Candlestick Patterns – Part 1
Presenter: Sajid Khan Ghori
LEARNING OUTCOMES
Introduction & Understanding of Candlestick Patterns
Doji, Hammer, Inverted Hammer, Spinning Tops & Bottoms
Engulfing Patterns, Bullish Piercing & Dark Cloud
Candlestick Chart
Japanese Candlestick chart is a style of price chart
which depict the plotting of the price movement of a
security or financial instrument.
An individual candle will usually plot the price
movement in one of two ways being up or down. A
candle that plots price movement in a positive or
upward direction is called a Bullish Candle. On other
hand, the candle that plots price movement in a
negative or downward direction is referred to as a
Bearish Candle.
You may get 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.
Candlestick Patterns
Candlestick chart may seems a simple price chart at first glance but
a careful & investigative look tells the story of tug of war between
Buyers & Sellers.
Candlestick chart shows many different types of candles which vary
in the size of their bodies & wicks/shadows with each other.
Although every single candle portrays 4 types of price information
(as discussed earlier), not every candle has significance in terms of
anticipating the future direction of price movement.
There are some candlestick patterns which gives high probable
clues/hints of the likely future direction of price movement, are
called “Candlestick Patterns”. They have no value until they appear
on significant support & resistance levels.
Doji Candle
The Doji is an important single candle due to the fact that
it signifies indecision in the market, at least for that trading
time period. When the candle opens the price moves up or
down forming the upper or lower shadow then the
opposite direction forming the other shadow and finally
closing at or near the same price it opened at.
The psychology behind the Doji shows that buyers and
sellers were even for that time period with neither side
being able to get the upper hand to move the price. In an
oversold market the Doji has very bullish implications and
in an overbought market it has very bearish overtones. All
Doji signals are enhanced by a long daily range (shadows)
and overbought or oversold market conditions.
Doji causing trend reversal
Other Doji Formations
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. The Gravestone Doji can be considered very bearish at a
top or at levels of technical resistance.
The Dragonfly Doji Shows price action for the day that
finishes at the top of its daily trading range giving the Bulls
the slight upper hand for the day. The Dragonfly Doji is a very
bullish candle when forming at a bottom.
The Long Legged doji is a doji that could have either a very
long shadow on the top or bottom of the body of the candle.
The Long Legged doji signifies extreme uncertainty between
buyers and sellers on that specific trading day.
Gravestone Doji & Dragonfly Doji
Hammer
The Hammer is a single candle that also represents a possible change in trend
direction, similar to the Doji. The Hammer also has a couple of variations in
shape. A hammer has a long daily range compared to the difference between
the closing and opening price. 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.
The significance of a Hammer candle is its long shadow compared to the size of
its body. It depicts either buyers or sellers started the day off moving prices their
desired direction. Once prices moved 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 which may
show the force of the trend was weakening. A Hammer can have either bullish or
bearish overtones depending were it forms. If prices were moving in an uptrend,
the length of the shadow 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. The reverse is true if the hammer forms at
the bottom of a downtrend.
Hammer in Uptrend
Inverted Hammer
Inverted hammer usually has the same psychological implications as a
traditional hammer.
When we find the inverted hammer at the top of a trend it can give us a
very bearish signal. After the bulls have moved prices in an uptrend,
the day of the inverted hammer will signal that at the beginning of the
trading day the bulls continued moving prices higher but were met with
stiff resistance from sellers. The bears were able to push prices back
down close to the opening price leaving the upper shadow. The longer
the upper shadow gives us a more bearish signal in this situation.
When we find the inverted hammer at the bottom of a trend it will
signify buyers beginning to enter the market. While the prices have
been moving lower for a period of time, buyers enter on the day of the
hammer pushing prices higher. Even though the bears were able to
push prices back down leaving the upper shadow, the fact that they
had to gives a very bullish signal and we would begin to look for signs
of a reversal.
Inverted Hammer in Downtrend
Spinning Tops
Spinning tops are candles that have a small body
compared to the size of the shadows. Spinning top must
have long shadows at both ends of the body. Spinning
tops may or may not offer information depending on their
place on a 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 on a
level of support/resistance or forms within a few days of a
Doji.
Spinning Tops causing Reversal
Bullish Engulfing
The Bullish Engulfing formation is a very strong bullish two day reversal signal.
The Bullish Engulfing pattern consists of a black candle on the first day with the
price gapping down on the second day, 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 day’s opening price completely engulfing the first day’s body. A look
at the psychology behind this formation reveals the sellers or the supply declining
as prices move lower. When the price gaps down on the second day, buyers
begin entering with force. The pattern reveals a change in investor sentiment from
selling to buying. There are a few things we look for to indicate an even stronger
signal:
• A large body engulfing a small body.
• The body of the second day engulfing the body and the shadows of the first day.
• The pattern forms at any technical price support area such as, a trend line, major
moving average, or horizontal support.
Bearish Engulfing
The Bearish Engulfing reversal pattern 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
on the second day price 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 overbought 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:
• A large body engulfing a small body.
• A large body engulfing the body and the shadows of the first day.
• The pattern forms at any technical price resistance area such as, a trend
line, major moving average, or horizontal resistance.
Bullish Piercing
The Bullish Piercing pattern, also referred to a Piercing Line, is a two day
formation that consists of a longer than average black candle on the first day
followed by a white candle that rebounds to close into the body of the first
candle.
This pattern forms in a very bearish climate after a significant downtrend with
the long black candle of the first day demonstrating heavy selling and fear. The
long shadow on the second day indicates fear is still present, but throughout
the second day selling dries up and buyers come in with vigor sending prices
back into the body of the first day’s candle. Even though this is a very strong
reversal signal it should be confirmed by the following day’s candle.
There are some factors that we can look for to strengthen the signal:
• A large dark candle.
• The distance the first candle is penetrated by the second day’s candle.
• The pattern is formed at an area of technical support such as a major moving
average, trend line, or horizontal support.
Dark Cloud
Dark Cloud formation is the bearish counterpart of the Bullish Piercing pattern. This
two day reversal formation is made up of a white (or clear) body on the first day,
followed by a dark candle on the second day that gaps up and comes back down into
the body of the first day’s candle. While the Dark Cloud is a strong reversal signal,
confirmation is required by the next day’s candle to determine its strength.
The Dark Cloud pattern forms after a substantial uptrend has been in place. On the
first day’s white candle buying has peaked. The small number of buyers that are left
the next morning cause the price to gap up above the close of the first day and sellers
begin to step in bringing prices back down into the body of the first day’s candle.
We can watch for a couple of indications that will help us determine the strength of the
Dark Cloud formation:
• The distance the second day’s dark candle penetrates the white body of the first day.
• The bigger the candles on both days the better.
• The pattern forms at a major technical resistance such as an upper trend line,
horizontal resistance or major moving average.
