upper part of the candlestick;
4. The color of the candlestick is not important, even though a negative one is recommended.

Here are two illustrations of possible shifts:

HAMER-AND-HANGING

Shooting Star and Inverted Hammer 

inverted-HAMMER-and-Shooting

The Inverted Hammer is a candlestick that appears at the end of a downtrend. It indicates that bears have succeeded in bringing down the price drastically. Nonetheless, buyers have also played a role – by “battling” with the price drop – so that it hasn’t been able to reach a new bottom. From this point onwards, it is expected that bulls will be in control for the near future.

The Shooting Star candlestick signals a top. The fact that the close is much below the peak level indicates that the bulls have perhaps grown tired from their activity. If they decide to pull out from the market, only bears will remain, and in turn, they will bring the price down.

These two candlestick types have the same characteristics as the ones listed above. The main difference is that the ratio of main body to tail is at least 1:2. Let us illustrate some possible reversals:

Inverted-HAM-and-Shooting-StarWe will continue the review of candlestick patterns. Let’s continue with the ones that comprise two or more candles, this time – however – in a sequence.

Bullish and Bearish Engulfmentengulfing-Final

The first candlestick marks the direction of the main trend. The second one is in the opposite direction, and its main body is larger. This is why we talk about visual “engulfment”. The tails are not important in this pattern, as long as they are not much longer than the main body. If the latter is true, this might give rise to an entirely different formation.

In the case of bullish engulfing, the second candlestick is positive. This sends a strong signal that the buyers are dominant over the sellers from the previous period.

In the case of bearish engulfing, the second candlestick is the one falling (i.e. negative). As the price plummets below the open of the previous positive candle, and closes there, we can anticipate further depreciation.

TweezersTweezers-Final

Tweezers refer to two consecutive candlesticks of approximately equal bodies and tails. They point in a single direction (i.e. upwards during a top and downwards during a bottom). The two are opposite in color, and indicate a possible reversal of the movement leading up to them. Here are some general guidelines:

  1. The first candlestick follows the direction of the main trend, leading up to this moment.

  2. The second candlestick has the opposite color to the first one.

  3. The tails on both have to be of equal length.

    We will finish our review of the patterns with those containing more than three candlesticks. Such patterns signal possible price reversals.

    Morning and Evening Starsmorning-and-evening-stars-Final

    The Morning Star and the Evening Star are formations of three candlesticks, which typically indicate a market reversal. This is how you can recognize them:

    1. The first candlestick is in the direction of the price movement till that point;
    2. The second candlestick is with a smaller body and indicates indecision. It can be a doji or a spinning top, but also a candle that is not as specific;
    3. The third candlestick is in the opposite color to the first on. This candlestick closes beyond the middle of the first candle in this formation.

    Three White Soldiers and Three Black Crowsthree-soldiers-and-crows-Final

    The Three White Soldiers are three bullish candlesticks, following some serious bear action or a short period of consolidation, immediately after that. The first candlestick shows the reversal in price movement. The second one reaffirms it. It should have a larger body than the first one, whereas its tails should be minimal or non-existent. The third candlestick should be as large as the second one (or larger), and it should also be without an upward tail.

    The Three Black Crows are the exact opposite. They comprise three falling candlesticks, after a solid upward trend. Exactly the same rules apply, as the ones mentioned above, with regard to each of them. The first candlestick simply indicates the reversal. The second one, which is larger and lacks (or almost lacks) a tail, confirms this. Whereas the third one, which is almost as big as the second one, signals the trader to enter into a short position.

    Three Inside Up and Three Inside Downthree-inside-Final

     

    The Three Inside Up candlesticks also demonstrate a reversal of price movement. Here is how to recognize such patterns:

    1. The first candlestick follows in the direction of the first trend. Its body is pretty large;
    2. The second one is in the inverse direction, and should extend beyond the middle of the first one;
    3. The third candlestick should close beyond the first one, in order to confirm the reversal.

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