Different candlestick formations

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Yonela Ngulugulu and WikiVisor 22 Sep 2017

A study of different candlesticks their formation and their meaning. This will help one understand how they can influence a trader in taking trading decisions...


What are candlesticks and why are they important

Candlesticks are graphic representation of price movements over time. These candlesticks indicate the opening price and the closing price of that session, but not only that. They indicate the highs and lows of that trading session too. While this may sound confusing for a beginner or an inexperienced trader. One can be rest assured that they are not as complex/complicated as they seem. Japanese candlesticks use a simple logic. Similar to that of bar charts, but in a more cool graphic way. It is for this reason that Japanese candlesticks are widely used by traders worldwide. So, still not sure why are they so popular? Well try the reasons mentioned below:

Figure 1
  • They are easy to understand and the information they convey is easy to interpret.
  • They are easy to remember, unlike line or bar charts

Therefore, traders use these candlesticks to analyze the markets and to aid them in making sound decisions. Understanding candlesticks is fundamental to reading price movements. It is only when one has mastered the art of reading price movements that they can be on their path to trading success. So one can imagine just how important it is to understand candlesticks. As already explained that candlesticks are similar to bar charts in that they both show the same information, however as you will see in figure 1 just why more traders appreciate candlesticks more than bar charts.

Japanese candlesticks are fun to look at, as psychology shows that we recall information easier if we add color and fun to learning. Candlesticks are colorful as already shown in the illustration above. Now that you know why candlesticks are used by most traders/investors/speculators. The following section will explain different candlestick patterns and their meanings.


Different candlestick patterns

In this section of the page, emphasis will be placed on the basic candlestick patterns and what exactly could one expect should any of these candles print on their charts. The overall focus will be mainly on candlesticks such as Marubozu, Spinning tops, Doji, Hammer, Shooting star. So all five of these candles will be briefly discussed below. Firstly comes the Marubozu.

Marubozu candle

Figure 2. Marubozu candlesticks

The Marubozu is a very strong candle. It is a very bullish or a very bearish candle, depending on the current trend at play. The characteristics of this candle include a long filled body. The body has no wicks/shadows. This is indicative of the predominant group, between bulls or bears. So a red filled bar means that the bears were in control the entire session. A green filled candle means that the bulls were dominant from the begging till the end of that session. It is commonly a continuation candle.This is a case where the opening price is the same as the high of the trading session in a bearish setting, the opposite is true in a bullish setting. The opening price is the same as the low of that session. Remember, Bulls buy low and sell high, whereas, Bears sell high and buy low. Nevertheless, the closing price of a bearish Marubozu is equal to the low price of that session. Once again the opposite is true for a Bullish Marubozu candle, the closing price is equal to the high price of that trading session. While this may sound confusing, Figure 2 illustrates this information in a simple and easy to understand way.

Spinning top candle

Figure 3. Spinning top

Secondly, follows the Spinning top candle. The candle, as termed, it looks like a spinning top. With this candle, the color is not important. The structure of the overall candle is what is more important. This candle appears or rather prints when there is indecisiveness between the Bulls and the Bears. This may be an indication that the current trend is running out of steam. The candle has two wicks on either side of the body as illustrated in figure 3. Spinning tops are formed when there is no winner between the Bulls and the Bears. This is when there is a fight for turf between the Bulls and the Bears. Figure 3 below illustrates what a spinning top really is and what it looks like.

Doji candles

Figure 4. Doji candles
Next up are Doji candles. Doji candles can be classified into different types. There is a long legged Doji. Gravestone Doji, Dragonfly Doji. The characteristics of such candles are easy to spot and identify. These candles have little to no body at all. This means that the opening price is the same as the closing price of the candle.They will mostly appear as either a cross, an inverted cross or a plus sign. These type of candles appear if there is a fight between the Bulls and the Bears. This means for one, the current trend may be exhausted and some more power is needed to push the prices even higher or lower. Therefore it is advisable for one to wait for the next candle to serve as confirmation. Others would take a trade as soon as they see this candle, again it depends on the experience that one possesses, but for beginners, it is safer to wait for the following candle then enter the trader if the candle is a favorable one. The following candle should either be a reversal candle e.g a hammer, shooting star or a bullish big belt candle or a bearish big belt (confirmation candles) all these will be explained later on.

Should such a candle print on a significant resistance or support then this is an indication that the current move may have come to an end and the market is about to reverse. These candles are more reliable on higher timeframes say, daily or weekly charts. The picture provided herein shows market moves precipitated by Doji candles on a daily chart.

In this chart above (from left to right) you will see that a Dragonfly Doji printed followed by a candle with a long wick on the upside this shows that the current move was ending and there was selling power at that price. What happened next? The market fell. then the same candle appears on the end of that move, the following candle is a Bullish confirmation candle. After these two candles, what happened next? The market rose up. Then there came a retracement of that move, when this retracement ended, what was the indication that the market was about to reverse? the Dojo right? What happened next, the market rose up some more. These candles are powerful especially on bigger timeframes, They are catalysts for trend reversals if understood when to trade them.

Figure 5. Types of Doji

Types of Doji

So what are the different types of Dojis? and what do they look like? The following picture illustrates what they look like. Figure 5.

Hammer

Figure 6 shows how a hammer is formed

A hammer is a candle that is characterized as having a long wick or shadow to the downside and a small body. Some textbooks say the wick/shadow has to be at least three times the size of the body. However, as you will see in your trading career that this does not always happen. The candle will not always have a wick that is at least three times the size of its body. Nevertheless, the market still reverses after such a candle. It is for this reason that most traders like to use other aspects of trading such as the basic support and resistance, as well as indicators in some instances to complement their analysis. This is a powerful candle in a way that it precipitates a change of the trend or a reversal. Naked chart traders look for candles such as these. Naked chart traders are traders who trade using pure price action, without any indicators whatsoever. This is a strong catalyst for a change in trend. It is a bullish candle and it usually appears at the end of a downtrend or at the beginning of an uptrend, which would then mean that bulls are ready to take over and push the price higher. The following is an illustration of what a hammer looks like.

Shooting Star

figure 7

A shooting star is like an upside down hammer. Same characteristics as the hammer but only mean the opposite. This candle appears at the end of an uptrend, and signals that the market is about to reverse. It is a reversal candle and more powerful when prints on a resistance. This candle means that the bears are taking over, hence the wick to the upside. A shooting star candle warns the bulls of the imminent retracement or a change in the current trend. So should this candle form in the chart after a prolonged uptrend, it may warn traders that the current trend is coming to an end and the market is ready to turn. As a result, other traders may close long positions and perhaps re-enter when another bullish candle forms, say a hammer at a support. Following is a picture of a shooting star, what it looks like and how it is formed. The color is not important

Summary

So there you have it. A Marubozu is a strong candle either bullish or bearish depending on the trend. It usually forms at the beginning of a new trend or in the middle of an existing trend a continuation candle, say when the market breaks a support or a resistance, a Marubozu will be a good start. A spinning top shows market indecision. This happens when the Bulls or the Bears are in a way fighting on no one gets the upper hand or wins the battle. Same applies to a Doji. it also shows market indecision. However should this candle print on a support or resistance it could warn traders that the current trend may have come to an end. Moreover, one should wait for the following candle to serve as confirmation. A bullish or a bearish candle will mean that the market is headed in whatever the direction of that confirmation candle is. A hammer is a trend reversal candle, it a bullish reversal candle. it means the current trend is ending or has ended, provided that the candle itself has formed on a prominent support. Lastly but certainly not least, a shooting star is also a reversal candle. A bearish reversal candle at that, and means that the uptrend may have come to an end. depending on whether or not the candle itself has printed on a resistance. If this is the case then it is a high probability setup in that it is a reversal candle and that it printed on a resistance.

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