Candlestick Patterns

Question 1

What is a Candle?

Answer 1

The candle is comprised of two parts, the body and the shadows. The body encompasses the open and closing price for the period. The candle body is black if the security closed below the open, and white if the close was higher than the open for the period. The candlestick shadow encompasses the intraperiod high and low. (Note: In candlestick charting the following periods are often used; 5 min, 15 min, 1 hour, daily and weekly). Long shadows, show that the trading extended well beyond the opening and/or closing price, while short shadows, show that trading was confined closely to the open and/or closing price.

Question 2

Long, and Short Bodies; Marubozo and Spinning Tops

Answer 2

A long body, is a candlestick with a very long body when compared with other recent candles. White bodies show intense buying pressure, where as black bodies show intense selling pressures. Long white candles are generally bullish, but are also found at blowout tops, so they must be interpreted with surrounding candles. Similar long black candles are generally bearish, but are also found at capitulation bottoms. Long bodies with no upper and lower shadows are called Marubozo’s. Marubozo’s are more powerful than long candles as they show a steady advance (or decline if black)throughout the trading period. A short candle is the opposite of a long candle and usually implies consolidation, as the stock traded in a narrow range during the period. Short candles with long upper and lower shadows are called spinning tops, and are potential reversal signs, as it shows that despite trading in a wide range, the security closed close to the open. A spinning top becomes a doji as the closing price approaches the open price.

Question 3

Doji’s

Answer 3

Doji’s are powerful reversal indicating candlesticks and are formed when the security opens and closes at the same level, implying indecision in the stock price. Depending on the location and length of the shadows, doji’s can be categorized into the following formations: doji, long legged-doji, butterfly doji, gravestone doji, 4 price doji, etc. Doji’s become more significant when seen after an extended rally of long bodied candles (bullish or bearish) and are confirmed with an engulfing.( a long candlestick formed over the next period which engulfs the doji body).

A long legged-doji is formed when the stock opens at a level, trades in a considerable trading range only to close at the same level as it opened. Long legged-doji’s become more powerful when preceded by small candles, as a sudden burst of volatility in a relative unvolatile stock, can imply a trend change is coming.

Dragonfly Doji’s are doji’s that opened at the high of a session, had a considerable interperiod decline, then find support to rally back to close at the same level as the open. Dragonfly Doji’s are often seen after a moderate decline, and are bottom reversal indicators when confirmed with a bullish engulfing.

Gravestone Doji’s are the opposite of the Dragonfly Doji and are top reversal indicators when confirmed with bearish engulfings. As the name implies, gravestone doji’s look like a gravestone, and could signal impending doom for a stock.

4 price doji’s occur when the stock opens, trades and closes at virtually the same level for the period. These are very rare, except with thinly traded securities.

Question 4

Engulfings

Answer 4

An engulfing occurs when the candle body engulfs the previous candles body. White engulfing candles are bullish engulfings, where as black engulfing candles are bearish engulfings. Bullish engulfings are commonly found at short term bottoms, where as bearish engulfings at tops. Many candlesticks, such as dojis, hammers, hanging mans need confirmation of a trend change with an engulfing (bullish engulfing at bottoms, bearish engulfings at tops).

Question 5

Hammers/ Hanging Man

Answer 5

Hammers and hanging man’s are short body candle’s with little or no upper shadow, and a lower shadow at lease twice as long as the candle body. Hammers are formed after declines, and hanging man’s after advances. When confirmed they become powerful reversal signals, especially the hammer. The expression “hammers out a bottom” refers to when after the open, the downtrend in a stock continues, until at some point, enough buying interest is generated, to bring prices close to where they open. Confirmation comes from a bullish engulfing, showing the trader that the up trend is established. The color of the hanging man/hammer is unimportant, but some consider white hammers and black hanging man’s more potent reversal signals.

Question 6

Gaps

Answer 6

A gap occurs when a candlestick body doesn’t fall within the range of the previous candlestick body, a more loosely interpreted definition of a gap, requires no overlap between the shadows, making it obvious on a bar chart as well. You will often hear “All Gaps Get Filled”, which is untrue. While the vast majority of gaps do get filled, you can find some charts, where a gap has never filled. Depending on how you define a gap, should base your definition of a gap fill. For instance I consider a gap when 2 bodies don’t overlap, so I wait for a body fill to call the gap close. If one was using the criteria of shadow overlap, a gap fill would occur with a shadow fill. Gaps are typically continuation patterns, and sometimes mark the 50% point of a move. They become more significant as the stock approaches the level of the gap as it often acts as a magnet. During a gap fill, it is considered bearish closing below the bottom of the gap and bullish closing above it. Once formed gap’s will often serve as strong support/resistance levels even after being closed for some time.

Exhaustion gaps signify the end of market bottoms and tops, where initially overwhelming buying pressure, is soon consumed by selling pressure (and vice versa for bottoms). Exhaustion gaps have significant volume associated with them, and are often closed within 3 trading days. Sometimes an exhaustion gap will be followed by another gap at the same levels, some examples are shooting stars, doji stars, abandoned baby, etc. These 2 gap formation are powerful reversal signal’s.

Three Gap Play occurs when a stock gaps in the direction of the trend for close to 3 consecutive periods, with the final gap is an exhaustion gap that is larger then the previous gaps with respect to size and volume. After the exhaustion gap, the trend changes all of the gaps immediately get filled. After the final gap is filled, the stock turns and continues well beyond the initial exhaustion gap. Although pretty rare, they can be very profitable if recognized early and swing traded.

Question 7

Which Moving Average to Use

Answer 7

Question 8

Western analogy to the Japanese engulfing pattern

Answer 8

Question 9

Two Kinds of Confirmation

Answer 9

Question 10

The Criteria for engulfing pattern

Answer 10

Question 11

Stop Losses

Answer 11

Question 12

Simple Moving Average

Answer 12

Question 13

Reverse Head & Shoulder

Answer 13

Question 14

Profitable Trades

Answer 14

Question 15

Prime use for engulfing pattern

Answer 15

Question 16

Price Confirmation

Answer 16

Question 17

Options

Answer 17

Question 18

Moving Averages

Answer 18

Question 19

Money Management I

Answer 19

Question 20

Head and Shoulder Variation - Upward Sloping Head & Shoulder

Answer 20

Question 21

Head and Shoulder Variation - Downward Sloping Head & Shoulder

Answer 21

Question 22

Head and Shoulder Variation - Complex Head & Shoulders - More Significant than Simple Pattern

Answer 22

Question 23

What is a Head and Shoulder Pattern

Answer 23

Question 24

Head and Shoulder - Volume Considerations

Answer 24

Question 25

Exiting a Losing Trade

Answer 25

Question 26

East + West Confirmation

Answer 26

Question 27

Doji

Answer 27

Question 28

Dojis II

Answer 28

Question 29

Doji - Nison Insights

Answer 29

Question 30

Complex Reverse Head and Shoulder

Answer 30

Question 31

Calls and Puts IV

Answer 31

Question 32

Calls and Puts III

Answer 32

Question 33

Calls and Puts II

Answer 33

Question 34

Call and Puts

Answer 34

Question 35

3 Moving Averages

Answer 35

Question 36

2 Moving Averages

Question 37

Stars

Answer 37

A star is a small real body that gaps away from a large real body preceding it. It is still a star as long as the star’s real body does not overlap the prior real body. They can occur at tops or at bottoms. If a star is a doji instead of a small real body, it is called a doji star. The star, especially a doji star is an indication that the trend is ending. The market psychology of a star is that the small real body represents a stalemate in the tug of war between the bulls and the bears. A star indicates the power of trend has dissipated and the market is vulnerable to a setback. Four types of stars: morning evening doji shooting The morning star is a bottom reversal pattern. The evening star is the bearish counterpart to the morning star pattern. The shooting star is a two bar pattern that warns of an impending top. It is usually not a major reversal signal as is the evening star. Identified by: morning star — in a downtrend, first bar is long black real body followed by a star, the third bar is a white real body that moves well into the real body of the first black bar. evening star — in an uptrend, first bar is long white real body followed by a star, the third bar is a black real body that moves well into the real body of the first white bar. morning doji star — in a downtrend, first bar is long black real body followed by a doji, the third bar is a white real body that moves well into the real body of the first black bar. evening doji star — in an uptrend, first bar is long white real body followed by a doji, the third bar is a black real body that moves well into the real body of the first white bar. shooting star — small real body at the lower end of the range with a long upper shadow that gaps away from the previous bar.

Question 38

Piercing Pattern

Answer 38

This is a bottom reversal (trend in change) pattern. Can be either bearish or bullish depending on the penetration percentage of the previous black bar’s real body.

It is the opposite of the Dark Cloud Cover pattern. It is found in a falling trend.
Identified by:
first bar has black real body.
second bar has a long white real body that opens lower than the previous bar’s low and then closes above the mid-point of prior bar’s black real body.
The market psychology can be described as:
trend has been down.
next bar opens lower with a gap, then prices rise so that the second bar closes sharply above the previous bar’s close.
bear’s re-consider their commitment to their position.
those traders who want to be long have a clearly defined stop point (i.e. the low of the second bar).
If the white real body does not reach or exceed the mid-point of the prior bar’s real body, it is considered a bearish signal. Indicating that the previous downward trend is likely to resume.
Thus there are three potentially bearish (called On-Neck, In-Neck, Thrusting) and one bullish interpretation of this pattern. Whether bearish or bullish depends on the percentage that the white real body penetrates the black real body.
When prices fall below the white bar’s lows, long positions would be stopped out.

Question 39

Dark Cloud Cover

Answer 39

Dark Cloud Cover

(as found in Japanese Candlestick Charting Techniques by Steve Nison)

This is a bearish pattern.

A top reversal (trend in change) after an uptrend or at times a congestion band.

Identified by:

first bar has a white real body.
 second bar opens above the prior bars high (above the upper shadow).
 by the close, the market is near the low of the bar and well within the previous bars white body.

The greater the percent of penetration into the white real body the more likely a top will occur. If the black candlestick does not close below the halfway point of the previous bars white real body, it is best to wait for more bearish confirmation.

The market psychology could be described as the bulls are having second thoughts about being long.

It also provides a clearly defined stop point for those traders wishing to go short (i.e. the new high of the second bar of the dark cloud cover pattern).

Important considerations:

The greater degree of penetration of the black real body’s close into the real body of the previous white bar’s real body, the greater the chance for a top.
 If the black real body completely covers the prior bars white real body, a bearish engulfing pattern occurs.
 If the second bar opens above a major resistance level and then fails, it indicates that the bulls could not sustain the upward trend.

Question 40

Harami

Answer 40

The bearish harami is made up of two candlesticks. The first has a large body and the second a small body that is totally encompassed by the first. There are four possible combinations: white/white, white/black, black/white and black/black. Whether a bullish reversal or bearish reversal pattern, all harami look the same. Their bullish or bearish nature depends on the preceding trend. Harami are considered potential bearish reversals after an advance and potential bullish reversals after a decline. No matter what the color of the first candlestick, the smaller the body of the second candlestick is, the more likely the reversal. If the small candlestick is a doji, the chances of a reversal increase.

In his book, Beyond Candlesticks, Steve Nison asserts that any combination of colors can form a harami, but the most bearish are those that form with a black/white or black/black combination. Because the first candlestick has a large body, it implies that the bearish reversal pattern would be stronger if this body were black. This would indicate a sudden and sustained increase in selling pressure. The small candlestick afterwards indicates consolidation before continuation. After an advance, black/white or black/black bearish harami are not as common as white/black or white/white variations.

A white/black or white/white combination can still be regarded as a bearish harami and signal a potential reversal. The first long white candlestick forms in the direction of the trend. It signals that significant buying pressure remains, but could also indicate excessive bullishness. Immediately following, the small candlestick forms with a gap down on the open, indicating a sudden shift towards the sellers and a potential reversal.