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CANDLESTICK PATTERNS

Candlestick patterns are specific price formations identified on a candlestick chart. These patterns are useful as a tool for forecasting future price movement and especially as concerns forecasting trend reversals.

 

Introduction to Candlestick Patterns

Candlestick patterns recognition can be made manually or it can be part of an automated process via the use of specialized software.

Candlesticks Formation

A single candlestick includes information such is the high, low, opening and closing price of a particular trading period. Every candlestick includes:

(i) A Body, which reflects the opening and closing price

(ii) The Shadows (or wicks or tails) which reflect the higher and the lower price of the period

-The bullish candlesticks are colored in White or Green

-The Bearish candlesticks are colored in Black or Red.

Basic Candlestick Patterns

There are tens of recognizable candlestick patterns, here are the most important patterns:

  1. Doji (Bullish / Bearish Doji)

  1. Hammer / Hanging Man

  1. Shooting Star / Inverted Hammer

  1. Morning Star / Evening Star

  1. Harami (Bullish / Bearish Harami)

  1. Marubozu (Bullish / Bearish Marubozu)

  1. Three White Soldiers / Three Black Crows

  1. Spinning Top (Bullish / Bearish Spinning Top)

  1. Railway Tracks (Bullish / Bearish Tracks)

 

-1– Doji

The Doji pattern is a very common pattern found in the charts of many different financial assets (Forex, commodities, bonds, etc.). A Doji candlestick looks like a cross and it usually appears after a strong movement. It is characterized by an identical opening and closing price. There are four common Doji pattern types:

  • Common Doji (like a cross)

  • Long-Legged Doji (like a long cross)

  • Dragonfly Doji (like a pin)

  • Gravestone Doji (like a reversed pin)

The Doji reflects a market that is indecisive without following a clear trend. Usually, a Doji is followed by a short price reversal. Therefore traders identifying the Doji should open positions targeting the opposite direction than the current price movement. The stop-loss is placed below the minimum Doji price in case of long trades or above the highest Doji price in case of short trades.

  • Long Trades, Stop-Loss placement below the Doji lowest point

  • Short Trades, Stop-Loss placement above the Doji highest point

 

-2– Hammer / Hanging Man

The Hammer and Hanging Man Candlesticks may signal a possible price reversal.

Hammer Candlestick

After the market has moved downwards for long, the hammer candlestick opens at the previous close and then drops. As the market refuses to go further down the candlestick closes higher. This is a general bullish signal.

Requirements

This pattern must have a long lower shadow {minimum twice (2x) the size of the real body} but also a little or none upper shadow.

Hanging Man Candlestick

Hammer and Hanging Man patterns look the same, the difference is that the Hammer pattern is identified after a declining market and the Hanging Man is identified after a bullish market.

  • The Hammer pattern is found at the end of a declining market and it is a bullish signal

  • The Hanging Man pattern is found at the end of a bullish market and it is a bearish signal

Hanging Man Requirement

As in the case of the hammer candlestick, this pattern must have a long lower shadow {minimum twice (2x) the size of the real body} but also a little or none upper shadow.

As concerns the stop-loss placement:

  • Long Trades, Stop-Loss placement below the Hammer lowest point

  • Short Trades, Stop-Loss placement above the Hanging Man highest point

Note that when using a Bar Chart, the hammer formation is

 

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-3– Shooting Star / Inverted Hammer

The Shooting Star pattern is exactly the same as an Inverted Hammer pattern. The difference between those two is that:

  • A Shooting Star is a bearish signal and it is identified at the end of a bullish market

  • An Inverted Hammer is a bullish signal and it is identified at the end of a bearish market

Shooting Star

In the case of a shooting star candlestick, the market opens to the previous close and moves fast to a new high, then it starts to fall signaling weakness. The Shooting Star signals an exhausted bullish market that tends to create a trap for potential buyers. The trap is formed as the market has moved to a new high and buyers tend to anticipate the continuation of the uptrend, but they are wrong.

As concerns the stop-loss placement:

  • Short Trades, Stop-Loss placement above the Shooting Star’s highest point

Inverted Hammer

In the case of an Inverted Hammer candlestick, we should expect the exact opposite market conditions.

 

-4- Morning Star / Evening Star

The Morning Star formation is an early indicator that a declining market is about to reverse.

Morning Star Candlestick

The Morning Star candlestick signals a bullish reversal in a bearish market. After a long bearish (red) candlestick a small star signifies a potential price reversal. The third long bullish (white) candlestick confirms the uptrend formation. A Morning-Star candlestick pattern includes three candles as follows:
1. The first candlestick is a long red candlestick found in a declining market.
2. The second candlestick is a small candle (no matter red or white) that closes below the first red candlestick.
3. The third candlestick is large and bullish (white) that opens above the second candle and closes near the center of the first candlestick body.

Evening Star Candlestick

The exact opposite formation is called an Evening-Star pattern and occurs at the top of an uptrend. The evening star formation is an early indicator that a bullish market is about to reverse.

 

-5– Harami (Bullish / Bearish Harami)

Harami is a price reversal formation that includes a large bar and a second ‘inside’ bar. The word Harami in Japanese means ‘the pregnant’. The Harami pattern is formed by two candles. The first candle is a large candle and the second is a smaller candle that moves and closes within the first candle. As this 2-candle pattern is not very reliable for early identification of a price reversal, traders may wait for the 3rd candle for confirmation. This 3rd confirmative candle should be also an Inside-Down (in the case of bearish Harami) or Inside-Up candle (in the case of a Bullish Harami).

There are two types of Harami formations, a bullish and a bearish formation.

Bullish Harami Candle

A bullish Harami pattern in a downtrend occurs when a large bearish red candle is followed by a smaller candle that is formed inside the range of candle-1. The second candle must prove unable to move lower than the bearish close of the first candle. It is even better that the second smaller candle closes above the middle of the first large candle’s body.

Bearish Harami Candle

A bearish Harami pattern in an uptrend occurs when a large bullish candle is followed by a smaller candle that is formed inside the range of candle-1. The second candle must prove unable to move higher than the bullish close of the first candle. It is even better that the second smaller candle closes below the middle of the first large candle’s body

 

-6– Marubozu (Bullish / Bearish Marubozu)

Marubozu or Morobozu is a Japanese candlestick meaning ‘Close-Cut’, it can also be found as ‘shaven head and shaven bottom’. Marubozu candlestick lacks either a lower or an upper shadow. Sometimes Marubozu is formed solely by a body without any shadow at all. Usually, Marubozu is a large candle. There is a bullish and a bearish Marubozu:

  1. A bullish White Marubozu opens at its low and closes at its high

  2. A bearish Red Marubozu opens at its high and closes at its low

Bullish White Marubozu

In a daily candle, the white Marubozu signals that during a trading day buyers were significantly stronger than the sellers throughout the trading period. Probably this buying frenzy isn't over yet. Assuming neutral news the buyers will come again the following day, creating an up-trending market.

Bearish Red Marubozu

In a daily chart, the existence of a Red Marubozu candle indicates that sellers were controlling the market throughout the trading period and probably their appetite for selling will continue during the following period creating a declining market.

 

-7- Three White Soldiers / Three Black Crows

Three white soldiers is a bullish chart pattern that is formed by three consecutive white (bullish) candles. The pattern consists three long candlesticks appearing after a declining market.

Three White Soldiers Formation

Each candlestick must have closed progressively upwards forming a new short-term high. The opening of each candlestick must be within the body of the previous candle. The three white soldiers is an early signal that a particular bearish market has gained strength and now it is reversed upwards.

Here are the conditions for the three white soldiers:

  1. The market is found in a downtrend

  2. Three consecutive long bullish candles occur

  3. Each candle closes higher than the previous candle

  4. The opening of the 2nd and the 3rd candle is within the body of the previous candle

  5. Ideally, each candle closes in the middle of the previous body

Three Black Crows Formation

The three black crows is the exact opposite formation of the three white soldiers. It consists three long bearish candlesticks that trend downwards. Each candle is opened within the previous candle and it is closing by forming a new low.

Here are the conditions for the three black crows:

  1. The market is found in an uptrend

  2. Three consecutive long bearish candles occur

  3. Each candle closes lower than the previous candle

  4. The opening of the 2nd and the 3rd candle is within the body of the previous candle

  5. Ideally, each candle closes in the middle of the previous body

The three black crows formation indicates the beginning of a new bearish market. It is better to trust this formation in long-term charts (daily and weekly charts).

 

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-8- Spinning Top (Bearish and Bullish Spinning Top)

This is a reliable formation that can be easily recognized in any price chart, it is also called as the Reversal Candle. The Spinning Top is a very common formation in Forex trading and indicates an upcoming price reversal, either bullish or bearish.

Requirements

The spinning top candlestick must have a small body and two shadows significantly larger than the body. The color of the spinning top body is not very important but in any case, it is better to be on the same side of the reversal:

  1. White Body in an Uptrend Reversal

  2. Black or Red Body in a Downtrend Reversal

 

-9- Railway Tracks or Railroad Tracks (Bearish and Bullish)

Railway Tracks is a strong and reliable candlestick pattern signaling trend reversals. This pattern can lead to great profits when it appears on a major Support/Resistance Level. Strong support and resistance may be formed according to Historical Highs / Lows, Trendlines, Pivot Points, Fibonacci Levels, etc.

Traders must seek for the Railway Tracks pattern only in trending markets and not in ranging markets. The Railway Tracks on ranging markets does not constitute a reliable candlestick pattern. The applicable timeframe can either be short or long but this pattern is more reliable in H1 and longer timeframes.

Railway Tracks Formation

The Railway Tracks pattern is formed by two opposite candles. The two candles must have an identical body no matter the size of their shadow.

  1. Bullish Railway Tracks

As the market declines, traders continue to sell the market and the first (black) candle is formed. Then as the selling pressure is exhausted traders realize that they are on the wrong side of the market. Immediately traders who were selling the market before now open the exact opposite positions and a bullish same-size candle is formed.

  1. Bearish Railway Tracks

As the market is characterized by a buying frenzy traders open new long positions and the first (white) candle is formed. Then as the buying appetite is exhausted traders realize that they trade on the opposite side they should. Therefore they open short positions, in ton exact opposite side. A new bearish same-sized candle is formed.

 

Tips when Trading Candlestick Patterns:

Recognizing candlestick formations can be particular useful especially at times when traders are indecisive about the upcoming market direction. The tip here is to combine the recognition of a candlestick pattern with confirmation generated by another system. For example, a reversal candlestick formation can prove much more reliable if it is confirmed by a Major Support / Resistance Level, Trendline, Daily Pivot Point, Fibonacci Levels, etc. If you seek for confirmation you will end with a considerably lower number of trades but with a considerably improved winning ratio (Winning Trades / Overall Trades).

 

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Forex Candlestick Patterns

George Protonotarios, Investment Consultant

for WebForex.net ©