In this trading lesson, we are going to share with you some great trading strategies using candlesticks. These trade setups are simple yet highly effective, though you will need to take the time to learn how to use them.
Candlesticks also known as traditional Japanese Candlesticks, are a great way to visually spot reversal signals through price action. The great thing about Candlestick charting is its effectiveness across multiple markets, whether its FX, Equities, Bonds or Commodities.
The above diagram depicts 2 candle sticks. The green one, on the left, is bullish as the closing price was higher than the opening price. While the pink one on the right, is bearish, as the closing price was lower than the opening price. Candlesticks come in many different varieties and we will begin to cover some of the most important ones now.
The first pattern we will look at is know as the Doji. A Doji occurs when the opening and closing price of the security are the same (or almost the same). There are 5 different types shown below, in order from left to right Standard, Long Legged, Dragonfly, Gravestone and 4 Price.
Doji's represent indecision in the market between buyers and sellers and are a warning of a pending change in direction of the security. The type of Doji and the preceding price activity will determine the likelihood that the trend will change.
The Gravestone Doji is a bearish indicator and the longer the shadow the more bearish it is, especially at the top of a up trending move.
The Dragonfly Doji is a bullish indicator and the longer the shadow the more bullish it is. The bullish aspect comes at the bottom of a downtrend and all the selling has been exhausted.
The Doji Star is a Standard Doji at the top or bottom of a trend. The Star is formed when the candle opens and closes above (uptrend) or below (downtrend) the last closing price.
The above shows both a bullish and bearish (left to right) Doji Star patterns. If you see a Doji Star, prepare for the market to change direction by either tightening existing stops or setting limit orders.
Hammers and Hanging Man
The next Candlestick patterns we will look at are the Hammer and Hanging Man. Some people have renamed these patterns as Pin Bar Reversal patterns.
The Hammer pattern is a bullish reversal pattern that forms at the end of a down move. It shows that sellers were able to drive the price much lower, though buyers stepped in took control. This is a great pattern to watch for on at an Hourly and Daily time frame.
The Hanging Man is a bearish reversal pattern and forms at the top of an up move. It occurs on increased selling and buyers try to bid the security back up but cant take control of it.
Both the Hammer and the Hanging Man are great reversal indicators, though you must watch for subsequent price action to confirm the reversal.
The Harami Position is also referred to as the Inside Bar Setup. This is where the current Candle fits within the area of the previous Candle. Thus the current candle has higher low and a lower high than the preceding period. In the below examples the smaller candles have real bodies, however it is just as likely to see Standard Dojis here.
The Harami Position shows that the market has entered a minor period of consolidation. In general Harami Positions are continuation patterns of the previous move. However it's important to note that they can also represent a reversal pattern under the right circumstances.