Japanese Candlestick Patterns-Morning Star

Japanese Candlestick Patterns-Morning Star(Figure 22)

Figure 22 illustrates a Morning Star formation. A Morning Star is a three day reversal pattern that starts off with a dark candle on the first day, followed by a black or white candle that gaps down in price but trades into the range of the first day’s candle (wick). The final day of the formation reveals a white candle gapping up in price and closed well into the range of the candle of the first day. After a substantial downtrend, the first days candle reveals strong selling. On the second day sellers open the day lower but are losing steam as buyers step in and absorb the supply of stock causing a small trading range for the day. The third day reveals buyers taking control as demand for the stock increases dramatically, causing the last candle to trade well into the body of the first day’s candle and wiping out losses for the period. A few things we can look for to help strengthen the signal:

•The length of the downtrend preceding the formation.
•High volume on all three trading days of the formation.
•The length of the first and last candle. The longer the better.
•The distance the third candle trades into or above the candle of the first day.
•The pattern form at a point of technical support such as a major moving average, trend line, or horizontal support.

Japanese Candlestick Patterns-Morning Star

Trading candlestick patterns-Shooting Star

Trading candlestick patterns(Figure 20)

Figure 20 illustrates a Shooting Star reversal pattern. The Shooting Star pattern is a three day pattern consisting of a white (or clear) bodied candle on the first day, followed by a small bodied black or white candle on the third day that gaps up above the first day’s close. The final day of the Shooting Star will complete the pattern with a longer than average black (or filled) candle that gaps down below the body of the second candle, closing well into the body of the first candle of the formation. After a substantial uptrend, buyers carry prices higher as the first day of the formation reveals itself. At the beginning of the second day there are enough buyers left to cause a gap up in price, but demand for the stock decreased as sellers move in to take their profits and cause the formation of a candle with little price movement (small body). The third days dark bodied candle forms as the sellers overtake buyers causing an oversupply in the stock being traded and prices quickly decline throughout the day, eliminating much of the move of the previous two days. There are a few indications you can look for to reinforce the signal:

•High volume on all three days of the Shooting Star formation.
•Very long candles on the first and third day of the formation.
•The third day penetrates the first days candle by greater than 50%.
The pattern forms at a point of technical resistance such as an upper trend line, major moving average, or horizontal price resistance.

                                                          Trading candlestick patterns

Japanese Candlestick patterns-Hanging Man

Japanese Candlestick patterns-Hanging Man(Figure 7)

The Hanging Man formation (Figure 7) gets its name from the patterns unique appearance it gives on a stock chart of a man hanging at the peak of an uptrend. The pattern is made up of three candles with the second candle being a hammer that has gaped up above the preceding candle. On the third day, prices start to decline below the wick of the hammer of the previous day completing the formation. When we see this formation we can observe selling coming in on the day that the hammer forms. After an uptrend, selling comes in after prices gap up and push prices lower. The buyers are able to regain control and push prices back up towards the opening price or beyond forming the lower wick and small body of the hammer. Even though the buyers were still around on the second day, the initial selling is seen as a warning the trend may be slowing. The third day’s dark candle is seen as conformation of this warning. There are a few things we can look for that will make this pattern more significant:

•A long wick at the bottom of the hammer candle indicating how much selling pressure was present.
•High volume on the second and third day.
•The pattern forms at a point of technical resistance such as a major moving
average, upper trend line, or horizontal resistance.

Japanese Candlestick patterns-Hanging Man

Bullish Engulfing

Figure 4

The Bullish Engulfing formation (Figure 4) is a very strong two day reversal signal consisting of a black candle on the first day, with the price gapping down on the second day and opening lower than the close of the first day. The price then rallies and the clear candle of the second day closes higher than the first days opening price, completely engulfing the first days body. A look at the psychology behind this formation reveals the sellers, or the supply of stock, dwindling as prices move lower. When the price gaps down on the second day and buyers start to step in with force, the pattern reveals a change in investor sentiment from distribution to accumulation. There are a few things we look for to strengthen the signal:

• High volume on the second day with low volume on the first.
•A large body engulfing a small body.
• Prices heavily oversold, with prices falling faster than the angle of the trend preceding the formation.
• The body of the second day engulfing the body and the wicks of the first day.
• The pattern forms on any technical price support area such as, a trend line, major moving average, or horizontal support.

Forex candlestick patterns strategy-Bearish Engulfing

Figure 1 illustrates the Bearish Engulfing reversal pattern, a major reversal pattern that is made up of a clear body the first day and a dark body on the second. On the first day a white body forms and the price on the second day gaps up and opens higher than the close of the first day, the price on the second day then drops and closes lower than the open of the first day, completely engulfing the body of the first day’s candle. We look for this formation in an oversold market to signal us of a major change in investor psychology. After a good strong uptrend, the engulfing candle of the second day shows heavy selling in a larger proportion to the buying of the first day. To make this signal stronger we would look for:

• Heavy Volume on the second day
• A large body engulfing a small body.
• A large body engulfing the body and the wicks of the first day.
• A temporary run-up in price that was greater than the angle of the uptrend that proceeded it.
• Either candle hitting a point of price resistance, such as an upper trend line, major moving average, or other technical resistance.

             Forex candlestick patterns strategy     (Figure1)

Forex candlestick patterns strategy

Candlestick patterns indicator-Spinning Tops

Candlestick patterns indicator-Spinning Tops(Figure 12)

Spinning tops a re candles that have a small body compared to the size of the wicks. For a candle to be defined as a spinning top it must not only have long wicks, but must have wicks at both ends of the body. Spinning tops may or may not offer information depending on their place on a stock chart. In a market that is trending sideways a spinning top can usually be considered neutral. However, after a big move in price in either direction a spinning top can have the same reversal implications as the doji, especially if it is accompanied by a spike in volume or forms within a few days of a doji.

Candlestick patterns indicator-Spinning Tops(Figure 13)

In Figure 13 you can see spinning tops at reversal points in the price of EUR/USD. Examining this chart will reveal more spinning top candles assuming a more neutral roll.

Forex Candlestick Patterns-Hammers

The Hammer, which is similar to the Doji, is a single candle that represents a possible change in trend direction. Also similar to the Doji, the Hammer has a few different variations. A hammer has a long daily range compared to the difference between the closing and opening price. Unlike the Doji, The Hammer will have either a white or black body, with the white body being somewhat more bullish or a dark body being slightly more bearish. Below are two variations of the Hammer candle (Figures 5 & 6)

Figure 5 – Hammer

Figure 6 – Inverted Hammer

The significance of a Hammer is its long wick compared to its open and close. It depicts either buyers or sellers started the day off moving prices their desired direction. Once the price went up or down a significant amount, depending whether the initial pressure was selling or buying, the opposite side got the upper hand and were able to push prices the other direction showing the pressure of the trend was lessoning. On the day of a hammer, the signal will be improved by higher volume and the length of the prior trend. A Hammer can have either bullish or bearish overtones depending were it forms. If the trend was an up trend, the length of the wick warns of selling pressure. Even though the bulls were able to push prices back to the top of the daily range, the fact that they had to tells us the trend may be weakening.

Japanese candlestick patterns -The Doji

The Doji is one of the most important signals in Candlestick analysis. A Doji has the appearance of a cross, with the opening price the same as the close. It signifies indecision in the market (Figure 2).

Japanese candlestick patterns (Figure 2)

Other variations of the Doji are the Gravestone Doji and the Dragonfly Doji (Figure 3& 4). The Gravestone Doji shows price action that opens and closed at the bottom of its daily range, giving the bears a slight upper hand for the day and can be considered very bearish at a top. The Dragonfly Doji opens and closed at the top of its daily range and can be considered very bullish.

Japanese candlestick patterns (Figure 3)

Japanese candlestick patterns(Figure 4)

The psychology behind the Doji shows that buyers and sellers were even for the day, without one side or the other being able to get the upper hand to move the price of the stock. In an oversold market the Doji has very bullish implications and conversely, in an overbought market it has very bearish overtones. All Doji signals are enhanced by a long daily range, and overbought or oversold market conditions. Let’s look at a few charts and observe the Doji in different situations.

Japanese candlestick patterns -The Doji

The Basic Candles

To understand candlestick patterns, one first has to familiarize themselves with the basic candle types. In Figure 1, we saw a basic example of a black and white candle and most often these, or variations of the candles will be seen on the chart and will have no significant meaning whatsoever. These candles will be nothing more than random price movements without any clear signal for trading. However, there are some other variations of daily candles that you should familiarize yourself with before we go on to patterns. Some of these candles may carry important reversal implications when seen at the end of a long trend or at points of support and resistance. Many of these candles can give you an insight to the strength of a trend or a weakening trend. As we go through these candles we’ll explain the psychological implications of each and what may be happening as the buyers and sellers (Bulls and Bears) fight it out to move the price of a stock. Remember that all price movement is due to supply and demand. Try and visualize these candles as an indication of the daily battle between the Bulls and Bears so you can look at the larger picture of the price chart and assess who is winning the war. If you find yourself becoming confused between dark and light candle bodies, try to remember to look at each as if we were talking about the weather. A dark body has a stormy or bearish overtone and a clear body has a bright or bullish outlook. Enough analogies, lets move on to the candles.

Candlestick

Figure 1

The chart symbols used in candlestick charts are fairly easy to understand.
Candlestick charts get their name from the symbol used to represent the trading range in which you are charting (daily, weekly etc…), which are called candles. The candle has a wide area separating the open price from the closing price, which is called the body, Figure 1. On a trading day where the stocks price closed higher than its open, the candle will have an unfilled or clear body and on a day where the stock closes below the open price, the body will be filled (black in the example above). It’s important to keep in mind that a black candle does not necessarily mean the stock closed lower than the day before, just lower than the close. Conversely, a clear candle doesn't necessarily mean the stock closed higher than the day before, just higher than the open. On some charting software the unfilled bodies may be changed to green and the filled bodies to red. Many charting software also allow the user to change the colors themselves depending on their preference. The color of the body is not as important as the contrast between the two different candle types. For the illustrations in this article, we will use the traditional black and white bodies. On most candles there will be a thin line extending from the top and bottom of the body. The line extending from the top of the body represents the distance from the open or close (depending on the candle) and the high price of the day. Conversely, the line extending from the bottom of the body represents the distance to the low price. These lines are called the wicks, along with a variety of other commonly used names, such as whiskers
or hairs. Since candlestick theory puts its emphasis on the relationship of the open price, as compared to the closing price, the wicks rarely carry any technical significance. However, there are a few candles and patterns you will want to pay close attention to not only the wick, but also to the length of the wick.

Japanese Candlestick Charting

Candlestick charting was developed by Japanese rice traders over four centuries ago and could quite possibly be the oldest form of technical analysis. Since technical analysis is not only predicting probable price moves but also assessing market psychology, candlestick charting is probably the best tool to give the trader these answers in the shortest amount of time. Once a trader becomes familiar with candlestick charting, he or she can get a quick and highly visual signal because of the story candlesticks tell. Strict adheres to candlestick methodology take positions based on very short term patterns given by candlestick tradition. While candlestick charting is relatively unknown, and therefore unpracticed by the common investor, their use among active traders is growing. The greatest benefit candlestick charts provide the technical analyst is the ease of use and interpretation. The same price action, quickly seen using candlestick charts, may go unnoticed while scrolling through bar charts.
While analysis of chart patterns takes experience and some practice, so too will candlesticks. However, after learning the basic signals, candlesticks can provide the novice trader a shorter learning curve and also shorten the learning curve to chart reading in general. I like using bar charts to find chart patterns, and then switch to candlesticks for a closer look. Candlestick charts are especially useful when analyzing areas of consolidation such as triangles and flags for signs of reversal or continuation. The major signals in candlestick theory are reversal signals. Some of these signals are considered so strong by serious candlestick practitioners; they will enter a trade based on its signal alone, without the need for conformation. Since our trading style is to confirm everything, we won’t act on the signal alone, although we will pay close attention.
Our goal will be to teach you candlestick methods in their purest form, so we will alert you to the signals in which no conformation is said to be necessary. We will also break down each signal, expanding on its psychological implications on the chart. Our objective will be to not only educate you in the proper use of candlesticks, but also give plenty of examples of their improper use within a chart formation or pattern.