Technical Analysis — Identifying Patterns, Part 3

If you have ever wondered how to read technical charts and draw those seemingly random support and resistance lines, then this primer is a good start. Even if you do not believe in technical analysis, it is still an interesting topic. This article is the 3rd of a series in a straightforward, easy to understand introduction to technical analysis.

Disclaimer: The article is meant solely for educational purposes only and is not intended for use as an investment directive. By viewing any material or using the information within this page you agree that this is general education material and you will not hold any person or entity responsible for loss or damages resulting from the content.

Now that you have mastered reading the candlestick from the first two articles in the series, we can start examining some simple linking patterns. Technical Analysis are really most useful in helping to identify two fundamental scenarios: continuation or reversal of a trend. These are the most significant indicators informing you to take notice. It doesn’t necessarily mean that something will happen, just an indicator of some significance. Let’s get started.

You may want to revisit Candlestick 1, and Candlestick 2 to brush up on Candlesticks. We will still be here.

The first pattern is one of a continuing uptrend, known as the Three White Soldiers and it is a fairly strong. You have three consecutive days of higher close than the open as indicated by the white sticks. Additionally, it must open higher than the previous day’s open and the wicks should be relatively short with respect to the body. The trend should continue upward, although it’s not to say that the 4th day will be bullish as there may be some profit-taking.

The Three White Soldiers are pretty easy to spot.

Figure 1 — Three White Soldiers are indicative of Bullish sentiment

Likewise, there are the Three Black Crows indicating a bearish sentiment where three consecutive days of lower closing over the opening. Each of the day’s open must be lower than the previous days open, and again the wicks should be relatively short.

Figure 2 — Three Black Crows is bearish

In both of these patterns look for short wicks and the bodies must be overlapping. If there are gaps, then the gap overrides these two patterns. In poker parlance, the gap trumps both the Three White Soldiers or corresponding Three Black Crows. The three consecutive bodies must overlap. A gap is indicative of probably some major event, which cannot be ignored.

Let’s do some practice. The following charts will have either Three White Soldiers or Three Black Crows. The answers will be further below. Take your time. Review the indicators if needed. Here is the first one.

Note: The different charting styles are used to help get you used to being chart-agnostic. Again green and white bodies indicate that the day closed higher than the open. Black and red bodies indicate that the day closed lower than the open. Reminder: the color says nothing about whether the day closed high or lower than the previous day. It only indicates the intraday close relative to the open.

Figure 3—Example 1 — This one is tricky. Looks like both patterns are here, but not quite.

Let move onto the next example.

Figure 4 — Example 2

Figure 5 — Example 3

Figure 6 —Example 4

Figure 7—Example 5

Did you find them hard to spot? Its not easy at first. But don’t stress, you will quickly get a hang of it. Below I will go over each one with the indicated pattern called out.

Solutions:

EXAMPLE 1:

Figure 8 — Example 1 related to figure 3

If you see the Three White Soldiers then you are correct. Following the last white (green on this chart) soldier, you can see a breakout with a very strong 4th bullish day. But some may have incorrectly spotted a Three Black Crows starting with the 2nd bar from the left. The day after closed with a higher green day, both in terms that the close was higher than the preceding day (barely) and that the close was higher than the open.

But why were days (bars) 2–4 not considered a Three Black Crows pattern? If you look at days 2 and 4, they are shaven heads, which by themselves is indicative of a potential reversal. Indeed the 5th day is positive, and a brief three days of bears, the bulls came out in force, and carried it much higher as seen on the right.

EXAMPLE 2:

Figure 9— Example 2 related to figure 4

The Three Black Crows appear after a brief uptrend. As we move through the pattern, the three candles gain length: the second candle is longer than the first, and the third candle is longer than the second. This progressive lengthening indicated reversal, and as expected, a strong downtrend materializes soon thereafter.

EXAMPLE 3:

Figure 10— Example 3 related to figure 5

In our next example, after some ebbs and flows, a mid-sized uptrend appears. At the top, following a long-legged doji, Three Black Crows land on the chart. They’re similar in size and not particularly lengthy. Although the bears have made a strong showing and exhibited their strength, they fail! This example shows why you should always wait for confirmation. A bullish candle appears after the Three Black Crows, followed by a doji again and the price then surges upward in a spirited uptrend. The bears have failed in their quest. This is a lesson. Even the best indicators are not perfect.

EXAMPLE 4:

Figure 11— Example 4 related to figure 6

One might debate whether our third example qualifies as a Three Black Crows candlestick pattern. Do you know why? In a way, it lacks the very first criteria we mentioned above: a prevailing uptrend. Before the “Three Black Crows,” there is a small downtrend, two tiny candles moving upward, and then the signal. If you count those tiny candles as an uptrend, this is indeed a Three Black Crows pattern. As expected, the price dips after the signal appears.

While you’re here, take a look at the four red candles that appear about two-thirds of the way through the chart following an uptrend. Someone might try to claim that this is a Three Black Crows signal as well, but unfortunately, it lacks the overlapping quality of the signal. There are gaps between the 2nd and 3rd candles and the 3rd and 4th candles, disqualifying it.

EXAMPLE 5:

Figure 12— Example 5 related to figure 7

With our fourth example, we’ve hit the mother lode. There are three Three Black Crows soaring through the second half of this chart. The first appears after a noteworthy uptrend: check out the length of those bullish candles! However, this first attempt by the bears to steal the reins fails; a short uptrend occurs soon after.

Following another uptrend, the bears jump in and form what could be considered a Four Black Crows pattern (it might have been a Five Black Crows if the last two candles overlapped). As expected, the price then plummets.

Although the bulls attempt to raise the price again (forming a tiny uptrend), the bears will not let them win. They send in another Three Black Crows. Although we can’t see what occurs after this final iteration of the signal, the last candle of the chart (the tiny red candle) provides a weak form of confirmation. Although this doesn’t guarantee a downtrend will follow, it offers a bit of assurance.

Conclusion

Indicators are never perfect, they are just strong signals of probability. You can play it conservatively and wait for confirmation while leaving some profit off the table. There may also be multiple conflicting indicators. Do they cancel each other out? Does one take precedence over the other? It depends on your strategy, which I will get more in depth in future articles. More patterns to follow.