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4-Candlestick formations

Candlestick charts are said to have been developed in the 18th century by legendary Japanese rice trader Homma Munehisa. The charts gave Homma and others an overview of open, high, low, and close market prices over a certain period. This style of charting is very popular due to the level of ease in reading and understanding the graphs. Since the 17th century, there has been a lot of effort to relate chart patterns to the ldata points instead of one. The Japanese rice traders also found that the resulting charts would provide a fairly reliable tool to predict future demand.

Learn the candlestick formations and spend some time watching them on the charts. Start noticing how these formations can sometimes lead to trend reversals. You will want to be able to quickly spot them on a chart.

My mentors at Market Traders Institute, http://www.markettraders.com/landings/forexIQ/forexIQ.aspx?id=THEFOREXMOM(Blog), made it very easy for me to understand these candlestick formations and the best rules for trading them. Keeping it simple is the key.

The three black crows candle formation does not happen very frequently in stock trading, but when it does occur swing traders should be very alert to the crow’s caw.

The candlestick pattern’s metaphor is three crows sitting in a tall three. Essentially, it is a reversal formation that occurs following a strong advance.

On the day the first black crow makes its appearance, the formation is most predictive if the first “crow” — or dark candlestick — closes below the white candle’s real body. That is the first step in setting up a Minor trend reversal — where today’s high is lower than yesterday’s high and today’s low is below yesterday’s low.

Two more long-bodied consecutive down days then ensue. On each of these days, it appears as if the stock wants to regain its former strength, as the stock opens higher than on the previous day. By the end of each session, however, the sellers regain control and the stock drops to a new closing low. Here is what three black crows candlestick pattern looks like:

Three Black Crows

Three Black Crows

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Bearish three outside down candlestick formation

Bearish three outside down candlestick formation

After an established uptrend a clear bearish Engulfing pattern occurs (one blue candle and a second bear move that drives price below the prior day low and closes near the bottom of the range). The third day is a red day with an even lower close than the second day.

In a market characterized by uptrend, day-twos red candle close completely below day-one, engulfing it completely. The first two days are a classic pattern that suggests a sell-off has taken over the market and is breaking the established trend.

This bearish reversal is confirmed by a still lower day on day-three. 

 Connections to Bearish Engulfing Pattern

The Bearish Three Outside Down pattern is just a continuation for Bearish Engulfing with the third day as confirmation for trend reversal. A Bearish Engulfing pattern by itself is a moderately reliable reversal signal, but when it is followed by a red day (forming the Bearish Three Outside Down), the pattern becomes much more reliable.

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Bullish Three Outside Up Candlestick formation

Bullish Three Outside Up Candlestick formation

After an established downtrend, day-one continues the trend with a red candle. Day-two is a long blue day that engulfs the body of the first day, closing well above the previous days open.  The third day is a blue day with an even higher close than the second day.

The Bullish Three Outside Up pattern is one of the more clear-cut three day bullish reversal patterns. The formation reflects buyers overtaking selling strength, and often precedes a continued rally in price. In fact up to day-two we have a bullish Engulfing Pattern, itself a strong two-day reversal pattern.

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Three Inside down candlestick formation

Three Inside down candlestick formation

Following an uptrend, a long blue day occurs.  The second day is a red day where the body is engulfed by the body of the first.  The third day is a red candle with a lower close than the previous day.

During an uptrend a large upward price movement occurs, illustrated by a long blue candlestick. The price is then driven down, as shown by a red candlestick, reversing some of the upward movement from the previous day. The reversal pattern is confirmed with the third days red candle completes the bearish pattern.

This pattern is a confirmation of the Harami pattern.

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Three Bullish Inside Up Candlestick Formation

Three Bullish Inside Up Candlestick Formation

After an established downtrend, day-one is long red day.  Day-two is a blue day that trades up to the midpoint of day-one.  The third day is a blue day carrying price above the first bearish candle

Up to day-two we have a simple Bullish Harami pattern. Haramis give a clear-cut formation reflecting buyers overtaking the strength in the downtrend. This formation often precedes a continued rally in price.

With just a Harami pattern, Candlestick analysts will usually wait for additional conformation before entering a long position. The Bullish Three Inside Three formation offers that confirmation.

Additional Confirmation For this candle to take full strength day-threes candle needs to close above day-ones high, creating a new high. The Bullish Three Inside Up formation suggest buyers have seized a degree of control from the bear trend and analysts will watch for buying opportunities to come.

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Bullish Three White Soldiers Pattern indicates a strong reversal in the market. It is found in a bearish market and consists of three long candlesticks stepping upward like a staircase. The opening of each candlestick is within the body of the previous day, and the opening of each day is slightly lower than the previous close.  It is better to see the opening prices above the middle of the previous day’s body. If the white candlesticks are very extended, one should be cautious about an overbought market.

Three White Soldiers

Three White Soldiers

Bearish Three White Soldiers Pattern indicates a strong reversal in the market. It is found in a bullish market and consists of three long candlesticks stepping downward like a staircase. The opening of each candlestick is within the body of the previous day, and the opening of each day is slightly higher than the previous close.  It is better to see the opening prices below the middle of the previous day’s body. If the white candlesticks are very extended, one should be cautious about an oversold market.

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marubozu candles

A White Marubozu contains a long white body with no wicks. The open price equals the low price and the close price equals the high price. This is a very bullish candle as it shows that buyers were in control the whole entire session. It usually becomes the first part of a bullish continuation or a bullish reversal pattern.

A Black Marubozu contains a long black body with no wicks. The open equals the high and the close equals the low. This is a very bearish candle as it shows that sellers controlled the price action the whole entire session. It usually implies bearish continuation or bearish reversal.

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  • Most of the formations will not appear as perfectly as they are in the manual.
  • Has the market been trending? up? down? Or is it consolidating (up and down)?
  • Is the market showing signs of exhaustion? Is each candle getting progressively smaller?
  • What time is it? Is this the opening of a trading session, the lunch time, or the closing of the trading session? Which trading session, Asian, European, or US? The first 2 1/2 hours of a trading session are best. Some traders close before lunch, many close before the closing of their trading session.
  • Does the formation agree with other technical considerations, such as fibonacci patterns (wave based or time based), pivot points, support/resistance, logic points, divergance?
  • Can you afford the trade? Does the trade meet your equity management rules?

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candles

Japanese Candlesticks

This is a picture of a Japanese Candlestick. It represents the price over a period of time. For example, this could be a 10 minute candle, or a 1 hour candle, or even a 1 month candle.

Let’s say this is a one hour candle. It represents the time from 8 AM to 9 AM. The price at 8 AM is called the Open price. The price at 9 AM is called the Close price.

During the time between 8 AM and 9 AM, the prices go up and down. The highest price between 8 AM and 9 AM is called the High Price. The lowest price between 8 AM and 9 AM is called the Low Price.

The area between the Open and Close is called the Body. The thin lines above and below the body are called Wicks.

A Japanese Candlestick tells us a story about the price during a period of time.

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bearVSbull

Bearish candlesticks vs Bullish candlesticks

In a bearish candlestick, the closing price is lower than the opening price. The price has dropped.

In a bullish candlestick, the closing price is higher than the opening price. The price has risen.

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