Now we will discuss what possibilities for
market forecast these combinations analysis gives. The thing is that different
candlestick combinations can indicate the changes in market psychology and
trend direction. These combinations are called patterns and, as graphical
models, they are divided into reversal patterns and continuation patterns. Let
us discuss first the reversal patterns.
REVERSAL PATTERNS. “HUMMER” AND “HANGING MAN”
Candlesticks with long lower shadows and short
bodies are shown in picture 1
a-b. Real bodies are placed at the top part of the daily price range. The striking feature of these candlesticks is the fact that they can be bullish or bearish
depending on what phase of trend they appear in. The appearance of named above
candlesticks in the downtrend is a signal that its domination is over. In this
case, the candlestick is called “hummer” (see pic. 1 a).
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| Pic. |
If a candlestick which is presented in picture
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| Pic. |
“Hummer” and “Hanging man” can be defined by three main features:
- The real body is at the top part of the price diapason. The Colour of the body is not important.
- The lower shadow is twice longer than the real body.
- Candlestick does not have an upper shadow or it is very short.
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| Pic 2 |
The long lower shadow is, the shorter upper
shadow is, and the shorter the body, the higher potential of bullish “hummer”
or bearish “hanging man” is. Though the bodies of these candlesticks can be white (unfilled) and black
(filled-in), hummer with white body has pronounced bullish character, and
“hanging man” with black body has pronounced bearish character.
White (filled-in)
body of the hummer signifies that prices were headily falling, then revival
started, and closing price approximate to the maximal price of the session and
became equal (pic.3). It indicates the intensification of bullish tendencies. The Black
(filled-in) body of the “hanging man” dictates that the closing price can not
return to the opening price level.
It is a feature of a bearish potential
increase. In case of hanging man appearance, it is better to wait for the
confirming bearish signal. Events’ logic is the following: the market is full of
bullish energy. Then a hanging man appears.
On this day trades open at the
maximal price level or near it, then price sharply falls and then rises again
and close at the maximal price or near it. It is impossible to conclude that hanging
man is a signal of reversal at the top by this price movement. Though such
considerable price falling during one session indicates that preconditions for
future reversal exist in market dynamics.
So the main principle which you
should remember in case of hanging man appearance, says: the more price gap
down between the body of the hanging man and the following day opening price is,
the more probability of the fact that hanging man is forming a top.
Black
candlestick can be one more confirmation of the bearish character of the market. The closing price of this candlestick is lower than the closing price on the day of the hanging man appearance (pic. 2)
Pic. 2. Appearance of the black candlestick confirmed the formation of
“hanged man” pattern and reversal of a bullish trend.
All said above is true quite opposite for hummer –
big price gap upwards between the hummer body and opening price at the next day
or white candlestick appearance which closing price is higher than the closing
price at the day of hanging man appearance determines the high probability of
the fact that hummer forms the bottom (pic.3)
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| Pic. 3. Hummer which appears at the beginning of October determined the pause in the bearish trend for more than two months. |
ENGULFING PATTERN
Hummer and Hanging man are single candle patterns.
However, most signals that arise on the charts of candlesticks are based upon not
the single candlesticks but upon their combinations. One of such combinations
is engulfing pattern. It applies to the number of the most important signals of
reversal and forms by two candlesticks with bodies of different colours
(pic. 4 a-b).
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| Pic. 4a |
Pic. 4a. Bearish engulfing model. It forms at the ascendant market.
“Engulfing” of the white body of the candlestick by the black one is a signal of
reversal at the top. In this situation, it is obvious that bears take over the
initiative.
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| Pic. 4b |
Pic. 4b. Bullish engulfing model. Downtrend prevails at the market, then bullish candle with the white body appears, which as though engulf of the previous candle with the black body. It indicates that buyers’ pressure exceeds the sellers’ pressure.
Engulfing pattern must meet three conditions:
1. Uptrend or downtrend (even short-term) should be
strongly marked at the market.
2. Engulfing pattern forms by two candles. The second the body should engulf the first one (shadows can not engulf).
3. The second body must be contrast by colour. So if
after the long downtrend short black body is being engulfed by the long white
body, it can be a signal of bottom reversal. And engulfing of the short white body
while the uptrend by the long black body can be considered as a top reversal.
The factors are enumerated below which increase the
probability of trend change after the engulfing pattern appearance:
1. If the first candle of the model has a short body and
the second one – long, indicates that the previous trend slackens, but new
one is growing in strength (pic.5-6).
2. If the engulfing pattern appears after a protracted or
too swift trend. If the trend lasts long, then all the potential buyers have
already taken up long positions. In this case, it is not likely to wait for a big
number of buying which is necessary for moving the market upwards. Fast price
rising “protract” the market and makes traders implement their profit
closing positions (pic. 5-6).
3. If the second price of the model engulfs several
bodies.
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| Pic. 5 |
Pic. 5. Engulfing at the top in June and February confirmed double top formation and gave signal about the beginning of a prolonged bearish trend.
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| Pic. 6 |
Pic. 6. Bullish engulfing at the end of July gave a signal about reversal and the beginning of the bullish trend.
DARK CLOUD COVER
Next reversal pattern – “dark cloud cover” (see
pic. 7a-b). This model consists of two candles appearing after the uptrend (or
at the top bound of the trading corridor) and signals about the reversal on top.
On the first day candle with a long white body appears. The next day opening
price exceeds the maximum of the previous day (i.e. it is above than upper shadow
of the first candle). However, by the end of the day closing price approximates the daily minimum and covers the major part of the previous candles with the
white body.
The lower the closing price of the second candle (the more part of the
white body is covered by the black body of the second candle), the more
possibility of the top formation. Some candlesticks’ analysts consider that the closing price of the black candle should cover more than 50 % of the white
body. If the closing price of the black body does not reach this 50 % level, it
is better to wait for the next signals confirming the probability of the bearish trend.
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| Pic. 7a. Schematic image “Dark cloud cover” |
The list of factors that intensify the significance of the “dark cloud cover” pattern is given below:
1. The closer the closing price of the black candle to the
opening price of the previous white candle (the more part of the white body is
covered by the black one), the higher probability of top formation. If the
black body covers the previous white body completely, then bearish engulfing
model forms. In the “dark cloud cover” pattern black body just partly covers the
white one, that is why the “dark cloud cover” pattern resembles partly solar
eclipse (i.e. only a part of the preceding white body is covered) (pic. 7 b).
Bearish engulfing model is a complete eclipse of the Sun, covered the whole Sun
(i.e. the whole white body is covered). Consequently, the bearish engulfing model
is a stronger reversal signal. If a long white candle formed with the closing price
which is higher than maximums formed by the “dark cloud cover” or
bearish engulfing model, a new price rising is quite predictable.
2. If during the long uptrend candle with long white the body appears which opening price is equal to the daily minimum (i.e. it does
not have a lower shadow), the closing price is equal to the daily maximum (i.e. it
does not have an upper shadow) and next day-long candle with a black body appears
opened at maximum and closing at minimum, one can say that it is “black day
with cut top and cut bottom”.
3. If the second candle of “dark cloud cover” (i.e.
candle with a black body) opens higher
than important resistance level and then price falls, it is a proof of the fact
that banks cannot control the market.
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| Pic. 7 b. “Dark cloud cover” – the significance of the model intensified by the black candle covered more than 50% of the white candle body. |
PIERCING LINE PATTERN
If “dark cloud cover” is a signal of reversal on
top, then its opposite is the “piercing line” pattern – the signal of bottom reversal
(see pic. 8 a-b). It consists of two candles and appears during the downtrend.
The first candles have a black body, the second one has a long white body. The white candle
opens much lower than the price minimum of the preceding black candle. Then the price
is rising forming a rather long white body that closes upper than the middle of the black candle body.
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| Pic. |
The bullish “piercing line” pattern is close to the bullish engulfing model. In bullish engulfing model white body fully covers the previous black body. In bullish “piercing line,” pattern white body just partly covers the preceding black body.
The more part of the black body is covered by the white body, then the bottom reverse is more probable. The psychological hidden motive of the “piercing line” model adds up to the
following: downtrend prevails at the market. The appearance of the bearish candle with the black body confirms its power.
The next day opening price forms the gap downwards and appears lower than the
previous minimal price. Bears are glad. Then prices start rising and by the end
of the trading day, the closing price not only becomes equal but considerably exceeds
it.
The significance of the “piercing line” pattern is determined by the same
factors as of the “dark cloud cover” model but in mirror image mode. In the case of the “piercing line” model, the rule of 50% covering of the previous candle must be
more strictly observed than while the “dark clouds cover” model forming (pic.
8b)
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| Pic. 8 b. “Piercing line” pattern, pointed at the chart, can pretend to the status “ideal” – the opening price of the white candle is lower than the minimum of the previous one; the real body of the black candle is covered in more than 50%. |
STARS
Stars are one of the most mysterious signals of
reversal. Star is a candle with a short
body which forms the price gap with the preceding candle which has a long body
(see pic. 9 a ).
The main condition for star formation is a gap between its body and the body of the previous candle, meanwhile, shadows’ intersection is acceptable.
The Colour of the candle is not important. Stars can appear at the bottom and at the top. If a candle corresponds to doji, i.e. it has a horizontal line instead of a body, it
is called “star Doji” (see pic. 9 b).
Star, especially “star Doji”, warns about probable completion of the previous
trend. A small body of a candle indicates that the exhausting fight between the bulls
and bears came to a full stop.
If a strong uptrend prevails on the market, the situation
is under the bulls’ control. Star appearance after the candle with the long white body
while the uptrend is a signal that buyers’ rule at the market is over and
adjustment between demand and supply. This balance is made conditional by
pressure release of buyers or pressure amplification of sellers. Anyway, the star
signals that the potential of an uptrend is exhausted and market change is probable.
The same but in a mirror image mode is true for stars while the downtrend: star
appearing right after the long black candle indicates a change of alignment
of forces on market. If during the downtrend bears ruled at the market, the situation changes after the star appearance: forces of bulls and bears become
equal. Energy pressed down is weakening. Bears lose firm ground.
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| Pic 9a Pic 9b |
Pic. 9 b. Schematic image of “star doji” candle.
Stars are compound of four reversal models:
1. Evening star;
2. Morning star;
3. Star doji;
4. Shooting star.
The body of the star can be white or black in these
patterns.
MORNING STAR
“Morning star” (see pic.1 0)
is a bottom reversal pattern. “Morning star” pattern consists of a candle with a black long body which is followed by the short-bodied candle with the gap
downwards (these two candles form the simplest model “star”). On the third day, a white candle arises, which body covers a major part of the first day black body. This
pattern signals that bulls seized the initiative.
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| Pic. |
Pic. 1 0. Reversal pattern
“Morning star”. The model was affirmed by the strong white candle that appeared after
the star formation.
EVENING STAR
“Evening star” is a bearish double of the “morning star”. The “Evening star” pattern is a signal of reversal at the top, so it becomes a signal to actions only if they arise after the uptrend (pic.
Star is a first hint of the market
approaching the top. The third candle confirms the top formation and
completes the pattern “evening star” consisted of three candles. The third
candle has a black body which covered the major part of the white body of the first
candle.
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| Pic. |
Reversal models “Morning star Doji” and “Evening star Doji” are different from considered above patterns by the following feature. Instead of the candle with a short body, the candle is forming which opening price is equal to the closing price, which absence of the body arising from.
Other requirements for models’ formation are similar to the models “Morning
Star” and “Evening Star”, but “Star Doji” are considered to be more important
because they conclude Doji candle.
Basically, all models composed of a star should
have a price gap between the first and the second bodies and one more gap between
the second and the third bodies. However as experience has shown, the second
gap is seldom and not obligatory for this model successful work.
SHOOTING STAR A ND INVERTED
HUMMER
“Shooting star” is a model of one candle warning
about the probable ending of the price rising. Its appearance corresponds to its
name. In contrast to the evening star, the shooting star is not that important
signal of reversal.
As shown in picture 1 2, the shooting star body is short and placed at the bottom part of the price diapason of
a candle; the upper shadow is long. Like other stars colour of the body is not
important. The body of the ideal shooting star makes a gap relative to the body of the preceding candle. However as it will be shown below, this gap is not
invariable.
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| Pic. |
This candle demonstrates that the trading session was
opened close to the daily minimum, then the price swiftly rocketed upwards and fell
again so that the closing price approximate to the opening price. In other words,
price rising during the trading session appeared to be unfounded.
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| Pic. |
Along with reversal patterns, candlestick combinations, as was mentioned above, can form continuation patterns. Let us consider some of them.
WINDOWS (GAPS)
The Japanese call the price gap “window”. If in the western
graphical analysis one uses the expression “to fill in the price gap”, then in Japan
The window is a price gap
between the closing and opening prices of the current and preceding trading
days (sessions). In picture 1 4 opened
windows in the uptrend are shown. Price gap appeared between the upper shadow
of the previous candle and the lower shadow of the next one.
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| Pic. |
The picture
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| Pic. |
Japanese analysts take up the position that trading should be opened to the direction indicated by the window. Windows also become resistance and support areas. So window in the uptrend is a signal of further price rises. While the correcting falls this window should support the prices.
If as a result of correcting fall window closes and sellers’ pressure remains, the preceding uptrend is complete. Window in the downtrend signals further
price falling. Any correcting price risings will face resistance at this
level. If the window closes and the price rising which was the reason for its closing,
then the downtrend is over.
“THREE METHODS” PATTERN
There are two variants of this pattern: bullish
model “three methods” and bearish model “three methods”. They are continuation
patterns. The following elements comprise bullish model “three methods” (see
pic. 1 6):
1. Long white candle.
2. After this white candle the group of falling
candles with short bodies follows. The ideal model has three such candles but it
can be two or more than 3. The most important thing is that they should not
transcend the diapason of white candle prices. Short candles can be any colour
but often they are black.
3. Last trading day should be presented by the long
white candle with a closing price higher than the closing price of the first day. The opening price of the last candle in the model also should be higher than
closing price of the preceding trading day. This model resembles bullish flags
and pennants at the western graphical analysis. Pattern “three methods” is
associated with the rest from trading or respite between the battles. Simply
speaking, with appearing of short candles market stops for a “rest”.
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| Pic. |
Bearish pattern “three methods” (see pic.
The opening price of the last trading session should be lower than the preceding closing price, and the closing price – lower than the closing price of the
first black candle. After this last session presented by the black candle,
price falling should continue. This model resembles bearish flags and pennons
in the western graphical analysis.
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| Pic. |
It is far from a complete list of the patterns which include the candlestick analysis method. We considered the most significant reversal and continuation models which are abundant at the market and giving the most reliable signals for analysis and decision making.