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• Direction: Bearish • Type: Reversal • Reliability: Weak • In an uptrend, the first day is a long blue candle continuing the established bull trend. • The second day is a candle (red or blue) with a real body at the lower end, a long upper wick and no (or almost no) lower wick.
Occurring in an uptrend the Shooting Star formation is indicative of a bearish change of momentum. Shooting Stars show that traders have tested the highs and settle the day near the open and low price. This suggests the rally is unsustainable and sellers are retaking the market. Although this pattern is fairly weak, for those traders with existing longs in the market the Bearish Shooting Star serves as a signal for the deteriorating strength of their position.
• Confirmation Many traders will wait for a bearish move on the third day, forming a formation similar to the Evening Star three-candle pattern. If day three is a long red candle, that pattern combined with the shooting star is a very strong reversal signal.
• Direction: Bearish • Type: Reversal • Reliability: Weak • First day is long blue candle continuing an established uptrend. • Day-two is a small candle or start whose range is within the first days body, above its midpoint.
Bearish Haramis are characterized by a long blue day followed by a small candle, also refers to as a star. The trading range of the star stays within the body of the previous days candle. The significance of this formation is quite clear, as price continues its uptrend it is halted by a bearish candle.
Bearish Haramis are very weak in signal strength though, since even in a strong bull trend it is very reasonable to see a sell-off that pulls price back down from highs. Longs paring off their exposure may cause this. Thus candlestick analysts will watch for bearish days to come, but probably not bet on them.
In non-FX markets gaps seen above that allow the star to occur deep within the body of the first days candle are typical. Such gaps are just not possible in Foreign Exchange Markets. Since the Forex Market version of this candle is more nuanced, traders pay attention to several details.
This formation is very similar to the Bearhish Engulfing formation, except that the Harami move does not trade below the previous candles body. Because Harami sellers are not able to drive price much past the previous days midpoint, this patterns offers a weaker signal.
In range bound markets this formation will occur frequently with little significance. But if this pattern occurs after a protracted uptrend, analysts will attach greater importance to it.
Lastly if this does turn out to be a reversal pattern the high of the two candles will likely turn into a significant resistance level.
• Direction: Bearish • Type: Reversal • Reliability: Moderate to Weak • In a uptrend a red or blue day occurs with a body in the upper part of the sessions range, a long lower wick, and little to no upper wick • Analysts do not care of the small candle is red or blue
The Hanging Man formation indicates trend exhaustion, and suggests a bearish reversal. After a bullish rally the day opens with a significant sell-off, creating a long bottom wick. However, buyers are able to push prices back to the upper range, creating a short body.
The meaning of the candle is a bit ambiguous. Even though sellers brought the market to low lows, in the end buyers brought the close price back up near the market open price. Overall this candlestick serves as an early indication that buyers are losing control and bearish traders are gaining strength.
Since the signal alone is fairly weak, traders look for a number of characteristics to reinforce the bearish signal.
In ideal conditions traders want the wick length to be several times longer than the body of the candle. The longer the candle, the stronger sellers were able to drive price down and the stronger the bearish signal this candle provides.
Although above we state that most analysts do not care if the small candle is red or blue, traders will actually take a red candle to suggest a slightly stronger bearish signal. Sellers being unable to bring the close price below the open price suggest stronger bearish control.
The bearish Dragonfly Doji serves as a stronger sell signal than the Hanging Man pattern. Since a Dragonfly candle (where open and close are identical, but we see a low similar in length to the Hanging Man) reflects more uncertainly and lack of direction, candlestick analysts will usually take it as a stronger bear signal.
• Hammer vs Hanging Man. Alone, Hammer and Hanging Man candles look identical. Their difference lies in what type of trend the candle follows. If the market had been trending up for a while the formation is a Hanging Man. In fact the name, Hanging Man, suggest price is hanging over a precipice, ready for a fall. Hammers follow a bearish trending market and its name suggests price has already been weighted down.
Although traders will usually wait for confirmation the next day, look for selling opportunities to come.
• Direction: Bearish • Type: Reversal • Reliability: Moderate • In an established uptrend, an average to small sized blue candle occurs on day-one. • In the second day a longer red candle forms • Ideally with a red candles high is above the previous days high. • The strength of the signal is additionally increased by the further the red candle closes below the low of the blue day.
The Bearish Engulfing is one of the more clear-cut two day bearish reversal patterns. The formation reflects sellers overtaking buying strength, and often precedes a fall in price.
• Day-One Characteristics for Signal Strength The first day may even appear as a Doji, and the smaller day-one is and larger the second day is, the stronger the reversal signal. Dojis and small candles reflect uncertainty in the markets trend, thus the smaller the first days candle the better the signal of an end to the established bull trend.
• Day-Two Characteristics for Signal Strength The second day bear move acts to confirm the death to the bull trend. The bigger the red candle reflects the deeper the bear move and the better the reversal signal.
• Overall Characteristics for Signal Strength This pattern is also more meaningful if it follows a lengthy bull trend, or a recent fast move up. Both these cases suggest the market may be overbought and more apt for a reversal.
Bearish Engulfing patterns also provide resistance levels for where the highest level of price action reached. In the future this level may be difficult to break.
Evening Stars start with a continuation of the bullish move. The second day sees a continuation of the move up, but a sell-off makes the market close at or near the open for the day. The first two candles meekly suggest a loss of bullish momentum. In fact up to day two this formation matches the Bearish Shooting Star weak-to-moderate strength reversal pattern.
Although the example above is a blue shooting star, the shooting star can really be any color.
Bearish Shooting Stars alone are decent signals for additional sell-offs on day three. Since the certainty for a shooting star indicator is low, the trend reversal should be confirmed by a red candlestick the next day.
Thus Bearish Evening Stars require on day three a sharp sell-off after the market open. Analysts want day threes high to be near equal to its open price, suggesting the market sell-off has no uncertainty in the new direction.
With this pattern watch for sells offs the follow days.
In non-FX markets gaps are quite common, and Evening Stars traditionally require a gap between the first and second day. In fact the wider the gap from day two to three the better the signal in non-FX markets, since the higher day-two goes the stronger day-threes bearish move is.
Because FX offers 24 hour trading, no gaps should be expected. The Forex Market version of this formation would share the same market close price on day one, and then start day twos rally from there. Day twos close would be the same whether in FX or any other market restricted to fixed exchange hours. The formation would tend to see a shooting start on day two. Thus this formation might more aptly be called Evening Shooting Stay when applied to the Foreign Exchange Market.
• Direction: Bearish • Type: Reversal • Reliability: Strong • The first day is a long blue day • The second day will close below the midpoint of the previous candles body
The market continues the uptrend on the first day. By day two sellers take price down to close near the open of the previous day.
In FX, traders view the higher the second day high the better since the bigger the rally after the open, the more sellers were able to drive price back down.
This formation suggests short sellers have begun to take charge of the market, and longs have been shaken by the sudden lost of bullish momentum. Declining days are common after this formation as more short sellers confidently to enter the market with a clear stop benchmark at the second day high.
The deeper day-two closes into the first day candlestick body, the greater the chance of the uptrend topping out. If the second day candle does not trade below the midpoint of the first day body, traders typically feel it safer to wait for confirmation on the third day.
Some traders wait for confirmation regardless of how deep the Dark Cloud Cover penetrates the second day.
In non-FX markets, traders want to see the second day gap up, opening above the close of the previous day. Because the Forex Market offers continues 24 hour markets, such gaps are not typically possible. But FX traders will turn to the high of the second day to indicate how strong the opening rally is, to gauge the strength of the subsequent bear move.
Candlesticks provide unique visual cues that make reading price action easier. Trading with Japanese Candle Charts allow speculators to better comprehend market sentiment. Offering a greater depth of information than traditional bar charts - where the high and low are emphasized - candlesticks give emphasis to the relationship between close price and open price.
Traders who use candlesticks may more quickly identify different types of price action that tend to predict reversals or continuations in trends - one of the most difficult aspects of trading. Furthermore, combined with other technical analysis tools, candlestick pattern analysis can be a very useful way to select entry and exit points.
The following image represents the design of the typical candlestick.
The body of a candlestick illustrates the difference between the open and closing price. Its color (in this case, red for down and blue for up) shows whether the day's (or week's or year's) market closed up or down.
The wicks (or shadows) point out the extreme low and the extreme high price for the currency that day.
Bar-Chart Side by Side With Candlestick Chart
Because the body of the candle is thicker than the shadow, candlestick charts visually stress how the close price relates to the open price far more than bar charts. Candlestick traders have a saying; the real body is the essence of price movement.
Bar charts on the other hand allow spikes to highs and lows to have prominence when exploring their data, these highs and lows often represent market noise, less significant to good analysis. The power of candles is their ability to visually screen out this static and focus on what the market was able force price to do during a period of trading
Outside of the trading pit, Technical Analysis is really the only way to gauge market emotion. A candlestick alone does not give much information useful to determining market sentiment. Market professionals do however look for specific patterns of candlesticks to gauge future price movements. Many of these candlestick names have eccentric names like Morning Star, Dark Cloud Cover or Engulfing Pattern that are based translations of their Japanese names. The names also tend to reflect market sentiment.
Reversal Patterns
One of the most significant goals of technical analysis is to identify changes in direction of price action. Because candlesticks give insight into what the market is thinking, one of the most useful aspects of candlestick analysis is its ability to suggest changes in the sentiment of the market. We call these candle formations Reversal Patterns.
There are a number reversal patterns in western technical analysis, such as Head & Shoulders and Double Tops. Those formations often don't give much insight into what the market is thinking, they simply represent common patterns found in price action that precede a reversal. Reversal patterns in western analysis often take many periods to form. On the other hand Candlestick interpretations concentrate much more on understanding market psychology than anything else. And because the vast majority of Candlesticks formations take one to three time periods, they give traders more of a real time picture of market sentiment.
Important to note is that with candlesticks a reversal pattern does not necessarily suggest a complete reversal in trend, but merely a change or pause in direction. That could mean anything from a slowdown in trend, sideways trading after an established trend, or a full turnaround following a reversal candle pattern.
Continuation patterns suggest the market will maintain an established trend. Often the direction of the candlesticks themselves are in the opposite direction of trend in continuance. Continuation patterns help traders differentiate between a price action that is in full reversal and those merely taking a pause. Most traders will tell you there is a time to trade and a time to rest. The formation of continuation candlestick patterns imply consolidation, a time to rest and watch.
Using Candlesticks
Candlesticks serve as valuable insight into the market. Most candlestick analysts will tell you though; do not to use them as your sole technical analysis tool. These patterns are often made irrelevant by technical analysis events outside of what candle formations can tell you. The most prominent candlestick analysis proponents in the West use these patterns to confirm traditional western technical or fundamental analysis techniques.
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Candlesticks are formed using the open, high, low and close.
If the close is above the open, then a hollow candlestick (usually displayed as white) is drawn.
If the close is below the open, then a filled candlestick (usually displayed as black) is drawn.
The hollow or filled section of the candlestick is called the “real body” or body.
The thin lines poking above and below the body display the high/low range and are called shadows.
The top of the upper shadow is the “high”.
The bottom of the lower shadow is the “low”.
Long bodies indicate strong buying or selling. The longer the body is, the more intense the buying or selling pressure.
Short bodies imply very little buying or selling activity. In street forex lingo, bulls mean buyers and bears mean sellers.
Upper shadows signify the session high.
Lower shadows signify the session low.
Candlesticks with a long upper shadow, long lower shadow and small real bodies are called spinning tops. The pattern indicates the indecision between the buyers and sellers
Marubozu means there are no shadows from the bodies. Depending on whether the candlestick’s body is filled or hollow, the high and low are the same as it’s open or close.
Doji candlesticks have the same open and close price or at least their bodies are extremely short.
The hammer is a bullish reversal pattern that forms during a downtrend. It is named because the market is hammering out a bottom.
The hanging man is a bearish reversal pattern that can also mark a top or strong resistance level.
The inverted hammer occurs when price has been falling suggests the possibility of a reversal.
The shooting star is a bearish reversal pattern that looks identical to the inverted hammer but occurs when price has been rising.
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For a pattern to qualify as a reversal pattern, there should be a prior trend to reverse. Bullish reversals require a preceding downtrend and bearish reversals require a prior uptrend. The direction of the trend can be determined using trendlines, moving averages, or other aspects of technical analysis.
Hammer and Hanging Man
The hammer and hanging man look exactly alike but have totally different meaning depending on past price action. Both have cute little bodies (black or white), long lower shadows and short or absent upper shadows.
The hammer is a bullish reversal pattern that forms during a downtrend. It is named because the market is hammering out a bottom.
When price is falling, hammers signal that the bottom is near and price will start rising again. The long lower shadow indicates that sellers pushed prices lower, but buyers were able to overcome this selling pressure and closed near the open.
Word to the wise… just because you see a hammer form in a downtrend doesn’t mean you automatically place a buy order! More bullish confirmation is needed before it’s safe to pull the trigger. A good confirmation example would be to wait for a white candlestick to close above the open of the candlestick on the left side of the hammer.
Recognition Criteria:
The long shadow is about two or three times of the real body.
Little or no upper shadow.
The real body is at the upper end of the trading range.
The color of the real body is not important.
The hanging man is a bearish reversal pattern that can also mark a top or strong resistance level. When price is rising, the formation of a hanging man indicates that sellers are beginning to outnumber buyers. The long lower shadow shows that sellers pushed prices lower during the session. Buyers were able to push the price back up some but only near the open. This should set off alarms since this tells us that there are no buyers left to provide the necessary momentum to keep raising the price. .
Recognition Criteria:
A long lower shadow which is about two or three times of the real body.
Little or no upper shadow.
The real body is at the upper end of the trading range.
The color of the body is not important, though a black body is more bearish than a white body.
Inverted Hammer and Shooting Star
The inverted hammer and shooting star also look identical. The only difference between them is whether you’re in a downtrend or uptrend. Both candlesticks have petite little bodies (filled or hollow), long upper shadows and small or absent lower shadows.
The inverted hammer occurs when price has been falling suggests the possibility of a reversal. Its long upper shadow shows that buyers tried to bid the price higher. However, sellers saw what the buyers were doing, said “oh hell no” and attempted to push the price back down. Fortunately, the buyers had eaten enough of their Wheaties for breakfast and still managed to close the session near the open. Since the sellers weren’t able to close the price any lower, this is a good indication that everybody who wants to sell has already sold. And if there’s no more sellers, who is left? Buyers.
The shooting star is a bearish reversal pattern that looks identical to the inverted hammer but occurs when price has been rising. Its shape indicates that the price opened at its low, rallied, but pulled back to the bottom. This means that buyers attempted to push the price up, but sellers came in and overpowered them. A definite bearish sign since there are no more buyers left because they’ve all been murdered.
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Candlesticks with a long upper shadow, long lower shadow and small real bodies are called spinning tops. The color of the real body is not very important.
The pattern indicates the indecision between the buyers and sellers
The small real body (whether hollow or filled) shows little movement from open to close, and the shadows indicate that both buyers and sellers were fighting but nobody could gain the upper hand.
Even though the session opened and closed with little change, prices moved significantly higher and lower in the meantime. Neither buyers nor sellers could gain the upper hand, and the result was a standoff.
If a spinning top forms during an uptrend, this usually means there aren’t many buyers left and a possible reversal in direction could occur.
If a spinning top forms during a downtrend, this usually means there aren’t many sellers left and a possible reversal in direction could occur.
Marubozu
Sounds like some kind of voodoo magic huh? "I will cast the evil spell of the Marubozu on you!" Fortunately, that's not what it means. Marubozu means there are no shadows from the bodies. Depending on whether the candlestick’s body is filled or hollow, the high and low are the same as it’s open or close. If you look at the picture below, there are two types of Marubozus.
A White Marubozu contains a long white body with no shadows. The open price equals the low price and the close price equals the high price. This is a very bullish candle as it shows that buyers were in control the whole entire session. It usually becomes the first part of a bullish continuation or a bullish reversal pattern.
A Black Marubozu contains a long black body with no shadows. The open equals the high and the close equals the low. This is a very bearish candle as it shows that sellers controlled the price action the whole entire session. It usually implies bearish continuation or bearish reversal.
Doji
Doji candlesticks have the same open and close price or at least their bodies are extremely short. The doji should have a very small body that appears as a thin line.
Doji suggest indecision or a struggle for turf positioning between buyers and sellers. Prices move above and below the open price during the session, but close at or very near the open price.
Neither buyers nor sellers were able to gain control and the result was essentially a draw.
There are four special types of Doji lines. The length of the upper and lower shadows can vary and the resulting candlestick looks like a cross, inverted cross or plus sign. The word "Doji" refers to both the singular and plural form.
When a doji forms on your chart, pay special attention to the preceding candlesticks.
If a doji forms after a series of candlesticks with long hollow bodies (like white marubozus), the doji signals that the buyers are becoming exhausted and weakening. In order for price to continue rising, more buyers are needed but there aren’t anymore! Sellers are licking their chops and are looking to come in and drive the price back down.
Keep in mind that even after a doji forms, this doesn’t mean to automatically short. Confirmation is still needed. Wait for a bearish candlestick to close below the long white candlestick’s open.
If a doji forms after a series of candlesticks with long filled bodies (like black marubozus), the doji signals that sellers are becoming exhausted and weakening. In order for price to continue falling, more sellers are needed but sellers are all tapped out! Buyers are foaming in the mouth for a chance to get in cheap.
While the decline is sputtering due to lack of new sellers, further buying strength is required to confirm any reversal. Look for a white candlestick to close above the long black candlestick’s open.
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Just like humans, candlesticks have different body sizes. And when it comes to forex trading, there’s nothing naughtier than checking out the bodies of candlesticks!
Long bodies indicate strong buying or selling. The longer the body is, the more intense the buying or selling pressure.
Short bodies imply very little buying or selling activity. In street forex lingo, bulls mean buyers and bears mean sellers.
Long white candlesticks show strong buying pressure. The longer the white candlestick, the further the close is above the open. This indicates that prices increased considerably from open to close and buyers were aggressive. In other words, the bulls are kicking the bears’ butts big time!
Long black (filled) candlesticks show strong selling pressure. The longer the black candlestick, the further the close is below the open. This indicates that prices fell a great deal from the open and sellers were aggressive. In other words, the bears were grabbing the bulls by their horns and body slamming them.
Mysterious Shadows
The upper and lower shadows on candlesticks provide important clues about the trading session.
Upper shadows signify the session high. Lower shadows signify the session low.
Candlesticks with long shadows show that trading action occurred well past the open and close.
Candlesticks with short shadows indicate that most of the trading action was confined near the open and close.
If a candlestick has a long upper shadow and short lower shadow, this means that buyers flexed their muscles and bid prices higher, but for one reason or another, sellers came in and drove prices back down to end the session back near its open price.
If a candlestick has a long lower shadow and short upper shadow, this means that sellers flashed their washboard abs and forced price lower, but for one reason or another, buyers came in and drove prices back up to end the session back near its open price.
Buy a copy of School of Pipsology for $49 in PDF format
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While we briefly covered candlestick charts in the previous lesson, we’ll now dig in a little and discuss them more in detail. First let’s do a quick review.
What is a Candlestick?
Back in the day when Godzilla was still a cute little lizard, the Japanese created their own old school version of technical analysis to trade rice. A westerner by the name of Steve Nison “discovered” this secret technique on how to read charts from a fellow Japanese broker and Japanese candlesticks lived happily ever after. Steve researched, studied, lived, breathed, ate candlesticks, began writing about it and slowly grew in popularity in 90s. To make a long story short, without Steve Nison, candle charts might have remained a buried secret. Steve Nison is Mr. Candlestick.
Okay so what the heck are candlesticks?
The best way to explain is by using a picture:
Candlesticks are formed using the open, high, low and close.
If the close is above the open, then a hollow candlestick (usually displayed as white) is drawn.
If the close is below the open, then a filled candlestick (usually displayed as black) is drawn.
The hollow or filled section of the candlestick is called the “real body” or body.
The thin lines poking above and below the body display the high/low range and are called shadows.
Continuation patterns suggest the market will maintain an established trend. Often the direction of the candlesticks themselves are in the opposite direction of trend in continuance. Continuation patterns help traders differentiate between a price action that is in full reversal and those merely taking a pause. Most traders will tell you there is a time to trade and a time to rest. The formation of continuation candlestick patterns imply consolidation, a time to rest and watch.
