Traders use technical analysis to most accurately predict the future market behavior. In the process, we use price levels, figures on charts, and candlestick patterns. Today we’ll talk about the last one on the list.
The patterns suggest a further price behavior in the nearest future: whether the market continues to go in the same direction or will reverse. Thanks to the high accuracy of such signals, they are used in several financial markets:
- Forex
- Commodities
- Stocks
Let’s talk about the main patterns that will become the basis of your technical analysis.
How to Read Japanese Candlesticks
First, you should learn to read candles. They are of two types:
- Ascending or bullish. On the charts, they are painted white or green.
- Descending or bearish. On the charts, they are black or red.
Any candlestick has open and close prices that form its main body. For a rising candle, the open price is located below the close price. For the downward candle, it’s vice versa.
The shadows, also called tails or wicks, show the upper and lower prices reached during the formation period of a particular candlestick.
Candles carry useful data about the behavior of sellers and buyers. For instance:
- The long tail below tells that the sellers managed to greatly reduce the price before the buyers could raise it.
- The upper wick, by contrast, shows the maximum price that the bulls managed to form until the bears entered the trade.
Technical analysis is carried out through the use of entry and exit points along with the highs and lows of each candle. Some Japanese candles, alone or in combination with others, form special patterns that help to make an assumption about further price movement. Let's look at the main kinds.
Doji
The predictions made with this pattern show really great results. It’s a single candlestick whose open and close prices are the same. Because of this, Doji doesn’t have the main body. This happens when neither the bulls nor the bears could push the price enough. That signals the indecisiveness of both sides.
The lack of certainty in bears and bulls gives quite powerful signals to traders:
- When you see a Doji on the rising trend the market might turn to the downside. In the mirror situation, it tells about a reversal to the upside.
- If the market rolls back down to support and forms a Doji during a bullish trend, then most likely it will reverse to the upside again. When the price bounces from the resistance line on a bearish trend, the Doji gives a signal about a possible further drop in the price. The best solution is to confirm the signal with the next candle and only then enter the trade.
- Long-legged Doji, especially with equal shadows, known as rickshaw, indicates complete uncertainty in the market. Neither sellers nor buyers were able to push the price. At such a moment, the bulls try to consolidate the profit in an uptrend, and the bears in a downtrend. This usually leads to a market reversal.
- When you notice a gravestone on an uptrend, it indicates an imminent price reversal. If you have open buy positions, you need to take your profits or at least trail your Stop Loss. The same tactics must be applied when forming a “dragonfly” on a downtrend when you have short positions.
- At the highest point of an ascending market, the Doji gives a stronger signal than at the lower level of the descending trend. This signal is especially strong if there is a bullish candle right before the Doji. We’ll talk about it later.
- Do not rely on the Doji when the price moves sideways in a channel. You should expect a reversal after the pattern only on a confident bearish or bullish trend.
- As Dojis usually form highs and lows and later become the support and resistance lines.
- Even when it’s not an actual Doji and the candlestick has a very tiny body, it might give similar signals as the standard Doji pattern.
Stars
This must be one of the strongest signals about market reversal you’ll ever get. The star is a Japanese candlestick with a small body. It appears after a gap at the upper or lower price of a rising or descending trend. How to read the pattern:
- On the bearish chart, the star is called the Morning Star. This pattern has three parts - a bearish candle, a star with a small body and short shadows, and of an ascending candle. In this case, the middle candlestick, as a rule, is separated by gaps from the other two and forms the support level. This pattern gives a powerful signal of further price growth, as we see that the bears have lost strength and the bulls are gaining momentum.
- “Evening Star” mirrors the previous pattern. It is also formed of three candles - bullish, star, and bearish. Gaps around the middle candlestick are also a must. The pattern signals a further decline in the market.
- If there is a Doji in the middle of the Evening or Morning Star, then the signal becomes even stronger and gives an almost one hundred percent guarantee.
Unfortunately, both of these star patterns rarely appear on the market. As a rule, the reversal is more often signaled by the hammer and the inverted hammer, which we will talk about in the next article. These patterns give less guarantee for a reversal. So if you are lucky to notice a Morning or Evening Star, don’t miss the chance and open a trade.
Well, that’s enough for today. In the next article, I will tell you about several other patterns that will raise your technical analysis to a completely different level and greatly improve your overall trading performance.