Useful Candlestick Patterns in Stock and Forex Trading

Useful Candlestick Patterns in Stock and Forex Trading

Candlesticks are a way of that the price activity of buyers and sellers are depicted on the charts, using shapes that look like candlesticks.

So the price depiction that is called the candlestick has a real body, and may have one or two shadows (the wick) located at the top or bottom of the real body. There are some candlesticks that do not possess a real body and are only formed by shadows (such as a doji candle). At the same time, there are some candles that do not have upper and lower shadows (marubozu candles).

Parts of a Candlestick

Every candlestick has two parts: a body and a shadow.

  • The real body: This is the difference between the opening and closing price of a candle, no matter the time frame.
  • The shadow: This is formed when price move towards the body after retreating from high and low prices (when the high or low prices is different from the open or close prices).

Candlestick parts

  • High price: This is the highest point of the candle. If the candle has an upper shadow, then the upper tip of the shadow is the highest price.
  • Low price: This is the lowest point of the candle. If the candle has a lower shadow, then the tip is the low price.

In a bullish candle (green or white colour), the closing price is higher than the opening price. In a bearish candle (red or black colour), the close is lower than the open.

bulish candlestickbearish candlestick

Candlestick shapes and sizes

The shapes and sizes of each candlestick tells a story about market activity between buyers and sellers. Here are some common shapes and sizes and what they mean. Here are some special candlesticks and what they represent.

1) Bearish Candle With No Upper Shadow

bearish candlestick with no upper shadow

This is a long, bearish candle with no upper shadow. The price picture is that there are no buyers to drive prices above the open price. This indicates that there is strong selling pressure in the market as the open and high prices are the same.

2) Bullish Candle With No Lower Shadow

bullish candlestick with no lowwer shadow

3) Maximum Bid/Maximum Offer: Marubozu Candles

We also have situations where there is maximum buying and maximum selling pressure in the market, causing candles to open and close without the formation of either upper or lower shadows.

bearish and bullish candlesticks with no shadows

As it is, price just kicks off and terminates with no opposing action from market participants on the other side.

4) Doji Candle

When the candle’s closing price is the same as the opening price, a doji forms. The equal lengths of the upper and lower shadows indicate that buying and selling pressure is equal. It is a mark of indecision among sellers and buyers.

doji candlestick

Doji also has variations

  • A gravestone Doji has an upper shadow but no lower shadow. This candle shows that the indecision in sellers is more than the indecision on the part of the buyers.
  • A dragonfly Doji has no upper shadow but a lower shadow. This signifies a greater degree of indecision on the part of buyers than on the part of sellers.
  • Four-price Doji: This is a doji with no upper or lower shadows, and indicates that there is no market activity on the buying or selling side.

doji candlestick

Candlestick Patterns of Importance

Extensive work by chartists such as Bulkowski have shown that there are more than 80 candlestick patterns. These candlestick patterns can be arranged on the basis of reliability. The candlesticks of importance are those that have a high degree of reliability. But even then, it is not important to know all of them. Some of these candlesticks have as many as 5 component candles. Unless you have been trading for decades, it is virtually impossible to remember and identify all these candlesticks when you see them on the chart. In any case, some of these do not occur frequently.

So the candlesticks of importance which are discussed below are those which are easily recognizable and tend to occur very frequently on the charts. Some of them are listed below.

Single Candle Patterns

These candlestick patterns have only one candle. These candles are usually known as pinbars, because of the appearance of the longest shadows on the candles that make them look like pins. There are four common pinbar candles.

  • Hammer
  • Hanging man
  • Shooting star
  • Inverted hammer

– Hammer occurs when a downtrend is ongoing and is considered a candlestick that signifies that a potential bottom is forming, hammering out a bottom.

– Hanging man is a similar-looking candlestick to the hammer, but it occurs during an uptrend and signifies that a potential top is forming.

– Shooting star occurs when an uptrend has been on for some time. It features a candle with a small body, a long upper shadow and a small or absent lower shadow. This signifies that sellers have pushed prices lower after hitting a top (the tip of the long shadow).

– Inverted hammer resembles a shooting star, but occurs at the bottom of the trend. It represents a failed attempt by sellers to achieve a lower low on the price, and usually requires a bullish candle to follow it to confirm the trend reversal.

Hammer and Shooting star candlesticks

Inverted hammer candlestick

Hanging man candlestick

In terms of reliability, these candlesticks are not enough to indicate that the trader should trade in the direction of the reversal. However, they are very important because they precede the candlesticks that actually indicate the reversal. There are some criteria which must be followed to make them more reliable.

  • The lower shadow has to be at least twice the real body’s length. Longer lower shadows in the hammer/hanging man increase reliability, while longer upper shadows do the same for the shooting star and inverted hammer.
  • The colour of the real body is of no importance.
  • The upper shadows of the hanging man and hammer should be very short or even absent. The lower shadows of the shooting star and inverted hammer should also be short or absent.
  • The candle that follows the pinbar must be the colour of the direction of the reversal in order to confirm the reversal.

Two-Candle Patterns

1. Dark Cloud Cover

  • Bearish candlestick pattern with 2 candles. Day 1 candle is bullish, reflecting the prior uptrend of the asset.
  • The day 2 candle opens with a gap above the day 1 high, but closes below the halfway point of the day 1 candle. This close below the halfway point of the day 1 candle indicates that bearish pressure has overwhelmed bullish momentum, which raises the probability of a bearish outcome eventually.

Dark cloud cover candlestick pattern

2. Piercing Line

  • Bearish candlestick pattern with 2 candles. Day 1 candle is bearish, reflecting the prior downtrend.
  • The day 2 candle opens with a gap below the Day 1 low, but closes above the halfway point of the day 1 candle. This shows that bullish momentum is overwhelming bearish pressure. It is the opposite setup to the dark cloud cover. This candlestick pattern is displayed below.

piercing line candlestick pattern

3. Engulfing Patterns

  • A reversal pattern with 2 candles where the 2nd candle “engulfs” the 1st candle. The day 1 candle assumes the colour of the initial trend, & the second candle assumes the colour of the reversal trend. The pattern has bullish and bearish variants.
  • The length of the body of the 2nd candle covers the whole length of the body of the 1st candle. In essence, the day 2 high is higher than the day 1 high, and the day 2 low is lower than the day 1 low.

Bearish engulfing candlestick pattern

Bullish engulfing candlestick pattern

Please note that the shadows are not used in the measurement of the candles. Only the real bodies of both candles are considered when checking to see if the 2nd candle engulfs the first one.

4. Harami Pattern

This pattern has a bullish and bearish variant.

  • This is a 2-candle pattern.
  • “Harami” is the Japanese word for pregnant.
  • The day 1 candle is “pregnant” with the day 2 candle.
  • The day high is higher than the day 2 high, and the day 1 low is lower than the day 2 low.

The candle that follows the pattern must close higher than the day 1 high, or close lower than the day 1 low, for the pattern to be deemed valid.

This pattern usually requires confirmation from a third candle known as the outside day candle. This 3rd candle must be longer and close lower than the day 1 candle (bearish) or long and close higher than the day 1 candle (bullish).

Bullish and bearish Harami candlestick pattern

Take note of the colour of the candle that follows the harami pattern, as well as the length and closing price of this candle. It must follow the reversal direction and at least close higher (bullish) or lower (bearish) than the harami pattern.

5. Kicker Pattern

  • This is a combination of two Marabozu candles. There are two variants of the kicker pattern (bullish and bearish).
  • The Marubozu candlestick of one colour is followed by Marubozu of the opposite color. In other words, a bullish Marubozu gaps upwards and comes after a bearish one (bullish kicker), while a bearish Marubozu follows a bullish one and gaps below it (bearish kicker).
  • The day 1 candle follows the direction of the prevailing trend. The second candle opens at the same open of the previous day (i.e. opens with a gap) and reverses the trend by heading in the opposite direction.
  • The bodies of the candles are opposite colours.

Bullish Kicker candlestick pattern

This formation is indicative of a dramatic change in investor sentiment. A gap must occur between the two lines. It works equally well in both directions. Its relevance is magnified when occurring in the overbought or oversold area. No confirmation is required.

Three-Candle Patterns

From the 2-candle patterns, we now move to the more complex 3-candle patterns. Due to the fact that they use up more candles, the index of reliability of these patterns is higher than with the 2-candle patterns. The important ones are discussed below.

1. Morning/Evening Doji Star

The pattern is a 3-candle pattern and is very reliable.

  • Day 1 candle assumes the colour of the initial trend, while the Day 2 candle is a doji candle. The doji DOES NOT form a gap above the day 1 candle.
  • Day 3 candle assumes colour of the trend reversal, indicating that the opposing group of market players have taken over.

Morning Doji star candlestick pattern

Evening Doji star candlestick pattern

The difference between the morning/evening doji star patterns and the morning/evening star patterns discussed below, is the location and appearance of the 2nd candle.

– In the morning/evening star patterns, the 2nd candle forms a gap above or below the 1st candle. Also, the 2nd candle is not usually a doji. The 3rd candle closes the gap and continues the reversal trend.

– In the morning/evening doji star, the 2nd candle is always a doji.

2. Morning/Evening Star

This is a 3-candle pattern made up of:

  • Long day 1 candle which assumes the colour of the initial trend.
  • Short day 2 candle which could be bullish or bearish (no bias).
  • Long day 3 candle which assumes the colour of the reversal. There is a small gap between the day 2 and day 3 candles.

Morning star candlestick pattern

Evening star candlestick pattern

3. Three Black Crows

Bearish reversal pattern

  • Made up of 3 long bearish candles, occurring after a bullish trend.
  • The words “black” reflect the colour of the candles and the trend they show, which is actually black/bearish, even though most charts will show bearish candles as red candles.

Three black crows candlestick pattern

The three black crows tend to be of almost equal length, but this is not a hard rule.

4. Three White Soldiers

Bullish reversal pattern

  • Made up of 3 long bullish candles, occurring after a bearish trend.
  • The words “white” reflect the colour of the candles, which is actually white/bullish, even though most charts will show bullish candles as green candles.

Three white soldiers candlestick pattern

The three white soldiers tend to be of almost equal length, but this is not a hard rule.

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