Candlestick patterns of reversal and continuation of the trend - features and requirements

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Candlestick charts were invented by a Japanese rice trader in the 18th century. Munehisa Homma. His prowess in the marketplace was legendary. Over the centuries, his methods of technical analysis have undergone further additions and modifications, and today they are applied to modern financial markets. The Western world was introduced to this method through Stephen Nison's book Japanese Candlestick Charts.

Today they are included in the technical analysis toolkit of all trading platforms and are supported by the charting programs of every financial trader. The depth of the displayed information and the simplicity of the components made the indicator popular among professional market participants. And the ability to combine several candlesticks into a reversal and trend continuation candlestick pattern is an effective tool for interpreting price changes and predicting them.

How to read a chart?

A candlestick consists of three parts: the upper and lower shadows and the body. The latter is colored green (white) or red (black). EachA candlestick represents price data for a specific period of time. For example, a 5-minute candle displays data on trades made within 5 minutes. Each indicator represents 4 prices: open, close, low and high. The first of them corresponds to the first deal of the given period, and the second – to the last one. They form the body of the candle.

The high of the price is represented by a vertical line extending from the upper part of the body, called the shadow, tail or wick. The minimum is depicted by a vertical line emanating from the lower part of the body. If the close is higher than the open, the candle turns green or white, indicating an increase in the net price. Otherwise, its red or black color indicates a depreciation.

Application in technical analysis

Candlesticks tell about the course of the battle between bulls and bears, buyers and sellers, supply and demand, fear and greed. It is important to keep in mind that all candlestick patterns need confirmation based on the context of past and future data. Many beginners make the mistake of spotting a lone pattern without considering past and future prices. For example, the Hammer indicates a trend reversal if it occurs after the previous three bearish candles. And in the neighborhood with "flat" indicators, it is useless. Therefore, understanding the “story” that each figure tells is essential for confident orientation in the mechanics of Japanese candlesticks. These patterns tend to repeat themselves all the time, but the market often tries to cheattraders when they lose sight of the context.

Coloring brings some emotionality to the diagrams. For best results, it is important to ensure that other indicators are taken into account. The article shows the most popular candlestick patterns among traders.

Belt Grip - what is it?

The Belt Grab candlestick pattern is considered a secondary trend indicator that can indicate both bullish and bearish trends depending on the nature of the pattern and the direction of the market in which it appears. Represents a candle with a high body and little or no shadows, indicating the strength of bullish or bearish activity. In an uptrend, it represents a potential reversal peak and consists of a red pattern with an open at the high and close at the low of the price. Shadows are either very small or absent. In a downtrend, it consists of a long green candle and indicates a bullish reversal. At the same time, the size of the indicator indicates the likelihood of a change in the direction of the market movement: the larger the body, the higher it is.

Both bullish and bearish Belt Grabs are more reliable when they appear near the extremes of the market, indicated by support and resistance lines, moving averages, etc. The pattern becomes even more important in the composition of « Dark Cloud Veils” or a bearish or bullish engulfing.

Hammer

This pattern is an indicator of a bullish reversal. This is one of the most (if not the most)widely followed Forex candlestick pattern. Used to determine if a trend has reached a bottom and then rises in price, which traders use to enter a long position.

A hammer forms at the end of a downtrend in the market and indicates an immediate bottom. The candlestick has a lower shadow forming a new downtrend low, and the closing price exceeds the opening price. The tail should be at least twice as long as the body. It represents a situation where long positions finally start to open and short positions close, and speculators take their profits. The growth in trading volume is another confirmation of the "Hammer". But for final confidence, it is important that the next candle closes above the low of the previous one and preferably above the body.

A typical buy signal would be an open above the high of the indicator following the Hammer, with a stop loss below the figure's body or shadow. Of course, you need to check with momentum indicators such as MACD, RSI or stochastic.

Shooting Star

This is a bearish reversal candlestick pattern that indicates a peak or top of a trend has been reached. She is an exact inverse version of the Hammer. A Shooting Star must form after at least three or more consecutive green candles indicating an increase in demand. Eventually, market participants lose their patience and chase the price to new highs before realizing they overpaid.

The top shadow should be 2 times bigger than the body. This indicates that the lastThe buyer entered the asset when the players closed their positions, and the sellers began to act in the market, pushing the price down, closing the candle at or near the opening price. This is essentially a trap for late bulls who have been chasing the trend for too long. Fear culminates here as the next candle should close at or below a shooting star, leading to a panic selloff as late buyers will struggle to get rid of their acquired assets to lock in losses.

A typical short sell signal is formed when the low of the next candle is broken and a stop is placed at the high of the body or the high of the Shooting Star tail.

Doji

This is a reversal candlestick pattern that can be bullish or bearish depending on the previous context. It has the same (or close) opening and closing prices with long shadows. The figure looks like a cross, but it has a very small body. Doji is a sign of indecision, but also a proverbial line in the sand. Since this pattern usually indicates a change in trend, the direction of previous indicators can give an indication of which direction it will take.

The Gravestone candlestick pattern is a Doji, the opening and closing prices of which are equal to the lowest rate of the session, i.e. when there is no lower shadow.

If the previous indicators were bullish, then the next one, which closed below the Doji body,when the low of the latter is broken, it signals the need to sell. A stop order should be placed above the high of the pattern.

If the previous candles were bearish, then the Doji is likely to form a bullish reversal. This triggers a long position above the body or indicator high with a stop below the low of the pattern.

Bullish Engulfing

This is a large green candle that completely covers the entire previous red row. The larger the body, the more extreme the conversion becomes. It should completely cover the red bodies of all previous candles.

The most effective bullish Engulfing occurs at the end of a downtrend with a sharp rebound that panics shorts. This motivates many to take profits, which puts even more buying pressure. Bullish Engulfing is a downtrend reversal or uptrend continuation candlestick pattern when it forms after a slight pullback. The volume of operations must be at least twice the average level in order for the figure to form the most effective shape.

A buy signal is formed when the next candlestick exceeds the high of the bullish Engulfing

Bearish Engulfing

Just as a massive tidal wave completely covers the island, this candle completely swallows all previous green indicators. This is the strongest sign of a trend change. Its body overshadows the body of the preceding green candle. The strongest effect has a figure,the size of which exceeds the previous indicators along with the upper and lower shadows. This Engulfing candlestick pattern could be a sign of massive selling activity in a panicky reversal from bullish to bearish market sentiment.

The previous rise in price supports the modest optimism of buyers, as trading should take place near the top of the uptrend. The bearish engulfing candle actually opens higher, giving hope for a new uptrend as it initially indicates more bullish sentiment. However, the sellers are very aggressive and cut the price to the opening level extremely quickly, causing some concerns among those who opened a long position. Selling intensifies as the price falls to the previous close low, which then causes some panic as most of yesterday's buyers are in losses. The amount of reverse is dramatic.

Bearish Engulfing is a reversal candlestick pattern when it forms on uptrends as it activates more and more sellers. The signal to start entering a short position is formed when the next indicator exceeds the lower level of the figure. With the current market downtrend, a bearish Engulfing could occur on the rebound of the recovery, thereby resuming the decline at an accelerated pace due to the attraction of new buyers trapped on the rebound. As with all candlestick patterns, it is important to keep an eye on volume, especially in this case. For the situation to have the mostinfluence, the volume of transactions should be at least twice the average level. Software algorithms are notorious for false closes due to bogus bearish engulfing candles, which are causing many shorts to fall into this trap.

Bullish Harami

This is another candlestick reversal pattern indicator. It looks like a reverse version of the bearish Engulfing. The small Harami should be preceded by a large engulfing red Japanese candle representing the lowest point in the sequence that indicates the final sell-off. The Harami should trade within the Engulfing range. Its small body size keeps sellers confident that the price will fall again, but instead it stabilizes and forms a pullback bounce that will catch shorts by surprise.

The pattern is a subtle clue that does not cause sellers to worry until the trend starts to slowly change. It is not as intimidating or dramatic as bullish engulfing candles. The subtle Harami body makes the pattern very dangerous for short sellers as the reversal is gradual and then accelerates rapidly.

A buy signal is formed when the next candle rises above the high of the previous female and stops can be placed below the lows of the pattern.

Bearish Harami

This is a reverse version of the previous model. The engulfing candlestick preceding the bearish Harami should completely eclipse its range,just as David defeated Goliath. A candlestick pattern forms at the peak of an uptrend when the previous green candlestick with a large body creates a new high. With the formation of the small Harami, the buying pressure gradually dissipates. Despite the gradual slowdown in demand, longs continue to assume that the pullback is just a pause before the resumption of price growth.

After the Harami closes, the next candle closes lower, which starts to worry buyers. When the low of the previous engulfing pattern is broken, a panic sell-off begins - long positions are closed to cut further losses.

A sell signal is formed when the bottom of the engulfing candle is broken and stops are placed above the Harami high.

The Hanged Man

Hanged Man and Hammer candlestick patterns look similar, but the former forms at the top of an uptrend, not at the bottom of a downtrend. The "Hanged Man" has a body 2 or more times smaller than the lower shadow, and the upper shadow is very small or absent. The pattern is different from Doji because it has a body that is formed at the top of the range. For some reason, the buyers took the potential star and pushed the price higher to close the upper range and keep the bullish mood going. Often this is done artificially. However, the truth becomes clear as the next session closes under the Hanging Man pattern as selling accelerates.

This trend reversal candlestick pattern is most effective at the peak of parabolic price jumps consisting of four andmore consistent green pieces. Most bearish reversal indicators form on Shooting Stars and Doji. The Hanging Men are unusual as they are a sign of a large buyer who is falling into the trap of trying to maintain momentum or feign market activity to increase liquidity for selling.

The Hanging Man signals a possible uptrend peak as bulls who have been chasing price look and wonder why they have been doing this for so long. The situation is reminiscent of the old cartoon, where the coyote chases the bird until it realizes that it has stepped over the edge of the cliff, and looks down before falling.

A signal to open a short position is formed when the low of the Hanging Man figure is broken, and a stop order is placed above its high.

Dark Cloud Veil

This formation is made up of three trend reversal candles. The Dark Cloud Cover forms a new high in the market's upside move when it breaks the previous session's close, but closes in red as sellers get in late. This indicates that the buyers took active measures and closed their positions even after reaching a new peak. Veil candles should have bodies with closing prices below the middle of each previous indicator. This is what distinguishes the pattern from bearish reversal candlestick patterns such as Doji, Shooting Star or Hanging Man. Thus, the previous candle, "Veil"and the next make one combination. The pattern must be preceded by at least 3 consecutive green indicators.

Sales prevail and new buyers are trapped. If the next session fails to create a new high (above the Veil) and the low of the third candle is broken, then this is a signal to sell short. Long positions begin to close in panic in order to fix losses. Stop orders should be placed above the upper shadow of the Veil.

A gap in the clouds

The candlestick pattern is the opposite of the Dark Cloud Veil. It indicates a new low of a downtrend that has overcome the closing price of the previous session. However, the current closure occurs at a higher level. At the same time, the center of the body of each “Gap” candle should be above the middle of the previous one. Similar to the Veil, there must be at least 3 red indicators before the Clearance in the Clouds.

A buy signal is formed when the next candle does not form a new low and exceeds the high of the third candle. Stop order should be set below the lowest price of Clearance.