Did you know that it is possible to design a trading strategy entirely around the most basic elements of a chart – the candlesticks?
The truth is that this is not only possible, but many traders are actually having huge success doing it. Even entire books have been written about it, perhaps best-known among them is Steve Nison’s Japanese Candlestick Charting Techniques, where he lays out the foundation for how candlesticks can play a role in any trading strategy.
It’s important to realize that each individual candlestick essentially tells a story of the constant battle going on between the bulls and the bears in a currency pair. Understanding this story by studying the candles can therefore give us an indication of who has the upper hand in the market, and as a result, where the market is headed next.
In this article, we will go over 7 essential candlestick formations that are easily spotted in any market. These patterns can sometimes be traded as they are, although a more powerful strategy may be to incorporate them into your own trading strategy, and let the candlestick serve as the specific buy or sell trigger for you.
1. Bullish engulfing pattern
The bullish engulfing pattern is a widely used candlestick pattern, probably because it occurs quite often. The pattern is comprised of a small red candle followed by a larger green candle that completely covers the previous candle. It suggests that a bearish trend has reached its bottom and that the market may reverse upwards.
2. Bearish engulfing pattern
Essentially the opposite of the previous pattern, the bearish engulfing pattern is made up of a small green candle followed by a large red candle. It indicates that the market has topped and that bears are taking control. Sell your holdings or go short!
3. Dark cloud cover
This pattern is a common occurrence in the stock market, but is somewhat unusual in the forex market. It is made up by a long green candle followed by a red candle that opened higher than the previous candle closed. Since forex is traded 24 hours a day, 5 days a week, such a “gap” in price can normally only happen over the weekend when the markets are closed.
It is a bearish sign in any market, and the rational behind it is that it looks like the market is about to move higher, when it instead reverses and moves lower. This frustrates traders who are long, and they are forced to sell their holdings as a result.
4. Rising sun
The rising sun pattern the opposite of the “dark cloud cover,” and is seen as a very bullish sign in the market. What happens here is that traders are expecting the market to move lower, and position themselves accordingly. However, when it instead moves up, everyone’s forced to adjust their positions and the price is pushed even higher as a result.
5. Bullish three-line strike
Made up of three consecutive red candles followed by a large green candle, this is a pattern that is commonly seen in all markets. It indicates that the bulls are stronger than the bears, generally a sign that prices can be expected to move higher.
6. Hammer or pin
An easily recognized pattern consisting of only a single candlestick.Based on the same idea as the “candlestick price rejections” we have covered in the past, these candlesticks are among the easiest and best patterns to look for on a chart. A pin pointing up is bearish, while a pin pointing down is bullish.
A candlestick like this basically tells the story of how price tried to move in one direction, but did not find sufficient support to remain at those levels. As a result, price backtracked in the direction it came from, and we are left with a candle with a long wick sticking out in either direction.
In itself a neutral pattern, a doji represents indecision among the traders. It is formed when both the opening and closing price of a candle is at about the same level. In a strong trend, the doji can sometimes be taken as a signal that the traders are losing confidence in the continuation of the trend. As a result, the trend may be coming to an end soon or become more volatile.
If you enjoyed reading this and you want all of these patterns in one handy PDF cheat sheet to use in your trading, go here to download our candlestick fact sheet now!