Candle stick patterns

Being a trader is very much like being a detective, imagine you're a detective who's
trying to solve a murder case. What's the first thing you'll need to do?
You'll probably first have to conduct a general survey of the crime scene, question all
the witnesses and try to determine the motives of the possible suspects. This will give
you a general idea of how, why, when, and by whom the crime was committed. In trading is the same, we also our charts to find how, why, when, where to find the best possible trades, to answer all these questions we use candle stick patterns to find answers.

Candle Stick pattern

What are Candlestick Patterns?

Candlestick patterns are a series of candlesticks on a chart, which display previous price action and are used to predict future price movements. A candlestick pattern either signals a trend reversal or trend continuation. This means that based on a series of candlesticks, the trader can tell if the current trend is likely to continue or reverse (change direction).  To identify the pattern we must be familiar with the trend we are looking at. Studying candlestick patterns will help a trader to decide whether to buy or sell a currency pair.  For example, when looking at a chart of candlestick and seeing a clear pattern in which the currency pair is strengthening, a continuation pattern would advise the trader to buy whereas a reversal pattern would signal the trader to sell the pair. The premise for understanding candlestick patterns is that history does tend to repeat itself, so future price movement is best predicted by understanding past price movement. Candlestick charting allows a quick read on changes in supply and demand. By analyzing the  price movements of an pair using candlesticks, a trader is able to confirm evidence of trend reversal very early on. Candlesticks draw an inductive, as opposed to deductive, view of markets, the facts are presented graphically, one has only to read and understand.

what do candle stick patterns signals?

  • Reversal of a trend
  • Continuation of a trend
  • Both

Does previous price history play any role

  • What matters is the current price when looking at patterns
  • Price does not matter
  • Previous price history turns to repeat itself hence it is important to look at it

Detecting the 'Right' Candlestick Signals

As one learns to interpret the different candlestick patterns, one should always keep in mind the following rules to assist in detecting patterns and determining possible actions to be taken. There are three simple rules to interpreting candlestick patterns: Take note that example are made with candle stick patterns on the rules and they will make more sense as we learn more on candle sticks patterns.

Size

Larger candles play an important role when identifying patterns. They represent accumulation or distribution within the market. When you begin to see an increase in size of the candles, the trend is accelerating and accumulation is occurring. When you begin to see a decrease in the size of the candles, the trend is decelerating and distribution is occurring.

Shape

The shape of the candlestick, or pattern, determines the type of pattern generated, the possible trading signal, and the potential direction of trend. Shape and size work hand-in-hand. A very small Engulfing Bullish pattern would indicate the potential for a market rally, yet the small size indicates that the trend has not yet begun to accelerate.

Location

The location of a candlestick pattern will assist in determining the possible trading signal. For example, a Shooting Star found after a defined up trend strongly indicates a potential bearish correction or top. A Piercing Line found after a defined down trend indicates a potential for a bullish reversal. Either of these two patterns found within a consolidated sideways trend, do not indicate as strong a potential for a trend reversal, and one should wait for confirmation of the candlestick pattern before taking action.

How does Size, Shape and location affect candle stick patterns?

The rule of two

Generally, no one candlestick should be judged in isolation. The general principle is even if you see a key reversal candlestick, you should wait at least part of one more day before acting. If for example, you spot a candle called a doji, seek verification from the action of the next trading day. If there is a down gap and prices begin to decline then it is to take your position.

Does single candles have special significance on their own?

  • Yes, a doji or any other candle are good enough to take a trading decision.
  • No, you need confirmation candles after a candle stick pattern has appeared in order to make a trading decision

Bullish Reversal Patterns

The bullish engulfing is most significant when it occurs after a prolonged downtrend. The currency pair has been selling off sharply. On the day of the bullish engulfing, prices will often start the day by falling. However, strong buying interest comes in and turns the market around.The bullish engulfing is named because this candle surrounds or engulfs the previous one. This pattern should be viewed in consideration of the trend at the time: if a bullish engulfing pattern appears in a downtrend, it can suggest a shift price trend and the onset of buying demand becoming the prevailing force that will ultimately push price higher in the context of the time frame being viewed.

Choose the three engulfing candlees

Hammer candlesticks

Hammer candlesticks form when a security moves significantly lower after the open, but rallies to close well above the intra day low. The resulting candlestick looks like a square lollipop with a long stick. If this candlestick forms during a decline, then it is called a Hammer signifying hammering the downtrend to a stop. When a hammer appears at the bottom of a downtrend, its long wick implies an unsuccessful effort by bears to push price down, and a corresponding effort by bulls to step in and push price back up quickly before the period closed. As such, a hammer candlestick in the context of a downtrend suggests the potential exhaustion of the downtrend and the onset of a bullish reversal.

Morning Star

Morning Star is a three day bullish reversal pattern consisting of three candlesticks - a long-bodied black candle extending the current downtrend, a short middle candle that gapped down on the open, and a long-bodied  candle that gapped up on the open and closed above the midpoint of the body of the first day. The morning star constitutes a potential bottom to the preceding bearish leg, and functions therefore as a buy signal.

Piercing Line

A bullish two candle reversal pattern. The first candle, in a downtrend, is a long bearish candle. The next candle opens at a new low, and then closes above the midpoint of the body of the first candle. these signal is reliable as a two-bar indicator of a trend reversal in proportion to the height of the second bullish bar. As the strength of the reversal signal is related to the size of the second candle

Doji

This candle has zero or almost zero range between its open and close.Rather than implying potential reversal or the clear dominance of either bears or bulls, these candles suggest indecision or balance between the two forces.Neither buyers nor sellers are fully in control. A doji that occurs in the context of a strong trend implies the weakening of the dominant force that resulted in that trend. A long-legged doji has long wicks in both directions, implying strong,balanced pressure from both buyers and sellers. The “dragonfly” and “gravestone” doji imply, respectively, that sellers and buyers controlled the market for most of the trading period, but then the opposite group managed to push price back to the open before the close. While tradition and long-legged dojis are reflective of indecision and stalling, gravestone and dragonfly are generally clearer, stronger indicators that a force is stepping into push the market in the direction of the wick and away from the body. In this respect, gravestone and dragonfly dojis are similar to hammer and hanging man patterns, which were discussed earlier during the course.