Candlestick patterns are crucial technical tools that traders use to determine the price movement of underlying assets. These patterns are similar to bar charts, but they are more informative. Candlesticks can capture the opening, closing, high, and low of an underlying assets in one bar pattern. This reduces the need to compare multiple trading charts in order to understand price movements. Candlestick charts can also be used to predict possible trend reversals within the trendline. There are many trend reversal candlestick patterns, each with its own merit. We will be discussing the most popular and effective and how to interpret them while trading.
Candlesticks that form in a reversal pattern indicate the end or beginning of a trend (uptrend, downtrend). This formation occurs in a downtrend and indicates a bullish trend reversal, or the end of the selling spree and the onset of a buying spell. In contrast, a trend reversal formation in an uptrend warns traders about a possible end of bullish run or onset of slump.
Candlestick patterns can be visual patterns that help traders see when the market sentiment is changing. This is why candlestick charts are preferred by many traders over other trading tools. Any trend reversal indicator must be consistent with other technical trading tools.
Steve Nison, who popularized candlestick patterns in the west, mentioned seven reversal pattern that are more powerful than others. He mentioned several reversal patterns in his book Japanese Candlestick Charting Techniques.
An engulfing formation is a two-candle pattern that signals trend reversal. There are both bullish and bearish Engulfing.
Bearish engulfing occurs in the uptrend. In the uptrend, the first candle is a green/white candle. The second candle opens higher than in the previous session, but closes lower than the first. This indicates that the bullish force had made a final push before the bearish forces took control.
Bullish engulfing appears at the bottom end of a downtrend and is the opposite of bearish.
Doji is a special formation. It's a candle that has no real-body, but which emits shadows. Doji can come in many forms, including Doji Star and Dragonfly Doji as well as Gravestone Doji and Long-legged Doji.
This is usually associated with market indecision prior to a trend reversal. Doji star, Gravestone Doji, and Dragonfly Doji are also indicators of a trend reversal. However, these must be correlated with other popular trading tools such as moving average, moving oscillator, or RSI to make your trading decisions.
Doji formations are often without real-body. This means that either the closing and opening prices are almost equal or the market has reached an equilibrium in which neither the buying nor selling forces can give it direction.
An abandoned baby may be a better trend reversal pattern that Doji. Although it's a rare phenomenon, traders should be able to adjust their positions accordingly when it does appear.
An abandoned baby can appear in either an uptrend or a downtrend, since it is a trend reverse pattern. An abandoned baby is a Doji Star that appears between two candles. The first candle should be in the direction of the trend. The second confirmation candle should be in the opposite direction. The shadow of the first candle should not overlap with the second candle. The moniker is given to the star that appears above or below the trend. It looks abandoned.
Hammer is a single candle that occurs in a downtrend. It indicates a trend reversal from bullish. It often has a short real-body and a long down shadow. This indicates that the market tried to fish for the bottom, but buyers prevailed and pushed the market upward. The result is a bullish candle with a short real body. To form a trading strategy, the candle that appears next to the hammer should confirm the trend reversal. It must close at the same time as the previous candle before the hammer.
An inverted hammer is the opposite of a hammer and can be seen in an uptrend. This is also a trend reverser pattern. The colour of the hammer is irrelevant, but the shadow above it is twice as big as its actual body. To confirm trend reversal, an inverted hammer needs stronger confirmation candles.
A hanging man is another similar formation in the candlestick charts. It is the hammer that appears during an uptrend. If the hanging man appears in an uptrend, it is a sign of a trend reversal. The trendline will confirm this with the next candles. The hanging man is a confirmation of a downward trend reversal if they are in a downtrend.
A piercing-line is a two-candle arrangement - a bullish long-bodied candle with a gap and a bullish candle that closes at the middle of the bearish candle. Both candles have long, sturdy bodies. This shows that although the market began in bearish impulses, buyers eventually gained momentum and pulled the market up to their advantage.
Harami patterns are very common. They can be either bullish or bearish. The Japanese word for pregnant is harami. This is a two candle formation. The second candle is a small, bodied candle that opens and shuts within the first candle's body. It represents a pregnant form. Harami Cross's second candle is a Doji Star.
Although A Harami is a reversal type, it is not as strong as the hammer. It needs confirmation from technical trading tools such as RSI and MACD.
The star formation is a 3-candles formation which appears in both an up- and downtrend. The evening star is the bearish star and the morning star the bullish star.
The trend's first candle is either bullish or bearish. The second candle is a small-bodied candle that opens and closes above or below the first trend candle. This indicates indecision. The confirmation candle, which confirms the trend's reversal, is the third candle. Stars are similar to other candlestick trend reversal forms. They can be combined with other technical tools to confirm the trend reversal.
Candlestick patterns can be used by traders to visualize market changes. They allow traders to see the opening, closing, high and low of a single candle. This eliminates the need to compare multiple charts to confirm trading. In order to be able to enter long and protect against drawdowns if the trend turns bearish, traders should look out for reversal patterns. Candlestick charts are used by traders in conjunction with other technical tools to improve their trading strategy.