What is technical trade analysis

Technical analysis: candle pattern

Technical analysis: candle pattern

In this lesson you will learn:

  • know the most popular candle patterns

  • how to recognize and trade the most popular trend reversal patterns

  • how to recognize and trade the most popular continuation patterns


All over the world traders are continuously trying to identify market trends and assess market sentiments: bullish or bearish, whether other traders realize profits or increase positions. Small hints are displayed in the chart and interpreted in different ways by technical analysis tools. Some traders focus on line charts, others prefer to trade with candlesticks. While classic patterns can be recognized in both variants, candles can provide additional technical signals. Due to their construction, interesting patterns can be recognized and identified from the price developments.

Generally, candlestick patterns can be divided into two broad categories: trend reversal patterns and trend continuation patterns. Let's take a closer look at both of them.

Base candles

Before we start analyzing specific patterns, let's take a look at the basic candles that are commonly shown on a chart. Doji and Marubozu are probably the most popular candle shapes on the charts. So you need an introduction first so that we can continue with specific patterns.

Doji:

Doji are candles that provide important information and also serve as the basis for a variety of patterns (candle formations). Dojis are formed when the opening and closing of a security are almost identical. The length of the upper and lower shadow can be different from each other. As a result, the candle looks like a cross. On their own, dojis are neutral patterns. In general, however, it can be said that any long or short trend is based on previous prices and future confirmations.

Marubozu:

Marubozu candles can help you see the strength of buyers and sellers. Marubozu have no upper or lower shadow and the high and low are indicated by the opening and closing. A white (or green) marubozu candle forms when the candle opens at the bottom and closes at the top. This shows that buyers were in control of the price movement all along. A black (or red) marubozu candle forms when the candle opens at the top and closes at the bottom. This means that sellers have dominated the market since the beginning of the period.


Trend reversal pattern

Trend reversals indicate the weakness of a trend, as well as a move in the opposite direction. For example, if you trade the EURUSD and see a certain reversal pattern, you can open a trade that contradicts the current trend. It is important to remember that most reversal patterns require further confirmation. So if you see a pattern but the price is not moving in the right direction, it could be that your potential reversal signal is no longer valid.

Here are some of the most popular trend reversal patterns:

  • Bearish and Bullish Engulfing

  • Bearish and Bullish Harami

  • Hammer and inverted hammer

  • Evening and Morning Star

  • Hanging Man

  • Shooting star

If you see any of these patterns, wait a candle (period) for your signal to be confirmed. For example, if the EURUSD has risen sharply and you see a bearish engulfing candle, you should wait for the second bearish candle to confirm the strength of the signal. This is a general rule that applies to almost all patterns. Therefore, keep these in mind whenever you are on the lookout for new patterns.

Bearish and Bullish Engulfing:

Engulfing candles are reversal patterns that can be either bullish or bearish, depending on whether they occur during an uptrend or a downtrend. The first candle, however, should be relatively small, followed by a second candle that completely "devours" the previous one.

Bearish and Bullish Harami:

Harami is a pattern that consists of two candles, the second candle has a smaller body and is also located within the area (between opening and closing) of the first candle. In addition, the candle must have a different color.

There are also so-called Harami-Crosses, where the construction is exactly the same. The only difference is that the second candle is a Doji candle, a candle with a narrow body.

Hammer:

Hammer candles are formed when the price of a security is significantly lower than when it opened, but then recovers at the end of the period. The resulting candle looks like a square lollipop with a long stem. If this candle forms during a price decline, one speaks of a so-called hammer. A shooting star is exactly the opposite of the situation described above.

Morning and Evening Star:

A morning star is a bullish reversal pattern, which consists of a total of three candles: a long black candle that exceeds the current downtrend, a smaller center candle that opens down after the opening and a white candle with a long body that opens up and over the center of the first candle closes.

An evening star is a bearish reversal pattern that ends an upward trend. Starting with a long white candle, followed by a smaller candle that opens upwards and ends with a candle that closes under the center of the first candle.

Both patterns could also appear on a Doji candle, like the second. So there is no difference in the result, only in the appearance of the second candle.

Hanging Man:

A hanging man formation occurs when a security price opens significantly below the opening price, but then closes above the low of the last candle. The result looks like a square lollipop with a long stem. If this candle formation forms during an upward trend, it is called a hanging man. The hanging man formation doesn't mean the cops are out of control for good. But it could be an early warning sign as momentum is weakening and a trend reversal could potentially be imminent. The signal looks like a hammer. But what is the difference between the two formations? The only difference is the trend direction in which they appear. When the pattern shows up on a chart during an uptrend and suggests a bearish reversal signal, it is known as a hanging man. If a bullish trend reversal is indicated in a downtrend, one speaks of a hammer.


Shooting Star:

A common pattern is the so-called shooting star, which indicates a potential end to a bullish trend. A shooting star is a pattern that consists of just a single candle. It has a small body and a long shadow pointing upwards. The color of the candle can be either black or white, but a strong sell signal is generated when the body is black. In order for the candle to be called a shooting star, the formation must appear during an uptrend and the distance between the highest price and the opening price must be at least twice the size of the shooting star's body.


The upper shadow of a shooting star implies that the market is testing a resistance level, only for sellers to push the price further down. After an upward trend, the shooting star can signal to traders that the upward trend can at least be over for a short time.

Trend continuation pattern

Trend continuation patterns can be used by traders who want confirmation of further market movement in the direction of the current price trend. They usually appear after a long period of stability or market correction. If you see such a pattern, which has also been confirmed by the candle below, you should open a position in the direction of the trend.

These are the most popular continuation patterns:

  • Three White Soldiers

  • Three Black Crows

  • Upside and downside Tasuki Gap

  • On and In Neck line

  • Mat hold

Three White Soldiers:

The Three White Soldiers formation is a pattern made up of three bullish candles, all of which have a similar construction. Each candle opens higher than the previous candle. Candles without a shadow increase the strength of the continuation pattern.

Three Black Crows:

The Three-Black-Crows is a pattern that consists of three bearish candles and also has the same construction. Each candle closes lower than the previous candle without a shadow and here increases the strength of the continuation pattern.

Upside and Downside Tasuki Gap:

An upside tasuki gap is a white candle that gaps up over the previous candle. If this gap is not closed, it means that the uptrend continues. Should the gap be closed, this indicates a trend reversal.

In turn, a downside tasuki gap is a continuation pattern with a long black body followed by a black body that has opened under the first candle. The third candle is white and opens in the body of the second candle and then closes the gap between the first and second candles, but it does not close the gap

On and In Neck Line:

An on-neck candle pattern, also known as an on-neckline, is a two-candle pattern that appears after a downward movement. A bearish (black) candle followed by a bullish (white) candle. The closing price of the second candle is very close to the closing price of the first. The on-neck candle pattern consists of just two candles. It is also relatively easy to see the pattern.

A similar signal is the neck candlestick pattern, which is a bearish neckline pattern that indicates a continuation of the current trend. In contrast to the on-neck, the second candle of the in-neck closes slightly above the first closure of the day. It's not as reliable as the on-neck. So be careful not to reverse the two patterns.

Mat Hold:

The mat hold is probably the most interesting pattern you can find on a chart. It is rated as very reliable, but is also relatively rare. The pattern signals that a price is continuing its previous trend direction. The signal is initiated by the first significant candle in one direction or the other, followed by three smaller candles in opposite directions. The fifth continues the trend of the first candle and pushes the price up or down depending on the movement.

A drop in the bucket:

Candlestick patterns are growing in popularity as they provide some interesting trading signals. They are an important tool that aids in technical analysis and understanding the emotions of the markets. Thanks to these patterns, possible turning points in the markets can be identified. That is the reason why it is also one of the most important strategic elements for technical traders. However, we have only introduced a few to you. Of course, a large number of other patterns can be recognized, but it is sufficient to focus on the most important ones, as these usually also generate the most reliable signals.

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Published by: X-Trade Brokers Dom Maklerski S.A