candlestick chart pattern

Principles behind the Art
Before learning how to analyze them, we need to understand that candle patterns, for all intents and purposes, are merely reactions of traders at a particular time in the marketplace. The fact that human beings often react en masse to situations allows candlestick chart analysis to work.

Many of the investors who rushed to the marketplace in the fall and winter of 1999-2000 had, before that time, never bought a single share in a public company. The volumes at the top were record breaking and the smart money was starting to leave the stock market. Hundreds of thousands of new investors, armed with computers and new online trading accounts, were sitting at their desks buying and selling the dotcom flavor of the moment. Like lemmings, these new players took greed to a level never seen before, and, before long, they saw the market crash around their feet.
Lets have a look at what was a favorite of many investors during that time. This presentation of JDS Uniphase (JDSU) on the chart above is a lesson in how to recognize long bullish candles, which formed as the company's stock price moved from the $25 area in late Aug 1999 to an outstanding $140 plus in Mar 2000. Just look at the number of long green candles that occurred during a seven-month ride.

Analyzing Patterns
Traders must remember that a pattern may consist of only one candlestick but could also contain a number or series of candlesticks over a number of trading days.

A reversal candle pattern is a number or series of candlesticks that normally show a trend reversal in a stock or commodity being analyzed; however, determining trends can be very difficult. Perhaps this is best explained by Gregory L. Morris in the chapter her wrote for John J. Murphy's classic "Technical Analysis of the Financial Markets" (1999):


"One serious consideration that must be used to identify patterns as being either bullish or bearish is the trend of the market preceding the pattern. You cannot have a bullish reversal pattern in an uptrend. You can have a series of candlesticks that resemble the bullish pattern, but if the trend is up it is not a bullish Japanese candle pattern. Likewise, you cannot have a bearish reversal candle pattern in a downtrend."
The reader who takes Japanese candlestick charting to the next level will read that there could be as many as 40 or more patterns that will indicate reversals. One-day reversals form candlesticks such as 'hammers' and 'hanging men'. A hammer is an umbrella that appears after a price decline, and, according to candlestick pros, comes from the action of "hammering" out a bottom. If a stock or commodity opens down and the price drops throughout the session only to come back near the opening price at close, the pros call this a hammer.

A hanging man is very important to recognize and understand. It is an umbrella that develops after a rally. The shadow should be twice as long as the body. Hanging men that appear after a long rally should be taken notice of and acted upon. If a trading range for the hanging day is above the entire trading range of the previous day, a "gap" day may be indicated.

Lets look at two charts, one with a hammer and the other with a hanging man. The first charts Lucent Technologies and shows a classic hanging man. After three days of the stock price rising, the hanging man appears, and on the following day, the stock price drops over 20%. The second chart shows a hammer from a period in 2001 when Nortel Networks was trading in the $55-$70 range. The hammer appears after two days of declining prices and effectively stops the slide, marking the beginning of a nine-day run with the stock price moving up $11.
Basic Patterns
There are some basic candlesticks patterns described in this part. But first of all some candlestick terms.
A long body has a very long body when compared with other recent candles.

A short candle is the opposite of a long candle and usually implies consolidation, as the stock market traded in a narrow range during the trading period.

White bodies show intense buying pressure, where as black bodies show intense selling pressures.

Long Days pattern
These candlesticks indicate the great difference between the open and the close price for a trading day. The shadow are much shorter than the real body.

Short Days pattern
These candlesticks indicate the small difference between the open and the close price for a trading day. Both the body and the shadow lines are very short.

Marubozu pattern
Marubozu means there are no shadows from the bodies.
A White Marubozu is a long white body with no shadows. It indicates a bullish trend and usually becomes the first part of a bullish continuation or a bullish reversal pattern.

A Black Marubozu is a long black body with no shadows. It usually implies bearish continuation or bearish reversal.

Spinning Tops pattern
This pattern has longer shadow than the real body. The color of the real bodies are not very important. The pattern indicates the indecision between the bullish and bearish trends.

Stars and Rain Drops pattern
A Star pattern appears when a small body gaps above the previous day's long body.

A Rain Drop pattern appears when a small body gaps below the previous day's long body. Stars and Rain Drops are the part of the more complicated patterns, such as the reversal patterns.
A Doji is formed when the open and the close are the same or very close. The length of the shadows are not important. The Japanese interpretation is that the bulls and the bears are conflicting. The appearance of a Doji should alert the investor of major indecision.

The Gravestone Doji is formed when the open and the close occur at the low of the day. It is found occasionally at market bottoms, but it's forte is calling market tops. The name, Gravestone Doji, is derived by the formation of the signal looking like a gravestone.

The Long-legged Doji has one or two very long shadows. Long-legged Doji's are often signs of market tops. If the open and the close are in the center of the session's trading range, the signal is referred to as a Rickshaw Man. The Japanese believe these signals to mean that the trend has "lost it's sense of direction."

The Bullish Engulfing Pattern is formed at the end of a downtrend. A white body is formed that opens lower and closes higher than the black candle open and close from the previous day. This complete engulfing of the previous day's body represents overwhelming buying pressure dissipating the selling pressure.

The Bearish Engulfing Pattern is directly opposite to the bullish pattern. It is created at the end of an up-trending market. The black real body completely engulfs the previous day's white body. This shows that the bears are now overwhelming the bulls.

The Dark Cloud Cover is a two-day bearish pattern found at the end of an upturn or at the top of a congested trading area. The first day of the pattern is a strong white real body. The second day's price opens higher than any of the previous day's trading range.

The Piercing Pattern is a bottom reversal. It is a two candle pattern at the end of a declining market. The first day real body is black. The second day is a long white body. The white day opens sharply lower, under the trading range of the previous day. The price comes up to where it closes above the 50% level of the black body.

Hammer and Hanging-man are candlesticks with long lower shadows and small real bodies. The bodies are at the top of the trading session. This pattern at the bottom of the down-trend is called a Hammer. It is hammering out a base. The Japanese word is takuri, meaning "trying to gauge the depth".

The Shooting Star Formation, at the bottom of a trend, is a bullish signal. It is known as an inverted hammer. It is important to wait for the bullish verification. Now that we have seen some of the basic signals, let's take a look at the added power of some of the other formations.