Chapter 2.

Candlestick Shapes

Basic candlestick anatomy

Whenever you look at a price chart, you will select a timeframe for that
chart – perhaps it’s a minute … or an hour … or a day.

Rather than simply plotting the open or close price for that time frame,
the candlestick gives you information about what went on during that
period of time …

Having all this extra information, gives you a heads-up about market
sentiment – and can offer invaluable clues about the way the market will
move.
The Doji

The Doji is a candlestick where the opening and closing prices are the
same (or almost the same). It can take many forms, as shown here,
depending on what the trading activity was in that period.

What’s key with a doji is that neither the bears nor the bulls have gained
control, and that the price has ended where it began. It’s a sign of
indecision in the market, and could (in conjunction with other indicators)
signal a change in market direction.

Applying doji candlesticks: a good trick is to look out for a doji near
the edge of a price channel (i.e., if a doji appears at the top of a channel
it could indicate a bearish correction.)
The Marubozu

The text-book marubozu is a long candle, which implies that the day’s
trading range has been large. And it should have no upper or lower wick
(“marubozu” in Japanese means “shaved”).

A green (or white) marubozu signals strong conviction among buyers, while
a red (or black) marubozu indicates that sellers hare eager to flee.

In practice, when you’re looking at charts, a marubozu will often have a

short wick at the top or the bottom.
 Chapter 3.
Candlestick Patterns

Throughout this chapter, I’ve grouped candlestick patterns in pairs where

the patterns are very similar, except that one is bullish, and the other is
its flipside bearish pattern.

The Harami (Bullish & Bearish)

The harami is one of the most common candlestick patterns you’ll come
across, so it’s important to recognize it – to understand what it means,
and to understand its limitations.

A harami is a two-session reversal pattern – i.e. it’s made up of two

candlesticks and implies that the price is about to turn.

It is indicated by a small body of the opposite colour, completely

contained by the body of the previous session. It is not essential for the
two candles to be opposite colours, but this tends to give a more
reliable signal.

As you can see here, the body of the small black candle is completely
within the confines of the body of the previous white candle. This indicates
that the upward trend is running out of steam.

Here are a couple of examples:

This bullish harami shows the sellers beginning to

dominate as they come back into the market:

!
 This bearish harami has a shadow that extends
beyond the body of the previous candle – some
traders wouldn’t regard this as a “true” harami.
However, it’s body is entirely within the previous
green candle, and a reversal follows:

I’ll be blunt with you – a harami doesn’t always live up to its hype. While
it is touted as a “reversal indicator” – you may find yourself disappointed
by its reliability.

The psychology behind a harami is that a possible change in sentiment

may be happening. The small candle does not necessarily mean a strong
reversal is coming. Often with a harami pattern, several days of tight
range trading, referred to as “congestion” or “consolidation,” will follow. A
harami on its own says “the chart MIGHT reverse.” It is best to look for
confirmation and to combine the harami with other longer-term patterns.

Be aware of haramis, and watch for what they are telling you about
market sentiment – but don’t have a blind faith in them.
A hanging man: is the same shape as hammer, but found in an uptrend.
We don’t expect to see strong selling pressure (seen in the long lower
wick on the candle) in an uptrend, so here it suggests a change of market
sentiment and a reversal to downside.

Here’s an example from a FTSE 1-minute

chart.

In this case, the hanging man shape coincides

with the Stochastics showing the price to be
overbought, and the next candle confirms the
move.

There's no hard and fast rule about what colour a hammer or a hanging man
should be – the fact that they have a short body already means that there's
indecision coming into the market. However, a green (or white) hammer and
a red (or black hanging man) are stronger indicators.

(The chart above is quite a good illustration, because you’ll probably be able
to spot a couple of hammers on there, too – see what you can find!)
Inverted Hammer (bullish) & Shooting Star (bearish)

This candlestick is, as you would expect – a hammer turned on its head …

It is a candle with a small body and long upward wick, signally a possible
reversal. Where it appears in a chart affects whether it’s an inverted
hammer or a shooting star.

An inverted hammer forms after a downtrend or

at the bottom of a period of consolidation. The
reversal isn’t confirmed until you have a bullish
candle in the next period.

A shooting star forms after an uptrend or at the top

of a period of consolidation.

Inverted hammers and shooting stars can have green or red bodies –
what’s important here is that the body size is small, that the upper wick is
at least twice the length of the body, and the lower wick is negligible.
Engulfing (Bullish & Bearish)

An engulfing pattern signals a reversal, and can be bullish or bearish. It

comprises two candles. The body of the second must engulf the body of
the first, and must be the opposite colour to the first.

For a bullish engulfing candle, we have a smaller red

candlestick, followed by a green candlestick, the body of
which is greater in size that the previous candle.

For a bearish engulfing candle, the first candlestick is

smaller and green, followed by a red candlestick, the body
of which engulfs the previous candle.

In this example of a bearish engulfing pattern, we have

a clear uptrend, where the final candle has a red body,
which engulfs the body of the previous candle. This
suggests that strong selling pressure has come into the
market, and could indicate a reversal or period of
stagnation.
!
Three White Soldiers (Bullish)
& Three Black Crows (Bearish)

Here’s a great example of three black crows I spotted on the AUD/USD

chart …

Three long red (or black) candlesticks with lower and lower closes appear
within an upward trend (in this case, a rising triangle). They show
powerful selling action which strongly suggest that more selling is
imminent. And, as we see, the price continued downwards through long-
term support at 10536.

The flip-side to three black crows are three

white soldiers – three strong green (or white)
candlesticks within a downtrend. These are a
bullish signal of strong buying action at work.
Piercing Line (Bullish) & Dark Cloud Cover (Bearish)

The piercing line and dark cloud cover are reversal signals similar to the
engulfing pattern except the second candlestick doesn’t completely engulf
the body of the first – it should close at least halfway into the real body of
the first.

A piercing line pattern occurs in a downtrend. A strong

red candlestick is followed by a candlestick that opens
below its close, which perpetuates the downtrend.
However, the price then moves up and closes above the
midpoint of the previous candle. This suggests to the
bears that a bottom could be forming.

Dark cloud cover occurs in an uptrend, when a red

candle opens above the previous candle’s closing price,
but then the price retreats to below the midpoint of the
previous candle.

As a reversal signal, these are not as strong as engulfing candles. The

further the close of the second candle cuts into the body of the first
candle, the more valid the signal. What piercing line and dark cloud cover
do offer traders is cause to pause – a minor top or bottom may be about
to form, or you may be entering a period of consolidation.
Candlestick Chart Sheet :-

Basic candle shapes

Doji Reversal: a sign of Marubozo Continuation: a sign
market indecision that the trend is
maintaining
momentum

Bullish patterns Bearish patterns

Bullish Reversal indicated Bearish Small body of
by small body of opposite colour
Harami opposite colour Harami contained in body
entirely contained of previous session
in body of previous signals possible end
session. of uptrend.

Hammer Buyers have come Hanging Suggests that many

in – the downtrend longs have positions
may be about to
Man they are trying to
reverse. sell – may indicate a
reversal.

Inverted The small body at Shooting Price gap followed

the bottom of the by small body to
Hammer trading range Star bottom of trading
should concern range suggests that
bears. Could form bulls are protecting
a “morning star”. their gains.

Bullish First candle Bearish Second candle

Engulfing reflects trend; Engulfing opens above the
second candle’s first but is followed
body engulfs size by a sell off that
of first candle’s engulfs body of first
body – a reversal is candle – the bears
indicated. are gaining ground.

Morning First candle is long Evening The small range of

and black; second the second candle
Star gaps below first’s Star suggests indecision,
close and trades in and the lower close
a small range; third of the third candle
is long and white. confirms the bears.

Three Three long white Three Three consecutive

White sessions with Black sessions of selling
higher closes each will worry bulls and
Soldiers day –powerful Crows may snowball into a
buying action is at sell-off.
work.

Piercing Long black session Dark This pullback in the

Line is followed by Cloud second session will
opening at a new cause bulls to
low, but closes Cover question their
above midpoint of stance.
first session.