Candlestick patterns can provide the trader with invaluable information on price action with just a glance. While common candlestick patterns can provide important insights into what the market is ‘thinking’, they can sometimes generate false signals, precisely because they are frequent. For this reason, it is also important to know the most advanced patterns that have a high degree of reliability as well as their use in combination with other tools. As with any other technical analysis resource, candlestick patterns should be supplemented with other analysis tools to confirm their signals.
We are going to list a few basic ones, and the we are going to keep up posting individual articles for each of the more complex patterns.
Bullish Engulfing
The bullish engulfing is most significant when it occurs after a prolonged downtrend. The stock or index has been selling off sharply. On the day of the bullish engulfing, prices will often start the day by falling. However, strong buying interest comes in and turns the market around.
The bullish engulfing is named because this candle surrounds or engulfs the previous one. When I discuss this candle with college students enrolled in my stock market course, I call it “Pac-Man” because like the video game character, it “eats” the candle before it. The bullish engulfing represents a reversal of supply and demand. Whereas supply has previously far outstripped demand, now the buyers are far more eager than the sellers. Perhaps at a market bottom, this is just short-covering at first, but it is the catalyst which creates a buying stampede.
When analyzing the bullish engulfing, always check its size. The larger the candle, the more significant the possible reversal. A bullish engulfing which consumes several of the previous candles, speaks of a powerful shift in the market.
The Hammer
This hammer marks a reversal off a bottom or off an important support level. On the day of the hammer, prices decline. They hit bottom and then rebound sharply making up all the ground – and sometimes more – compared to where the sell-off started. The candle shows that the buyers have seized control. A bullish candlestick on the following day confirms this analysis.
The Doji
If you were to learn only one candle by name, this would have to be the one. A “common” doji, as I call it, is shaped like a cross. A doji has no real body. What it says is that there is a stalemate between supply and demand. It is a time when the optimist and pessimist, amateur and professional are all in agreement. This market equilibrium argues against a strong uptrend or downtrend continuing, so a doji often marks a reversal day.
A doji in an overbought or oversold market is therefore often very significant. The opening of the next day should be watched carefully to see if the market carries through on the reversal. Note, a candle with a very small real body often can be interpreted as a doji.
Gravestone Doji
The gravestone doji occurs far less frequently than the common one, but gives even a clearer signal. At the top of an extended move, it says the bulls tried to move the market higher and couldn’t do it. The stock, or in this case the index, can not sustain the probe to new high ground. It opens and closes at the exact same level creating the appearance of a tombstone.
Dragonfly Doji
A Dragonfly Doji is a type of candlestick pattern that can signal a potential reversal in price to the downside or upside, depending on past price action. It’s formed when the asset’s high, open, and close prices are the same. The long lower shadow suggests that there was aggressive selling during the period of the candle, but since the price closed near the open it shows that buyers were able to absorb the selling and push the price back up.
Long Legged Doji
The long-legged doji is a candlestick that consists of long upper and lower shadows and has approximately the same opening and closing price. The candlestick signals indecision about the future direction of the underlying security.
It is used by some traders to warn that indecision is entering the market after a strong advance. It may also warn that a strong downtrend may be experiencing indecision before making a move to the upside.
Long-legged dojis may also mark the start of a consolidation period, where the price forms one or more long-legged dojis before moving into a tighter pattern or breaks out to form a new trend.
Four Price Doji
Four-Price Doji is a basic candle that has all four prices equal (i.e. open, close, low and high). Usually this means that we are dealing with a very small number of transactions, and in many cases, with a single transaction. Therefore, its importance is very limited.
Please note that we can assume, as for all other types of doji candles, that a very small body is acceptable. In the case of Four-Price Doji this means that open, close, high and low prices are not necessarily all the same, but are very much similar. Please see the following articles for more detail: The problem with doji candles (Part 1) and The problem with doji candles (Part 2).
Four-Price Doji often appears in pre-market and after hours trading. Also, when the candles are of a low frequency (e.g. 1-minute candles), the chances are higher that such candles will be seen. When such candles occur on a daily chart, it means that the trading volume is likely to be extremely low.
Neutral Doji
A Doji is drawn when the opening and closing prices are the same. The shadows of the Doji can have different lengths. Therefore, the Doji can have a cross, an inverted cross, or a plus sign shape. A single Doji is a neutral formation.
- Trend: Reversal
- Expected trend: Neutral
- Previous trend: Neutral
- Reliability: Low
- Type: Neutral
- Number: 1
