Understanding Candlestick Chart Patterns

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Understanding Candlestick Chart Patterns

Think there’s just one type of stock chart? Ever heard of candlestick patterns ? There are also several different types of stock charts that traders can review as part of their stock research.

If you’re a brand-new trader , you’ll probably start by looking at the simplest and least daunting line and bar charts. But once you start to gain a better understanding of the market, there’s a great tool to add to your stock chart analysis repertoire: candlestick patterns .

At first glance, candlestick patterns may look complicated. But they’re actually a lot easier to read than it might seem initially. And they offer different information than line or bar charts that can help give you a better bird’s-eye view of what’s going on with a stock.

Ready to learn more? In this post, you’ll get a basic education on candlestick patterns, including basic candlestick anatomy. I’ll also cover fundamental patterns and how to read and use the information you find.

Table of Contents

Candlestick Patterns: What Are They and How Do You Use Them?

Believe it or not, it’s likely that the candlestick pattern was initially developed in the 18th century … by a Japanese rice merchant.

Munehisa Homma was a rice trader in Osaka — and apparently an enterprising fellow. According to some accounts, he got ahead in the rice market by establishing a network of employees located at regular geographic intervals.

Through this long chain of people, he could quickly receive word about the most up-to-date market prices, and he used this information to get an edge in the market .

Homma is also said to be the father of the candlestick pattern, although the information about exactly how he developed it is kinda sketchy.

Regardless of whether he’s the inventor of candlestick charts, the concept took off. The candlestick pattern was adopted by others. And it later spread more widely via Steve Nison, who wrote the book “ Japanese Candlestick Charting Techniques .”

So what’s the fuss? A candlestick pattern can give you a lot of information about a stock in an easily deciphered graphic form. Many traders consider these patterns a great tool for technical analysis .

But what exactly is a candlestick pattern, and how can you use it? Here’s what you need to know…

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What Is a Candlestick Pattern?

To understand a candlestick pattern, let’s start with the candlesticks themselves.

Each candlestick can show a stock’s open, close, high, and low prices within a specific time frame that you set. But really a candlestick chart pattern can actually offer much more than that, once you learn how to read it. It can tell you a lot about the attention and trader action around a stock.

As with any other stock chart, candlesticks can reveal stock patterns that can help you confirm trends and help you make more-educated trade decisions.

How to Read a Candlestick Chart

The first time you look at a candlestick chart, it might seem incredibly complicated. Don’t let that dissuade you from learning this pattern. The good news is candlesticks really aren’t so complex. Let’s review the anatomy…

Candlesticks have two key parts: the body and the shadow.

The candlestick body looks like a pillar candle, and the shadow looks like the candle’s wick. The shadow can extend in either direction of the body, top or bottom — and sometimes even both ends (insert ‘burning the candle at both ends’ pun here).

The candle’s body can tell you a few main things within the time period you set:

  • Opening price
  • Closing price
  • Which direction the share price went — up or down

In StocksToTrade , a green candlestick tells you that the stock’s closing price was higher than its opening price.

On the other hand, red candles indicate that the closing price was lower than the opening price. At the bottom of the candlestick’s body, you’ll find either the opening or the closing price.

With a green candlestick, you’ll see the opening price at the bottom and the closing price at the top. With a red candlestick, you’ll see the opening price at the top and the closing price at the bottom.

What about those shadows? Within the time period you set, they can show you the high and the low.

The top shadow represents the period’s high, regardless of the candle’s bullish or bearish status. The bottom shadow indicates the period’s low.

Types of Candlestick Patterns

Now that you have an idea of how to decipher a candlestick chart, let’s discuss some of the different patterns you can look for.

Bullish Candlestick Patterns

Bullish candlestick patterns feature a closing price that’s higher than the opening price and will show an upward trend.

If the trend is moving upward within the time period you set for the chart, it’ll display in green on StocksToTrade.

Here are a few examples of popular bullish candlestick patterns:

The Hammer

This is a bullish candlestick pattern that shows that buying pressure has quickly overcome a temporary sell-off, aka bullish price behavior.

In this pattern, the candle’s body is short with a long lower shadow. This can be a sign that sellers are driving the prices down during the trading day, but that buyers are coming in to push the trading-day close higher.

But it’s important to be able to confirm that the trend is turning upward — keep a watchful eye and remember to check the trading volume .

Another variation of the hammer is the inverted hammer . An inverted hammer has a long wick above its body. So, if seen in a downtrend, it can indicate that the market has tested higher, then been sold off.

Traders can clue into the fact that the market was willing to test higher and look for further bullish price action. It could be an early indication of a reversal.

This can be a sign that the opening price was followed by lots of buying, then lots of selling that failed to bring the price below the opening price. And just like with the hammer, you should look for further confirmation with other bullish price action, such as a gap up on higher volume.

The Morning Star

Like the first rays of light in the morning, the morning star can be like a beacon of hope for the new day ahead…

This pattern features three candles:

  • The first one is a long red candle.
  • The middle has a short body and can be either red or green.
  • The third has a short green body.

This type of candle shows that prior selling pressure could be waning. The final candle can show that there’s a renewed trend of buying, potentially setting off a bullish reversal. This should always be confirmed with volume.

Bearish Candlestick Patterns

Bearish candlestick patterns feature a closing price that’s lower than the opening price and will show a downward trend.

If the trend’s moving upward within the time period you set for the chart, it will display in red on StocksToTrade.

Bearish Engulfing Pattern

This pattern sometimes occurs at the peak of an upward trend, or when a correction occurs during a downtrend.

This pattern is characterized by two candlesticks. The first has a long body, little shadows, and a higher close.

The second candle totally covers the body of the first candle, engulfing its entire range. It pretty much shows a total reversal in the momentum , with the second candle reversing the prior gains. That’s what makes it bearish.

Evening Star Pattern

The evening star is the yin to the morning star pattern’s yang. It’s another three-candlestick formation, featuring a first candle with a close that approaches the high.

The second candle extends above the first with a small body. And the third slips down below the second candle, closing beyond the middle of the first candle’s body.

This pattern is visually striking — the second candle is above the other candles, showing that the upward momentum may have played itself out.

Other Types of Candlestick Patterns

Another term you’ll encounter a lot when you start studying candlestick patterns is the doji. What’s that?

The Doji

The doji is a particular candlestick-pattern phenomenon. This candlestick shows an open and close that are pretty much equal.

A doji candle kinda looks like an elongated plus sign or a religious cross, and depending on where it crosses, it might be called a gravestone, long-legged, or a dragonfly. By itself, this candle type is neutral, but it can figure into a variety of other patterns .

Often, the doji can be a signal of a reversal pattern in technical analysis, which can show indecision. With a lack of clear conviction, this could be a sign that the trend’s about to change. But that’s not always the case.

The doji could also represent a moment when either buyers or sellers are temporarily at a standstill before a trend continues. In this way, it shows the market could be consolidating in preparation for its next move higher.

What to Look for Before Trading

That wraps up your basic training on candlestick charts and candlestick patterns. So how can you start to use them? Here are some things to keep in mind:

  • Don’t trade based on candlesticks alone. Candlesticks can tell you a lot about a stock’s momentum, but they should only be one part of your stock research. Be sure to back up your chart research with fundamental research and by checking indicators too.
  • Shadows are significant. If there’s a long shadow, it can be an indication that there’s resistance to either buying or selling pressure … And one always comes out ahead.
  • The time frame matters. Don’t make the mistake of thinking that you’re seeing something you’re not. A one-year chart is different from an intraday chart, for example.
  • Don’t forget the doji. The doji can show the balance between buyers and sellers and can give you an indication of a reversal — so learn about the doji and its variations!

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Traders: How do you use candlestick patterns to inform your trades? Newbies: Are you ready to use candlesticks in your market research? Leave a comment and let us know your experience!

Candlestick patterns. How to increase accuracy of candlestick patterns

Japanese candlesticks emerged as early as in the 18th century. Traders from the Land of the Rising Sun made first efforts of predicting the future rice price at that time. In other words, the candlestick pattern analysis is the most ancient type of technical analysis .

Perhaps, candlestick patterns worked well in the 18th century. However, their use in the pure classic form nowadays creates a wish to increase efficiency of their forecasts.

  • a review of popular classic patterns of the Japanese candlesticks;
  • advantages and disadvantages of using the Japanese candlesticks;
  • how to increase efficiency of the candlestick pattern signal , using the modern methods and progressive software.

Start to use ATAS absolutely free of charge! The first two weeks of use of the platform give access to its full functionality with 7-day history limit.

Popularization of candlestick patterns

Japanese candlesticks could be bearish and bullish. Picture 1 shows examples of the bearish and bullish candlesticks.

A combination of one to several candles forms specific patterns. For a long time the candlestick pattern analysis was used only in the country of its origin — Japan.

However, a milestone event happened in December 1989. At the time, Steve Nison wrote an introductory article about the Japanese candlesticks and got acquainted the Western world with them. The article was of such an interest that it, first, developed into a thesis paper and then in a book.

This book by Steve Nison was published in 1991. It is called Japanese Candlestick Charting Techniques and is still a bestseller.

Another classic paper about the candlestick patterns is Encyclopedia of Candlestick Charts. The book was published in 2008 by Thomas Bulkowski. In this book Thomas developed a ranking of the candlestick patterns on the basis of historical data testing. Thomas calculated reliability of patterns and assessed it in percentage terms.

In this article, we will use terminology and definitions from these 2 great books.

The authors specify more than 50 sub-types of candles and candlestick patterns. They also divide all candlestick patterns into two types:

  • reversal patterns;
  • continuation patterns.

We will consider only the most popular ones, which are considered to be reliable. For our study, we will consider examples in a day and four-hour charts of the RTS index futures (RIH9).

Reliable and frequent reversal patterns

3 outside up , three outside days upward – a bullish reversal pattern with 74% reliability. Look for three candles. The first one is black at the bottom of a bearish trend. The second candle is white and closes the body of the first one. The third candle is also white and closes higher than the second one.

3 outside down , three outside days downward – is a bearish reversal pattern with 69% reliability. Look for three candles. The first one is white on top of a bullish trend. The second one is black and it closes the body of the first one. The third candle is also black and closes lower than the previous one.

3 white soldiers – is a bullish reversal pattern with 83% reliability. Three tall white candles close each other and are closed at the very high.

Takuri line or hammer – is a bullish reversal pattern with 64% reliability. Look for a candle with a short body and very long lower shadow, more than three times longer than the body, at the bottom of a bearish trend.

Belt hold bullish – is a bullish reversal pattern with 71% reliability. Look for one white candle without a lower shadow with the closing nearly on the high at the bottom of a bearish trend.

Belt hold bearish – is a bearish reversal pattern with 68% reliability. Look for one black candle without the upper shadow with the closing nearly on the low at the top of a bullish trend.

Engulfing bullish – is a bullish reversal pattern with 62% reliability. Look for a pair of candles. The first one is black at the bottom of a bearish trend. The second candle is long white, which completely closes the body of the first one in an ideal pattern.

Pictures show not ideal engulfing patterns.

Engulfing bearish – is a bearish reversal pattern with 79% reliability. Once again, look for a pair of candles. The first one is white on top of a bullish trend. The second candle is long black, which closes the body of the first one in an ideal pattern.

Reliable and frequent continuation patterns

Last engulfing bottom – is a bearish trend continuation pattern with 66% reliability. Two multi-colored candles during the price decrease. The first one is white and the second one is black and closes the body of the first one, while the shadows can be ignored.

Last engulfing top – is a continuation of a bullish trend with 67% reliability. Two multi-colored candles during the price increase. The first one is black and the second one is white and closes the body of the first one, while the shadows can be ignored.

Doji star bearish – is a bullish trend continuation pattern.

Doji are candles, the opening and closing prices of which coincide. There are many different Doji sub-types: with long one-sided of two-sided shadows and the candle body on high or low. Doji emergence means uncertainty and absence of the market price direction. If Doji emerges after a long white candle and is higher than its body, then Bulkowski thinks that the bullish trend with continue with 68% probability. It is interesting that this pair is often considered as a reversal pattern, that is why it is called a bearish star.

Doji star bullish – is a bearish trend continuation pattern. As well as in the previous example, if Doji emerges below a long black candle during a bearish trend, according to Bulkowski there is 68% probability of continuation of the price decrease. Some sources also consider this pattern to be a reversal one.

Japanese candlesticks and volume analysis

Modern achievements in the field of technical analysis and computing equipment allow finding confirmation for the candlestick patterns, which age is calculated in centuries. It increases efficiency of the classical candlestick patterns .

Download the test version of ATAS. Combine the Japanese candlestick patterns with advanced instruments of the technical and volume analysis.

Example . Below we see a 5-minute chart of a RTS index futures (RIH9) with the Dynamic Levels Indicator and horizontal profile of the market for the current day.

1 – The maximum volume level moves downwards together with three red candles, closings of which go down too. The lower shadow of the third candle gives a signal that some buyers have emerged.

2 – The next candle – Doji – informs about a fight between the buyers and sellers. This pattern could be understood as a bearish trend continuation, but the next candle confirmation is required. The next candle is green. It is risky to sell in this situation.

3 – Doji emerges again after the green candle at the maximum volume level. In this case, the maximum volume level became the resistance level. The buyers failed to push the price upward. The next red candle confirms the victory of the sellers.

Now, let us consider the same situation using clusters. The Bid/Ask Imbalance cluster type with 300% overweight and Cluster statistic , Dynamic Levels indicators. We still see candles to the left from clusters.

1 – After the predominance of sellers at 10:25, we can see drying out of sells in low doji at 10:30, while the delta is positive.

2 – The predominance of buyers is at the maximum volume level at 10:35 and the delta is positive. But the volume is less than it was in the previous bars where sellers were active. It is worth waiting for the next candle to have a clear picture.

3 – Drying out of buys on the doji high at 10:40 immediately after the buyers imbalance warns that they failed to push the price upwards.

4 – The explicit predominance of the sellers at 10:45 confirms the volume growth.

Summary

The modern instruments of the cluster analysis help to get a clear understanding of the market situation and allow reacting fast. A combination of candlestick patterns with the cluster analysis (as an example) makes it possible to improve personal trading strategies.

Advantages and disadvantages of the Japanese candlestick patterns.

Advantages

  • Very simple visual method
  • Convergence with the technical and cluster analysis
  • Availability of Japanese candlesticks in all trading platforms

Disadvantages

  • It is necessary to wait for confirmation
  • It is difficult to use them on small timeframes due to the algorithmic trading
  • A big number of possible candlestick patterns and their combinations
  • Different interpretations of similar patterns

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Introduction to Candlesticks

Table of Contents

Introduction to Candlesticks

History

The Japanese began using technical analysis to trade rice in the 17th century. While this early version of technical analysis was different from the US version initiated by Charles Dow around 1900, many of the guiding principles were very similar:

According to Steve Nison, candlestick charting first appeared sometime after 1850. Much of the credit for candlestick development and charting goes to a legendary rice trader named Homma from the town of Sakata. It is likely that his original ideas were modified and refined over many years of trading, eventually resulting in the system of candlestick charting that we use today.

Formation

In order to create a candlestick chart, you must have a data set that contains open, high, low and close values for each time period you want to display. The hollow or filled portion of the candlestick is called “the body” (also referred to as “the real body”). The long thin lines above and below the body represent the high/low range and are called “shadows” (also referred to as “wicks” and “tails”). The high is marked by the top of the upper shadow and the low by the bottom of the lower shadow. If the stock closes higher than its opening price, a hollow candlestick is drawn with the bottom of the body representing the opening price and the top of the body representing the closing price. If the stock closes lower than its opening price, a filled candlestick is drawn with the top of the body representing the opening price and the bottom of the body representing the closing price.

Compared to traditional bar charts, many traders consider candlestick charts more visually appealing and easier to interpret. Each candlestick provides a simple, visually appealing picture of price action; a trader can instantly compare the relationship between the open and close as well as the high and low. The relationship between the open and close is considered vital information and forms the essence of candlesticks. Hollow candlesticks, where the close is greater than the open, indicate buying pressure. Filled candlesticks, where the close is less than the open, indicate selling pressure.

Long Versus Short Bodies

Generally speaking, the longer the body is, the more intense the buying or selling pressure. Conversely, short candlesticks indicate little price movement and represent consolidation.

Long white candlesticks show strong buying pressure. The longer the white candlestick is, the further the close is above the open. This indicates that prices advanced significantly from open to close and buyers were aggressive. While long white candlesticks are generally bullish, much depends on their position within the broader technical picture. After extended declines, long white candlesticks can mark a potential turning point or support level. If buying gets too aggressive after a long advance, it can lead to excessive bullishness.

Long black candlesticks show strong selling pressure. The longer the black candlestick is, the further the close is below the open. This indicates that prices declined significantly from the open and sellers were aggressive. After a long advance, a long black candlestick can foreshadow a turning point or mark a future resistance level. After a long decline, a long black candlestick can indicate panic or capitulation.

Even more potent long candlesticks are the Marubozu brothers, Black and White. Marubozu do not have upper or lower shadows and the high and low are represented by the open or close. A White Marubozu forms when the open equals the low and the close equals the high. This indicates that buyers controlled the price action from the first trade to the last trade. Black Marubozu form when the open equals the high and the close equals the low. This indicates that sellers controlled the price action from the first trade to the last trade.

Long Versus Short Shadows

The upper and lower shadows on candlesticks can provide valuable information about the trading session. Upper shadows represent the session high and lower shadows the session low. Candlesticks with short shadows indicate that most of the trading action was confined near the open and close. Candlesticks with long shadows show that prices extended well past the open and close.

Candlesticks with a long upper shadow and short lower shadow indicate that buyers dominated during the session, bidding prices higher, but sellers ultimately forced prices down from their highs. This contrast of strong high and weak close resulted in a long upper shadow. Conversely, candlesticks with long lower shadows and short upper shadows indicate that sellers dominated during the session and drove prices lower. However, buyers later resurfaced to bid prices higher by the end of the session; the strong close created a long lower shadow.

Candlesticks with a long upper shadow, long lower shadow, and small real body are called spinning tops. One long shadow represents a reversal of sorts; spinning tops represent indecision. The small real body (whether hollow or filled) shows little movement from open to close, and the shadows indicate that both bulls and bears were active during the session. Even though the session opened and closed with little change, prices moved significantly higher and lower in the meantime. Neither buyers nor sellers could gain the upper hand and the result was a standoff. After a long advance or long white candlestick, a spinning top indicates weakness among the bulls and a potential change or interruption in trend. After a long decline or long black candlestick, a spinning top indicates weakness among the bears and a potential change or interruption in trend.

Doji represent an important type of candlestick, providing information both on their own and as components of a number of important patterns. Doji form when a security’s open and close are virtually equal. The length of the upper and lower shadows can vary, with the resulting candlestick looking like a cross, inverted cross or plus sign. Alone, doji are neutral patterns. Any bullish or bearish bias is based on preceding price action and future confirmation. The word “doji” refers to both the singular and plural form.

Ideally, but not necessarily, the open and close should be equal. While a doji with an equal open and close would be considered more robust, it is more important to capture the essence of the candlestick. Doji convey a sense of indecision or tug-of-war between buyers and sellers. Prices move above and below the opening level during the session, but close at or near the opening level. The result is a standoff. Neither bulls nor bears were able to gain control and a turning point could be developing.

Different securities have different criteria for determining the robustness of a doji. A $20 stock could form a doji with a 1/8 point difference between open and close, while a $200 stock might form one with a 1 1/4 point difference. Determining the robustness of the doji will depend on the price, recent volatility, and previous candlesticks. Relative to previous candlesticks, the doji should have a very small body that appears as a thin line. Steven Nison notes that a doji that forms among other candlesticks with small real bodies would not be considered important. However, a doji that forms among candlesticks with long real bodies would be deemed significant.

Doji and Trend

The relevance of a doji depends on the preceding trend or preceding candlesticks. After an advance, or long white candlestick, a doji signals that the buying pressure is starting to weaken. After a decline, or long black candlestick, a doji signals that selling pressure is starting to diminish. Doji indicate that the forces of supply and demand are becoming more evenly matched and a change in trend may be near. Doji alone are not enough to mark a reversal and further confirmation may be warranted.

After an advance or long white candlestick, a doji signals that buying pressure may be diminishing and the uptrend could be nearing an end. Whereas a security can decline simply from a lack of buyers, continued buying pressure is required to sustain an uptrend. Therefore, a doji may be more significant after an uptrend or long white candlestick. Even after the doji forms, further downside is required for bearish confirmation. This may come as a gap down, long black candlestick, or decline below the long white candlestick’s open. After a long white candlestick and doji, traders should be on the alert for a potential evening doji star.

After a decline or long black candlestick, a doji indicates that selling pressure may be diminishing and the downtrend could be nearing an end. Even though the bears are starting to lose control of the decline, further strength is required to confirm any reversal. Bullish confirmation could come from a gap up, long white candlestick or advance above the long black candlestick’s open. After a long black candlestick and doji, traders should be on the alert for a potential morning doji star.

Long-Legged Doji

Long-legged doji have long upper and lower shadows that are almost equal in length. These doji reflect a great amount of indecision in the market. Long-legged doji indicate that prices traded well above and below the session’s opening level, but closed virtually even with the open. After a whole lot of yelling and screaming, the end result showed little change from the initial open.

Dragonfly and Gravestone Doji

Dragonfly Doji

Dragonfly doji form when the open, high and close are equal and the low creates a long lower shadow. The resulting candlestick looks like a “T” due to the lack of an upper shadow. Dragonfly doji indicate that sellers dominated trading and drove prices lower during the session. By the end of the session, buyers resurfaced and pushed prices back to the opening level and the session high.

The reversal implications of a dragonfly doji depend on previous price action and future confirmation. The long lower shadow provides evidence of buying pressure, but the low indicates that plenty of sellers still loom. After a long downtrend, long black candlestick, or at support, a dragonfly doji could signal a potential bullish reversal or bottom. After a long uptrend, long white candlestick or at resistance, the long lower shadow could foreshadow a potential bearish reversal or top. Bearish or bullish confirmation is required for both situations.

Gravestone Doji

Gravestone doji form when the open, low and close are equal and the high creates a long upper shadow. The resulting candlestick looks like an upside down “T” due to the lack of a lower shadow. Gravestone doji indicate that buyers dominated trading and drove prices higher during the session. However, by the end of the session, sellers resurfaced and pushed prices back to the opening level and the session low.

As with the dragonfly doji and other candlesticks, the reversal implications of gravestone doji depend on previous price action and future confirmation. Even though the long upper shadow indicates a failed rally, the intraday high provides evidence of some buying pressure. After a long downtrend, long black candlestick, or at support, focus turns to the evidence of buying pressure and a potential bullish reversal. After a long uptrend, long white candlestick or at resistance, focus turns to the failed rally and a potential bearish reversal. Bearish or bullish confirmation is required for both situations.

Bulls Versus Bears

A candlestick depicts the battle between Bulls (buyers) and Bears (sellers) over a given period of time. An analogy to this battle can be made between two football teams, which we can also call the Bulls and the Bears. The bottom (intra-session low) of the candlestick represents a touchdown for the Bears and the top (intra-session high) a touchdown for the Bulls. The closer the close is to the high, the closer the Bulls are to a touchdown. The closer the close is to the low, the closer the Bears are to a touchdown. While there are many variations, I have narrowed the field to 6 types of games (or candlesticks):

Long white candlesticks indicate that the Bulls controlled the ball (trading) for most of the game.

Long black candlesticks indicate that the Bears controlled the ball (trading) for most of the game.

Small candlesticks indicate that neither team could move the ball and prices finished about where they started.

A long lower shadow indicates that the Bears controlled the ball for part of the game, but lost control by the end and the Bulls made an impressive comeback.

A long upper shadow indicates that the Bulls controlled the ball for part of the game, but lost control by the end and the Bears made an impressive comeback.

A long upper and lower shadow indicates that the both the Bears and the Bulls had their moments during the game, but neither could put the other away, resulting in a standoff.

What Candlesticks Don’t Tell You

Candlesticks do not reflect the sequence of events between the open and close, only the relationship between the open and the close. The high and the low are obvious and indisputable, but candlesticks (and bar charts) cannot tell us which came first.

With a long white candlestick, the assumption is that prices advanced most of the session. However, based on the high/low sequence, the session could have been more volatile. The example above depicts two possible high/low sequences that would form the same candlestick. The first sequence shows two small moves and one large move: a small decline off the open to form the low, a sharp advance to form the high, and a small decline to form the close. The second sequence shows three rather sharp moves: a sharp advance off the open to form the high, a sharp decline to form the low, and a sharp advance to form the close. The first sequence portrays strong, sustained buying pressure, and would be considered more bullish. The second sequence reflects more volatility and some selling pressure. These are just two examples; there are hundreds of potential combinations that could result in the same candlestick.

Candlesticks still offer valuable information on the relative positions of the open, high, low and close. However, the trading activity that forms a particular candlestick can vary.

Prior Trend

In his book, Candlestick Charting Explained, Greg Morris notes that, in order for a pattern to qualify as a reversal pattern, there should be a prior trend to reverse. Bullish reversals require a preceding downtrend and bearish reversals require a prior uptrend. The direction of the trend can be determined using trend lines, moving averages, peak/trough analysis or other aspects of technical analysis. A downtrend might exist as long as the security was trading below its down trend line, below its previous reaction high or below a specific moving average. The length and duration will depend on individual preferences. However, because candlesticks are short-term in nature, it is usually best to consider the last 1-4 weeks of price action.

Candlestick Positioning

Star Position

A candlestick that gaps away from the previous candlestick is said to be in star position. The first candlestick usually has a large real body, but not always, and the second candlestick in star position has a small real body. Depending on the previous candlestick, the star position candlestick gaps up or down and appears isolated from previous price action. The two candlesticks can be any combination of white and black. Doji, hammers, shooting stars and spinning tops have small real bodies, and can form in the star position. There are also several 2- and 3-candlestick patterns that utilize the star position.

Harami Position

A candlestick that forms within the real body of the previous candlestick is in Harami position. Harami means pregnant in Japanese; appropriately, the second candlestick is nestled inside the first. The first candlestick usually has a large real body and the second a smaller real body than the first. The shadows (high/low) of the second candlestick do not have to be contained within the first, though it is preferable if they are. Doji and spinning tops have small real bodies, meaning they can form in the harami position as well. There are also several 2- and 3-candlestick patterns that utilize the harami position.

Long Shadow Reversals

There are two pairs of single candlestick reversal patterns made up of a small real body, one long shadow, and one short or non-existent shadow. Generally, the long shadow should be at least twice the length of the real body, which can be either black or white. The location of the long shadow and preceding price action determine the classification.

The first pair, Hammer and Hanging Man, consists of identical candlesticks with small bodies and long lower shadows. The second pair, Shooting Star and Inverted Hammer, also contains identical candlesticks, but with small bodies and long upper shadows. Only preceding price action and further confirmation determine the bullish or bearish nature of these candlesticks. The Hammer and Inverted Hammer form after a decline and are bullish reversal patterns, while the Shooting Star and Hanging Man form after an advance and are bearish reversal patterns.

Hammer and Hanging Man

The Hammer and Hanging Man look exactly alike, but have different implications based on the preceding price action. Both have small real bodies (black or white), long lower shadows and short or non-existent upper shadows. As with most single and double candlestick formations, the Hammer and Hanging Man require confirmation before action.

The Hammer is a bullish reversal pattern that forms after a decline. In addition to a potential trend reversal, hammers can mark bottoms or support levels. After a decline, hammers signal a bullish revival. The low of the long lower shadow implies that sellers drove prices lower during the session. However, the strong finish indicates that buyers regained their footing to end the session on a strong note. While this may seem like enough to act on, hammers require further bullish confirmation. The low of the hammer shows that plenty of sellers remain. Further buying pressure, and preferably on expanding volume, is needed before acting. Such confirmation could come from a gap up or long white candlestick. Hammers are similar to selling climaxes, and heavy volume can serve to reinforce the validity of the reversal.

The Hanging Man is a bearish reversal pattern that can also mark a top or resistance level. Forming after an advance, a Hanging Man signals that selling pressure is starting to increase. The low of the long lower shadow confirms that sellers pushed prices lower during the session. Even though the bulls regained their footing and drove prices higher by the finish, the appearance of selling pressure raises the yellow flag. As with the Hammer, a Hanging Man requires bearish confirmation before action. Such confirmation can come as a gap down or long black candlestick on heavy volume.

Inverted Hammer and Shooting Star

The Inverted Hammer and Shooting Star look exactly alike, but have different implications based on previous price action. Both candlesticks have small real bodies (black or white), long upper shadows and small or nonexistent lower shadows. These candlesticks mark potential trend reversals, but require confirmation before action.

The Shooting Star is a bearish reversal pattern that forms after an advance and in the star position, hence its name. A Shooting Star can mark a potential trend reversal or resistance level. The candlestick forms when prices gap higher on the open, advance during the session, and close well off their highs. The resulting candlestick has a long upper shadow and small black or white body. After a large advance (the upper shadow), the ability of the bears to force prices down raises the yellow flag. To indicate a substantial reversal, the upper shadow should be relatively long and at least 2 times the length of the body. Bearish confirmation is required after the Shooting Star and can take the form of a gap down or long black candlestick on heavy volume.

The Inverted Hammer looks exactly like a Shooting Star, but forms after a decline or downtrend. Inverted Hammers represent a potential trend reversal or support levels. After a decline, the long upper shadow indicates buying pressure during the session. However, the bulls were not able to sustain this buying pressure and prices closed well off of their highs to create the long upper shadow. Because of this failure, bullish confirmation is required before action. An Inverted Hammer followed by a gap up or long white candlestick with heavy volume could act as bullish confirmation.

Blending Candlesticks

Candlestick patterns are made up of one or more candlesticks and can be blended together to form one candlestick. This blended candlestick captures the essence of the pattern and can be formed using the following:

By using the open of the first candlestick, close of the second candlestick, and high/low of the pattern, a Bullish Engulfing Pattern or Piercing Pattern blends into a Hammer. The long lower shadow of the Hammer signals a potential bullish reversal. As with the Hammer, both the Bullish Engulfing Pattern and the Piercing Pattern require bullish confirmation.

Blending the candlesticks of a Bearish Engulfing Pattern or Dark Cloud Cover Pattern creates a Shooting Star. The long, upper shadow of the Shooting Star indicates a potential bearish reversal. As with the Shooting Star, Bearish Engulfing, and Dark Cloud Cover Patterns require bearish confirmation.

More than two candlesticks can be blended using the same guidelines: open from the first, close from the last and high/low of the pattern. Blending Three White Soldiers creates a long white candlestick and blending Three Black Crows creates a long black candlestick.

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