Decoding Market Signals: Understanding and Identifying Profitable Candlestick Patterns
Recall from previous article:
A candlestick chart is a financial chart that shows the price movement of a security, currency, stock, bond, or derivative. It’s like a bar chart, but each candlestick represents four pieces of information;
Open: The price at the beginning of the selected time frame.
Close: The price at the end of the selected time frame.
High: The highest price during the selected time frame.
Low: The lowest price during the selected time frame.
Candlestick charts are useful for traders because they show past patterns that can indicate future price movements.
The candlestick shows the open, high, low, and close prices of the stock price for a day.
In the realm of technical analysis, candlestick chart patterns are assessed based on their reliability, distinguishing between bullish and bearish formations, both classified as robust. A noteworthy characteristic of strong candlestick patterns is their propensity to resolve in the indicated direction with a probability exceeding 75%, making them at least three times more likely to exhibit the anticipated outcome.
1- REVERSAL PATTERNS
Reversal candlestick patterns are formations on a price chart that indicate a potential change in the prevailing trend of an asset. These patterns are crucial in technical analysis as they provide early signals to traders and investors about a potential reversal in the market direction. Reversal patterns can be bullish or bearish, signaling the end of an existing trend and the potential start of a new one.
a- Bullish Reversal Patterns:
- Signal potential upward trend reversal.
- Identify points in an up-trend where a shift is likely.
Examples for strong bullish reversal in a downtrend:
**Three white (green) soldiers**
Three tall green candles going up, partly overlapping, and each one ends high up.
**Morning Star**
A tall red candle is followed by a smaller green or filled candle, with a gap between the two. Then, an upward gap precedes a third tall green candle that closes above the mid-point on the body of the first red candle.
Examples for reliable bullish reversal in a downtrend:
**Three Line Strike**
Three declining red candles, each closing lower, are succeeded by a tall green candle that opens either below or at the same level as the previous close and concludes with a close surpassing the highest open.
**Morning Doji Star**
A tall red candle is succeeded by a smaller Doji candle (where the open and close are nearly equal), with a gap between their bodies. Following this, there is an upward gap leading to the body of a third green candle, which closes above the midpoint on the body of the initial red candle.
b- Bearish Reversal Patterns:
- Indicate potential downward trend reversal.
- Highlight points in a down-trend where a shift is anticipated.
Examples for strong bearish reversal in an uptrend:
**Three Black (Red) Crows**
Three descending tall red candles, with partial overlap between the candlestick bodies, and each concluding near the low. The three red soldiers pattern consists of three extended straight green candles with minimal shadows. Each new candle opens at a price relatively similar to the previous one but descends significantly with every close. This pattern is considered a robust bearish signal.
**Evening Star**
A tall green candle is succeeded by a smaller higher candle, either filled or unfilled, with a gap between their bodies. Subsequently, there is a downward gap leading to the body of a third red candle, which closes below the midpoint on the body of the initial green candle.
Examples for reliable bearish reversal in an uptrend:
**Bearish Engulfing**
In the ‘Bearish Engulfing’ pattern, a green candle is followed by a larger red candle that opens above the previous candle and closes below it. This two-candle pattern signifies a potential reversal when observed in an uptrend, suggesting that the stock price might reverse its upward trajectory.
**Evening Doji Star**
A tall green candle opens higher and gaps up to a taller Doji candle, where the open and close are nearly equal. Although the shadows may overlap, there should be a gap between the two bodies. Subsequently, there is a downward gap leading to the body of a third red candle that closes below the midpoint on the body of the initial green candle.
2- CONTINUATION PATTERNS
Continuation Patterns play a crucial role in technical analysis, providing valuable information about ongoing market trends. These patterns indicate that after a brief consolidation, the price is likely to continue its trajectory. Traders use them to identify entry or exit points and manage risk effectively.
a- Bullish Continuation Patterns:
Bullish continuation candlestick patterns are formations signaling the continuation of an existing bullish trend, offering insights into market sentiment and buyer strength. Notable patterns include the Bullish Engulfing Pattern, marked by a smaller bearish candle followed by a larger bullish one, indicating a momentum shift and potential upward continuation. The Three White Soldiers pattern, featuring three extended bullish candlesticks, reflects robust buying pressure, suggesting a continuation of the uptrend. The Bullish Harami pattern, where a small bearish candle precedes a smaller bullish one within its range, signifies a potential reversal of bearish sentiment and an ongoing bullish trend.
Summarize:
- Indicate potential continuation of an upward trend.
- Identify points in an up-trend where momentum is likely to persist.
b- Bearish Continuation Patterns:
Bearish continuation candlestick patterns are formations signaling the persistence of an ongoing bearish trend, providing insights into market sentiment and the strength of sellers. Notable patterns include the Bearish Engulfing Pattern, marked by a smaller bullish candle followed by a larger bearish one, indicating a shift in momentum and a potential downward continuation. The Three Black Crows pattern, comprising three consecutive extended bearish candlesticks, reflects robust selling pressure, suggesting a likely continuation of the downtrend. The Bearish Harami pattern, where a small bullish candle precedes a smaller bearish one within its range, signifies a potential reversal of bullish sentiment and the continuation of the bearish trend.
Summarize:
- Suggest potential continuation of a downward trend.
- Highlight points in a down-trend where downward momentum is expected to persist.
3- CONSOLIDATION PATTERNS
Consolidation Patterns are generally considered as less robust candlestick formations, exhibiting a near-even probability of resolving in either direction, indicating they are less than 1.5 times as likely to move in a specific direction.
Consolidation patterns in candlestick charting refer to periods when the price of an asset shows a temporary pause or sideways movement, forming a pattern of relatively tight price range. These patterns suggest a balance between buying and selling forces in the market, leading to indecision among traders. Consolidation patterns are characterized by a lack of clear trend direction and often occur after a significant price movement.
Previous Step:
Mastering Various Candlestick Charts: Uncovering the Language of Price Action for Strategic Trading Success — link
Thanks for reading, and see you soon.
SOURCES:
https://www.incrediblecharts.com/candlestick_patterns/candlestick-bullish-reversal-patterns.php
https://www.5paisa.com/finschool/continuation-pattern/
https://www.adigitalblogger.com/chart-patterns/pennant-pattern/
