Candlestick Patterns

CANDLESTICK CHART PATTERNS A GUIDE TO THE MOST COMMON CANDLESTICK CHART PATTERNS. THE STOCK MARKET GEEKS Candlestick Patterns A candlestick shows a stock’s price movement over a defined time range. The candlestick displays four different price levels. The highest point that price reached in that time period, the lowest price, the opening price and the closing price. Knowing how to read a candlestick is the first step in learning to understand and predict market movements. The next step, as a part of technical analysis, is piecing a series of candlesticks together and understanding what “story” is being told. Candlestick patterns are formed by a series of contiguous candlesticks and used to quickly interpret price information and form a thesis for future movement. They can be used to help identify key areas of supply/demand, otherwise known as support/resistance. We use candlestick patterns to identify the “story” between buyers and sellers and which side is stronger. Certain patterns help identify bullish sentiment, bearish sentiment, trend continuation, reversals or indecision. Understanding the basic patterns is crucial in constructing a trade theory. Below are 13 of the most common recurring patterns. These patterns can be found on all time frames and should be used accordingly. It is important to note that these patterns won’t always look picture perfect while actually trading. Nor is it important to remember the names of each of these patterns. What is important, is understanding the story (of buyers and sellers) that is being told by each pattern and how to piece that into your trading plan. Hammer Pattern The hammer candlestick pattern is formed at the bottom of a down trend. It contains a relatively small body with a long lower wick. This is telling us that the sellers were initially present and pushed the price lower. But then strong buying pressure stepped in and pushed price right back up. The color of the actual body can be either red or green, however green will showcase slightly stronger buyers. Once this candle is presented at the bottom of a down trend along with high volume, that can be a confirmation of a potential trend reversal. Hammer candle + High Volume = Potential move up. The level at which this candlestick forms can now be noted, for future price action, as a level where strong buyers are present (aka support level). Inverse Hammer The inverted hammer also forms at the bottom of a down trend and also serves as a potential reversal signal. The difference between this and the regular hammer pattern is that the wick on the inverse hammer is longer on the upside and shorter on the downside. This is telling us that buyers were present at the beginning of this candle, then sellers stepped in and drove prices back down. But the sellers were not strong enough to drive this price lower. Essentially the candlestick is telling us that buyers are beginning to show up, and price may soon start moving back upwards. Again, if strong volume is present along with this candle it makes more for a much stronger confirmation that price might move upward. The level at which this candle forms can now be noted, for future price action, as a level where strong buyers are present (aka support level). Bullish Engulfing The bullish engulfing pattern can occur anywhere on the chart, but it has more significance when it occurs after a move downward. In a choppy market this pattern has far less significance. This pattern is made up of two candlesticks. The first candlestick is a red candle, while the second candle is a larger green candle that completely engulfs the body of the red candle. This is showcasing that the buyers have overtaken the sellers, and that we can potentially expect a move upwards. Again, the accompaniment of strong volume on the green candle increases the strength, and likelihood of this pattern. Piercing Candle The Piercing Candle is a two-candlestick pattern that is found at the bottom of a down trend. Once it appears with significant volume, it can potentially signal a trend reversal. The first candle in this pattern closes red. The second candle then gaps down and ends up closing near the high of its body. The green candle should cover at least half of the first red candle. Breaking it down: The first candle is showing us the presence of strong sellers. The second candle gapping down also shows us that sellers were present at the open of that candle. The second candle is telling us that price has now moved to an area where the demand is strong, and buyers are aggressively stepping in. Morning Star The morning star pattern consists of 3 candlesticks and is interpreted as a bullish signal. This formation will typically form at the bottom of a down trend. After strong selling pressure there will be a gap down. A doji, or small bodied candle, will form at the bottom. (ideal to see relatively strong volume along with this candle). The following candle will then gap up and end green. Again, if the doji is accompanied with relatively strong volume, and the following green candle also has higher volume, then that can be used as a confirmation of the trend reversal. As you might have noticed, there are quite a few different patterns that can signal a trend reversal. Making it particularly important to understand what the candlesticks are showing us as opposed to strictly memorizing the names and exact picture-perfect setups. In reality these setups are never as perfect as depicted, but with a strong understanding of the price action we can develop a strong trading thesis for a profitable trade. Hanging Man The hanging man pattern is found at the top of an up-trend and signals a potential move downwards. It is presented when the stock has been on an uptrend, then a small body (can be red or green) candle appears with a long lower wick. This is telling us that during this candle sellers pushed the price down before buyers brought it back up. The key there, is that sellers are now beginning to show up and buyers are beginning to lose their momentum after a strong run trend up. So even though buyers were able to bring the price back up during that candlestick, the initial selling pressure shows us that investors are now beginning to think that price has potentially peaked. It is not advisable to take a short trade just off of this candle alone. Wait for a confirmation. Depending on your trading style, confirmation could be high volume on that candlestick followed by a red candle with increasing volume, for example. Shooting Star A shooting star is another possible formation that can occur at the top of an up-trend signalling a reversal. It is formed with a long upper wick, relatively small body, and little to no lower wick. Ideally, the wick should be at least twice as large as the body of the candle. But we already know that setups are never picture perfect. Nevertheless, the story being told here is the same. We see the three green candles below as part of a strong uptrend. Then we see that buyers bring the price higher on that fourth candle, but sellers are able to bring the price right back down. Similar to the hanging man pattern, this showcases that the buying pressure is weakening, and sellers are beginning to step in. As always, don’t trade based off of this candlestick alone. Wait for confirmation! Volume supported candle, and perhaps a second red candle confirming the downwards direction! Bearish Engulfing The bearish engulfing pattern is considered to be a bearish reversal pattern. It consists of two candlesticks. The first one being a smaller green candle, the second candle must be a much larger red candle. The second handle must engulf the entire body of the first candle for it to be considered a bearish engulfing candle. That red candle is telling us that sellers were able to completely take control and drive prices lower than that previous candle, showing us an incredibly aggressive change of sentiment. An entry could potentially be taken at the end of that large red candle, if accompanied by strong volume. The safer entry could be to wait for one more candlestick to confirm the downward move. Evening Star This is yet another three-candlestick pattern found at the top of an up-trend, potentially signalling a reversal. The first candle is typically a large green candle, followed by a candle with a short body and with upper and lower wicks, followed by a large red candle. The second candle is indicating that buyers are weakening, and sellers are beginning to show up. The accompaniment of large volume and the following red candle give us confirmation that sellers have now taken control to bring price lower. Dark Cloud Cover The dark cloud cover pattern forms at the top of an uptrend signalling a reversal. The first candle is green showcasing strong buyers. The next candle gaps up with the aggressive buying pressure. However, sellers then step in and drive that candle back down past the green candle’s closing price, and then at least half of that green candle’s body. Despite the buyer’s strong attempt, sellers were able to take control of the price. Ideal entry would be to see this candle with strong volume and perhaps wait for a confirmation candle as well. Doji A doji is a candlestick that can appear anywhere on a chart.

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