June 4th : The Way of the Candle

Below are some examples of basic candlestick patterns used in intra-day trading. Enjoy.

DOJI STAR - “Dynamic Doji”

This is the one of the most important signals in candlestick trading. The doji represents indecision between the bulls and bears battling for control of the trend. Upon seeing a doji after either a significant up or downtrend, it becomes a high probability reversal situation. Multiple doji one after the other would represent extreme indecision and would indicate that a sharp move is about to occur. This indecision can be portrayed in a few variations of the doji.

Examples of Doji Bullish Reversals:

Examples of Doji Bearish Reversals:

ENGULFING PATTERNS:

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The BULLISH ENGULFING PATTERN is formed at the end of a downtrend. A white body is formed that opens lower and closes higher than the black candle open and close from the previous day. This complete engulfing of the previous day's body represents overwhelming buying pressure dissipating the selling pressure. In intraday trading, you WILL NOT SEE “true” engulfing patterns involving two candlesticks due to the lack of gaps. Engulfing patterns are best identified when the pattern candle engulfs multiple candlesticks signifying the end of a true trend.

Examples of Bullish Engulfing Patterns:

The BEARISH ENGULFING PATTERN is directly opposite to the bullish pattern. It is created at the end of an up-trending market. The black real body completely engulfs the previous day's white body. This shows that the bears are now overwhelming the bulls. Again, you WILL NOT SEE “true” bearish engulfing patterns in intraday trading due to the lack of the gaps.

Examples of Bearish Engulfing Patterns:

HAMMERS and HANGING-MAN

The Hammer is comprised of one candle. It is easily identified by the presence of a small body with a shadow at least two times greater than the body. Found at the bottom of a downtrend, this shows evidence that the bulls started to step in. The color of the small body is not important but a white candle has slightly more bullish implications than the black body. A positive following period is required to confirm this signal.

This pattern at the bottom of a down trend is called a Hammer. This pattern at the top of an uptrend is called a Hanging-Man. In both of these patterns the color of the body is not important, although you would prefer the body to be light on a hammer and dark on a hanging man. The longer the tails are, the higher the probability for a reversal.

The Hammer is a Bullish Reversal Pattern.

The Hanging Man is a Bearish Reversal Pattern.

INVERTED HAMMER AND SHOOTING STAR

The Inverted Hammer is comprised of one candle. It is easily identified by the small body with a shadow at least two times greater than the body. Found at the bottom of a downtrend, this shows evidence that the bulls are stepping in, but the selling is still going on. The color of the small body is not important but the white body has more bullish indications than a black body. A positive following period is required the following day to confirm this signal. This is a bullish reversal pattern.

The Shooting Star is comprised of one candle. It is easily identified by the presence of a small body with a shadow at least two times greater than the body. It is found at the top of an uptrend. The Japanese named this pattern because it looks like a shooting star falling from the sky with the tail trailing it. It’s upper tail should be two times the length of the body and there should be no lower shadow. This is a bearish reversal pattern

In both of these patterns you would prefer the tail or upper shadow to be as long as possible. The longer the tails are, the higher the probability for a reversal.

MORNING STAR AND EVENING STAR

The Morning Star is a bottom reversal signal. It is formed after an obvious downtrend. It is made by a long black body, usually one of the fear-induces days at the bottom of a long decline. The following period the magnitude of the trading range remains small for the day. This is the star of the formation. The third period is a white candle day. And represents the fact that the bulls have now stepped in and seized control. The make up of the star, an indecision formation, can consist of a number of candle formations. The important factor is to witness the confirmation of the bulls taking over the next period. That candle should consist of a closing that is at least halfway up the black candle of two periods prior.

The Evening Star pattern is a top reversal signal. It is exactly the opposite of the Morning Star signal. It is formed after an obvious uptrend. It is made by a long white body occurring at the end of an uptrend, usually when the confidence has finally built up. In the following period the trading range remains small for the day. Again, this is the star of the formation. The third period is a black candle day and represents the fact that the bears have now seized control. That candle should consist of a closing that is at least halfway down the white candle of two periods prior. -MM