Candlestick patterns are a major component of contemporary technical analysis, but they were first used centuries ago by the Japanese in order to effectively trade rice.
The principles behind candlesticks are this: It is buyers and sellers fear and greed which cause markets to fluctuate. As a result, actions (price) speak louder than words (news, earnings, etc.)
All news is already reflected in the price, even if that price does not adequately reflect true value.
TorOption is an online trading platform offering tools to help traders produce better results. Understanding candlestick formations is one such tool.
Candlesticks are comprised of four basic components, the open, close, high and low of whatever time period your chart represents.
These can be daily charts, weekly charts, yearly charts, or even minute charts depending on your trading strategy. The fifth component is colour or shading of the candlestick body which enables the viewer to determine if the candle is bullish or bearish in nature.
There is a lot of information being conveyed in one single candlestick. As a result, candlestick charts are the preferred method of many traders for analyzing technical data. Long bodies tend to suggest stronger buying and selling pressure while shorter bodies convey a more consolidated price formation.
Short and long shadows indicate how closely buyers and sellers congregated around the open and close price. Shorter shadows suggesting less divergence from the open and close. Longer shadows indicate a little more volatility. On occasion one will see a white or black Marubozu candle. This is a long candle with no tail or wick. Marubozu candles suggest very strong buying and selling pressure.
The doji, in all its myriad formations, is one of the more powerful candlestick formations.
Doji form when the open and close are the same forming a candlestick whose body consists of merely a line. It is only in the relative capacity that this candle generates its strength.
A doji represents buyer or seller indecision at a particular moment and could lead to a reversal in trend. Doji patterns are particularly potent next to candles with larger bodies, as this signifies exhaustion more than a doji amongst smaller candles. Here are some specific doji worth mentioning:
These doji occur when the tails and wicks are long and of roughly equal length. They indicate market indecision. Despite large fluctuations in price, the price ended right where it began. It is particularly important to use follow up candles with these particular doji.
Gravestone doji have a large upper shadow and indicate buying pressure. Like any doji, its power lies in relative terms. After a long bear run downward, or at the brink of support, this candle could offer evidence of a market reversal. A confirmation candle in the bull’s favour would further support such a reading.
The Dragonfly Doji is the inverse candlestick of the Gravestone Doji. It has the appearance of a capital “T” with a long lower shadow. This represents strong selling pressure and, like the Gravestone Doji, could result in a market turnaround. This would be determined based on previous candlestick patterns on the uptrend, or a pattern on the verge of resistance.
Hammer and Hanging Man
Like doji, the Hammer and Hanging man are individual candles which have a lot to offer in terms of potential forecasting.
The hammer is a bullish candlestick with a short body and a long lower shadow. It indicates a potential market reversal when viewed in the context of a bearish run particularly when reaching a support base.
The hanging man is a similar candle only it is bearish in nature and results in an upward trend. Like the hammer, it could foreshadow a market shift in direction. In this case, it would be a move downward. This would be especially relevant near resistance.
While Doji are individual candlestick indicators, most formations derive from multiple candlesticks relative to each other. Here are some common candlestick formations to be aware of:
Harami formations occur when a small candle in one direction is contained within the confines of the proceeding candle going in the opposite direction. Harami means “pregnant” in Japanese. This formation is more powerful when the shadows are contained as well. It indicates a potential market reversal.
A star formation occurs when a smaller candle gaps up or down from a larger candle. Like the Harami formation, this could be indicative of a change in market direction.
Reading candlesticks patterns takes time and practice, but with a little effort, the results can prove very rewarding.