There are quite a few Japanese Candlestick Patterns with there very own "title" and degree of probability. Here are 10 of the best worth memorizing and getting comfortable with. The 10 that, when combined with certain technical indicators have the ability to forecast short term price direction with incredible accuracy!
Remember that these patterns are only useful when you understand what is happening in each pattern. Learn the underlying fundamentals of what's actually taking place, and you will truly understand the power of these profitable patterns.
Keep in mind, they must be combined with other forms of technical analysis to really be useful. Some would disagree, but I'll show you how to add a degree of certainity that will have you sleeping like a baby at night, and there's nothing worong with that.
The following patterns are divided into two parts: Bullish patterns and bearish patterns. These are reversal patterns that show up after a pullback or a rally.
Engulfing Pattern: This is my all time favorite candlestick pattern. This pattern consists of t
wo candles. The first day is a narrow range candle that closes down for the day. The sellers are still in control of the stock but because it is a narrow range candle, and volatility is low, the sellers are not very aggressive. The next day is a wider range candlestick that “engulfs” the body of the first candle, and closes near the top of the range. The buyers have overwhelmed the sellers (demand is greater than supply). Buyers seem to have "taken over" and theres bullish sentiment in the air.
Hammer: Tthe stock openes, then the sellers take control of the stock and pushed it lower. By day's end, the buyers have won and had enough strength to close the stock at the top of the trading range. Hammers can develop after a cluster of stop loss orders are hit. That’s when professional traders come in to grab shares at a lower price.
Harami: When you see this pattern the first thing that comes to mind is that the momentum preceding it has stopped. On the first day you see a wide range candle that closes near the bottom of the range. The sellers are still in control of this stock. Then on the second day, there is only a narrow range candle that closes up for the day. Note: Do not confuse this pattern with the engulfing pattern. The candles are opposite!
Piercing Pattern: This is also a two-candle reversal pattern where on the first day you see a wide range candle that closes near the bottom of the range. The sellers are in control. On the second day you see a wide range candle that has to close at least halfway into the prior candle. It’s almost as if the buyers are saying, "Wait just a minute! You sellers have taken this too far. It’s time for us take over!"
Doji: The doji is probably the most powerful candlestick pattern and for good reason. The stock opens up and goes nowhere throughout the day and closes right at or near the opening price. Quite simply, it represents indecision and causes traders to question the current trend. This can often trigger powerful reversals. There are several variations on the doji, including the gravestone doji, the dragonfly doji, the doji star (shown) and the long legged doji.
Bearish
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You will notice that all of these bearish patterns are the exact opposite of the bullish patterns. These patterns come after a rally and signify a possible reversal just like the bullish patterns.
OK now try and read each of these patterns. Try and determine why it is that these patterns constitute a potential reversal. What is the high, low, open and close and range telling us when combined with the preceding candlestick?
Most traders are taught to "wait for confirmation" , this means that they are supposed to wait until the following day to see if the stock reverses afterward. This is true for some formations, but not all...
These patterns represent the most used patterns in the application of these techniques. The opposing pattern is simply opposite from what you see here.
Take the time to look at each of these patterns and what each candlestick represents. For example the bullish engulfing formation pattern. Why is it a bullish reversal pattern?
Lets see...
The trend is down and the black candlestick represents a series of candlesticks where the close is lower than the open, significantly for 3 days in a row, then all of the sudden the open is lower as was was the case for the last 3 days, however, on this day the candlestick closed not only higher than the open, but higher than the previous days open. :-)
Make sense ?
Understanding candlestick patterns is a very important part of trading successfully. Yes, you can learn bar charts or other forms of charting, but the japanese candlestick is truly the ultimate tool in interpreting price action.
What Do They Mean ?
Lets take a hypothetical example of a random stock, not really any specific pattern, just a "formation" if you will, and lets break it down intuitively.
Remember that a candlestick pattern is nothing more than an open, a close, and a high and a low. Then, its all of those relative to the day before or days before, and when a candlestick pattern has formed it's "formation also includes possibly a candlesticks open, close, high and low being compared to the future and the past.
Lets take a look...
Here is a random candlestick pattern. I have isolated 5 candlesticks, starting with the first of 5, I want to walk you through the transition of bearish to a bullish candlestick pattern.
The first 3 candlesticks close lower than the open for 3 consecutive days. The 4th candlestick however opens lower than the previous days open and could go either way at this point. Think about the open, its almost smack dab in the middle of the previous day and at the open we still may be anticipating bearish sentiment.
What happens however is the candlestick closes beyond the previous days open (higher) and in fact right at the previous days high. (See the wick) This is a pretty good sign that there may be some bullish sentiment that follows.
The clue lies in the next day, (day 5) when the open is greater than the previous candles high. If the open was only greater than the previous close that would still be a good indication that the bulls may be taking over, but in fact the open was greater than or about equal to the previous days high.
TIP: Notice how price action reached my 3.0 standard deviation Bollinger band. Also a good indication of a potential reversal zone.
Applying Candlestick Pattern Analysis
Just remember that a candlestick pattern offers more insight than just open, close, high and low. You're looking for all of that relative to the previous day(s) and if you're looking at a completed candlestick pattern then you're looking at it relevant to the the next day as well.
Very High Probability Bullish
Candlestick Reversal Patterns
Abandoned Baby |
Baby Swallow
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Kicker |
Morning Star |
Morning Star Doji |
Piercing Line |
Three Inside |
Three Outside |
Three White Soldiers |
Very High Probability Bearish
Candlestick Reversal Patterns
Kicker |
Dark Cloud |
Abandoned Baby |
Evening Star |
Evening Star Doji |
Gap Up Two Crows |
Three Black Crows |
Three Inside Down |
Three Outside Down |
Study these patterns and watch your profits and success ratio improve!
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