Technical Analysis: Candlestick Patterns
The following is a breakdown of the various basic patterns you’ll see on candlestick charts. Keep in mind when you’re looking at each of these that each candle represents the time frame you’ve selected; could be daily, could by hourly, could be 5-min. These patterns all occur at what can be considered different levels of resolution, and you can zoom in and out according what kind of trade you’re hoping to make or what kind of support or resistance you’re trying to find.
Hammer Chart Pattern
A hammer has a shaven head and a clear body. Like this:
The lower shadow should be twice the length of the real body. When the hammer appears at the bottom of a downtrend, it’s a signal that the current movement might be breaking.
Hanging Man Candlestick
The hanging man has a shaven head as well, but the real body is dark. Same as the hammer, the lower shadow should be twice the length of the real body. When appearing at the top of an uptrend, it signals that the current movement may be ending. It looks like this:
Bullish & Bearish Engulfing Patterns
An engulfing pattern is a signal consisting of two candlesticks, and it can mean an impending reversal of a major trend. The relative size of the real bodies matter. The latter body needs to “engulf” the former one, meaning the upper and lower boundaries of the second extend beyond those of the first, respectively. And the bodies themselves need to be opposite colors.
A bullish engulfing pattern, a smaller dark body followed by a larger clear one, means a reversal in a downward trend. A bearish engulfing pattern, a smaller clear body followed by a larger dark body, occurs at the reversal of an uptrend.
If the next body formed engulfs the second bod of this pattern, the signal strengthens. Think of it as an amplification.
Dark Cloud Cover
Dark cloud cover is a bearish reversal pattern appearing either at the end of an uptrend or at the end of a period of congestion, or sideways movement.
The signal involves two candlesticks. The first has a substantial clear real body. The second candlestick’s price gaps open above the top of the previous clear body as well as its shadow (if there is one). The second candle closes within the price range of the previous day’s candle, but below the midpoint of it.
The deeper the second body moves into the lower part of the first, the stronger the signal that the bears are taking over.
However, if the dark cloud cover pattern is followed by a substantial clear real body closing above the highs of either candle in the pattern, it suggests the start of another rally.
Bullish Piercing Pattern
The bullish piercing pattern is dark cloud cover in reverse, forecasting the reversal of a downtrend.
The first candlestick has a dark body and is part of a falling price move. The second has a clear real body and gaps open lower than the previous candlestick’s low. Then the price jumps back up and the stock price closes further than halfway up the prior candlestick’s body.
If the second real body doesn’t close at least halfway into into the dark body, the signal is negated. If the second, clear real body opens lower than the previous day’s low and closes higher than the previous day’s high, this is considered a key reversal day.
Morning & Evening Star Patterns
A star is a three-candlestick formation indicating the price has gapped higher. A small-bodied candle is positioned above the price range of the previous candle, and its real body is small, indicating a strong surge that is now slowing. The bulls and bears are locked in contention for control. The star itself can be dark or clear. Stars warn of a shift in price movement, and they are very powerful warnings.
Evening stars signal the reversal of an uptrend. A long, clear body precedes a small-bodied star, either light or dark. The third candlestick has a dark real body dropping into the lower range of the first candlestick.
Morning stars are the opposite of evening stars, appearing before a downtrend begins. The first two candlesticks are a long dark body followed by a star with a small body, either clear or dark, gapping lower than the previous candle’s close. This indicates that buying pressure has begun, that the bears are losing momentum to the incoming bulls. The third star has a clear body that moves into the price range of the first candle of the pattern.
Doji Candlesticks: Morning & Evening Doji
Doji candlesticks are created when a stock opens and closes at or near the same price, leaving the real body a thin, insubstantial line. Next, Doji stars are doji that gap either above or below the previous candlestick’s real body. In a trend with strong volume, these are powerful indicators of reversal and need to be respected when they appear. A stalemate has been reached between the bulls and the bears, and the next move will give us the winner, either confirming the reversal or rejecting it.
Evening doji stars warn that the end of an uptrend might be imminent. It gaps open above the clear body prior to it and is followed by a dark body that descends into the light real body of the candlestick formed prior to the evening star. The bears have gained control, and the uptrend is broken. But if the candlestick after the evening doji star has a clear real body, the warning is negated.
Morning doji stars indicate the end of a downtrend. The star gaps open below the dark real body prior to it and is followed by a clear real body opens higher, and the price rises into the area of the black body prior to the morning doji star. The bulls have taken control, and the downtrend is broken. However, this signal is negated if the star is followed by a candlestick with a dark real body.
Shooting Star Doji
A shooting star is a single candle consisting of a small real body, either clear or dark, with a long upper shadow. This occurs at the top of uptrends and warns that the bulls are losing control. The long upper shadow indicates the bears’ increasing strength.
Gravestone Doji Candlestick Pattern
The gravestone doji is shooting star that closes at the low of the day, and it is a bad, bad sign.