Japanese Candlestick Patterns Part II
How to read a candle chart
In the last article, we discussed how the Japanese Candlestick Trading System has been around for over 400 years and has been so successful because it provides a high-probability indicator of investor sentiment. The idea is to take advantage of forecasted price direction change for any selected time period.
It was also introduced that there are around 60 different specific patterns but that knowledge of about 10 patterns would give a trader an ample toolbox for a comprehensive implementation of the system.
In this article, we will cover two of the most basic patterns: the Doji and the Bullish Engulfing
The Doji:
The Doji is formed when the open and the close are the same or very close. The length of the shadows is not important. The Japanese interpretation is  that the bulls and the bears are conflicting. The appearance of a Doji should alert the investor of major indecision.
A well-tested rule of Candlestick chart followers is that when a Doji appears at the top of a trend, in an overbought area, sell immediately. Conversely, a Doji seen at the bottom of an extended downtrend requires buying signals the next day to confirm the reversal. Otherwise, the weight of the market could take the trend lower.
Doji
 A
"Secondary” indication is large volume on the signal day. This increases the chances that a sell-off day may have occurred. Another secondary indi-cation is a gap away from yester-day’s close. This is usually a good indication of a strong reversal from the previous trend. But as with most indicators, it is best to have a confirmation by another pattern or signal.
A good signal to use in conjunction with the Doji could be the Relative Strength Index (RSI) which would confirm an over-bought or over-sold situation.
The Bullish Engulfing:
The Engulfing pattern is a major reversal pattern comprised of two opposite colored bodies. The Bullish Engulfing Pattern is formed after a downtrend. It opens lower that the previous day’s close and closes higher than the previous day’s open. Thus, the white (unfilled) candle completely “engulfs” the previous day’s black candle.
 The Black (or filled) Candle represents a day where the close for the day was lower than the previous days close. The white (or unfilled) Candle re-presents a day where the close is higher than yesterday’s open.
Bullish
Engulfing
The body of the second day (white or unfilled) completely engulfs the body of the first day (black or filled). Shadows are not a consideration. In other words, the body of the second candle is opposite in color of the first candle, the first candle being the color of the previous trend. The exception to this rule is when the engulfed body is a Doji or an extremely small body. Also, prices have been in a definable down trend, even if it has been short term.
Candlechart Pattern recognition for bullish engulfing is a large body engulfing a small body. The previous day shows the trend was running out of steam. The large body shows that the new direction has started with good force. Large volume on the engulfing day increases the chances that a sell-off day had occurred. If the engulfing body engulfs the body and the shadows of the previous day, the reversal has a greater probability of working. The greater the open gaps down from the previous close, the greater the probability of a strong reversal. In other words, after a downtrend has been in effect, the price opens lower than where it closed the previous day. Before the end of the day, the buyers have taken over and moved the price above where it opened the day before. The emotional psychology of the trend has now been altered-at least for the time being.
Learning how to use the Bullish Engulfing signal at the proper locations in a trend can produce consistent and high profit trades. The Bullish Engulfing signal, a major candlestick reversal signal, allows an investor to improve their probabilities of being in a correct trade.
Learning to invest in the stock market does not need to be confusing. The common sense elements conveyed in candlestick signals makes for a clear and concise trading technique for beginning investors as well as experienced traders.
In the next article, we will cover two more patterns and discuss some of the characteristics of a successful trader. |
