by Mike Lally
When you look at your charts, do you understand everything they’re telling you?
Most advocates of technical analysis will be familiar with important reversals patterns displayed by the bar chart.
Inside and outside days, bullish reversals, bull and bear shakeouts, isolated highs and lows, and so on.
Often important patterns consist of several days of price activity – patterns such as triangles, pennants, double tops and flags.
One of the most significant reversal candlestick patterns is the doji. This candlestick is unique in a sense because it actually looks the same whether you are using candlestick charts or bar charts.
In its common form, it looks like a cross.
The opening and closing price are just about equal.
This represents a period of uncertainty and is a warning that a reversal in the prevailing trend is possible. It pays to listen to the doji! Interestingly, this is rarely covered in technical analysis books.
There are about sixty-five recognised candlestick patterns and they can be broken down into 75% being reversal patterns and only 25% continuation patterns.
Let’s look at five popular examples:
Bullish Engulfing Pattern
It may appear to look the same as an outside day. This is misleading because in a bar chart outside day, the range of the second day exceeds the range of the first day. In the candle pattern, only the range of the open and close is considered. The bullish engulfing pattern is, as its name suggests, a very bullish pattern and it often needs no confirmation. It can be seen in a downtrend and it signals the beginning of an uptrend.
Bearish Engulfing Pattern
This pattern is the bearish equivalent of the bullish engulfing pattern. It can be seen in an uptrend and it signals the beginning of a downtrend.
The piercing pattern is also a bullish reversal pattern. The second day opens lower than the previous day’s low but closes above the mid-point of the previous day’s open/close range.
This pattern uses the high and low range.
Dark Cloud Cover
This is the bearish equivalent of the piercing pattern. The second day opens above the previous day’s high but closes below the mid-point of the previous day’s open/close range. This pattern also uses the high and low range.
The doji signifies indecision and heralds a potential turning point. There can be a considera
wible range difference between the high and low but the open and closing price remain roughly the same. The doji can be bullish or bearish depending upon where it occurs. If it is seen in an uptrend it has bearish connotations and if it occurs in a downtrend it has bullish connotations. Watch for a doji formation appearing in successive bars – this can be a very strong indicator of impending change.
As noted, the formations we are concerned with are the reversal patterns.
I have shown some of them above.
It pays to take a close look at the following patterns:
Engulfing patterns for either an uptrend or downtrend reversal
Hanging Man for an uptrend reversal
Hammer for a downtrend reversal
Shooting Star for an uptrend reversal
Inverted Hammer for a downtrend reversal
Dark Cloud Cover for an uptrend reversal
Piercing Pattern for a downtrend reversal
Morning Star for a downtrend reversal
Evening Star for an uptrend reversal
Doji for either an uptrend or downtrend reversal
Spinning Top for either an uptrend or downtrend reversal
Harami for either an uptrend or downtrend reversal
A profitable exercise is to visually compare candlesticks and bar charts. Start by analysing both types of patterns and attempt to observe and identify something different. It may surprise you that new thoughts quickly emerge and your analysis improves!
MORE ON CANDLESTICKS IN FUTURE ARTICLES!