Candlestick Patterns

Sunday, October 27, 20130 comments

One candle by itself can provide important information about the strength or weakness of the market during a given day or other time period, visually portraying where the market closed relative to the open.

Candlestick Basics

The real “body” of the candle represents the difference between the opening price and the closing price. If the body is green, it indicates prices moved higher from the open to the close for the period and buying was the dominant force. This is a bullish sign. 

If the body is red, it indicates prices moved lower from the open to the close for the period, and selling was the larger factor. This is a bearish sign.

Candlestick analysts have added a little mystique to candlestick charts by giving various patterns and given them specific meanings, depending on their location on a chart and the length of their bodies and tails.

Different Candlestick Pattern

Doji

Perhaps the best-known candlestick analysis reflecting an indecisive market condition is a group of individual candles known as doji. When the open and close prices are at the same price level or nearly so, there is no real body. A doji indicates neither buyers nor sellers were in charge from the open to the close during the trading session and suggests the market has reached some kind of equilibrium.

Two powerful versions of the Doji formation are discussed below:


Dragonfly Doji



Dragon­y doji has a long lower tail and little or no upper tail. If it appears after an uptrend, it may mean a bearish reversal. If it appears after a downtrend, it may indicate that traders have rejected lower prices and may trigger a shift to an uptrend.






Gravestone Doji


A gravestone doji looks like the dragonfly doji upside down – the upper tail is long and there is no lower tail. If prices have been moving up and a doji forms with the open and close at the low of the period, it suggests traders have rejected higher prices and is bearish. The longer the upper tail is, the more bearish the outlook may be.





Reversal Patterns

One of the most important clues that most traders want is when and where a market is ending one trend and starting another so they can get on the new trend early. For this reason, many traders are most interested in the reversal signals that candles can provide.

Shooting star

The shooting star has a long upper tail, a small real body at the lower end of the price range and little or no lower tail. In many respects, it looks like the hammer described below, but it appears at the top of a trend rather than the bottom. The candle pattern following an upward move suggests a strong rally o‑ the open on buying enthusiasm, which fades as the market rejects the higher prices and collapses back down to close near the open. Demand has dried up. If the market has gapped up on the open before failing, the move is even more signi­ficant.



Evening Star

The evening star pattern covering three candles depicts this type of bearish scenario. The ­first of three candles is a long green candle. The second candle features a gap-higher open and a small real body (red or green) that is completely above the real body of the ­first candle. The third candle has a red real body that closes well into the range of the fi­rst candle’s green body. The longer the red real body of this third candle is, the more meaningful it is in forecasting a bearish turn. High volume on this third down candle adds con­firmation to the reversal signal.



Morning Star

The Morning Star pattern is a bullish reversal pattern. This pattern also includes three candlesticks. The fi­rst is a long red candle after a decline. The second features a gap-lower open and a small real body (red or green) totally below and not touching the real body of the fi­rst candle. The third candle has a long green real body that closes well into the price range of the fi­rst candle’s long red body. The longer the green real body of the third candle is, the more meaningful it is as a bullish turn signal. Again, high volume on the third candle adds con­firmation to the reversal signal.


Engulfing patterns

Sometimes an event or other new information can cause an abrupt change in investor sentiment. This change shows up visibly with several candle formations on a chart, the most vivid of which is the engulfing pattern. As with other candle patterns, they can mark tops or bottoms.

Bullish Engulfing pattern




The Bullish engulfing pattern is a bullish reversal pattern. In a bullish engulfing pattern, prices open below the previous close and then surge higher, resulting in a green candle body that completely engulfs the body of the previous candle.





Bearish Engulfing pattern




The Bearish engulfing pattern is a bearish reversal pattern. In a bearish engulfing pattern, prices open above the previous close and then collapse lower during the trading session, producing a red body that completely engulfs the previous candle.





Harami

The harami is a reversal pattern that looks somewhat like the engulfi­ng pattern except that this candle is smaller than the previous candle, lying completely within the price range of the previous candle. It looks like a child within the body of the mother candle and can give birth to a new trend.

After an uptrend and especially after a long green real body candle, a bearish harami is formed by a shorter red body candle where all prices are within the price range of the green body of the previous candle. A bullish harami occurs after a downtrend when prices of the current candle all fall within the price boundaries of the previous big red body candle.

This pattern does not assure a price reversal but requires immediate upside price action after a bullish harami or immediate downside price action after a bearish harami to con­firm the candle pattern signal.

Piercing line pattern




The piercing line appears after a downtrend and a large red body candle when the market gaps lower on the open, then rallies sharply and closes in the upper half of the previous red candle.





Dark Cloud Cover




The dark cloud cover is a mirror image that occurs at a top after a long green candle body – the market gaps higher, indicating bulls are still willing to push prices up, but then tumbles and closes below the midpoint of the previous green candle’s body.





Hammer


The hammer occurs within an extended downtrend and has the look of a hammer (body) with a long handle (tail). The body may be green or red, but green would be more bullish than red. If prices gap higher or form a long green candle during the next period, it would enhance the prospects of a bullish move as traders appear to be rejecting a move to lower prices and the downward momentum is declining.




Hanging Man



The hanging man is a bearish reversal pattern that occurs within an extended uptrend. It has the appearance of man (body) with a leg dangling down (tail). The small real body may be green or red, but red is more bearish than green. If prices gap lower or form a long red candle during the next period, it would increase the odds of a bearish price move.




Tweezer top and bottom




Tweezers are minor reversal signals that have two or more candles with matching bottoms or matching tops – not necessarily consecutive or requiring follow up for confi­rmation. Traditional bar chart analysis might consider these double tops or double bottoms. 











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