Dominate the Markets with Smart Technical Analysis | TA 101 – Part 16
Smart Technical Analysis of Candlestick Patterns
A trader can gain insight into the current market psychology and the likelihood of price movements in the near future by observing a series of candlestick patterns that frequently develop into recognizable patterns. Numerous of these one-, two-, or three-candlestick patterns are utilized as indicators of upcoming trend reversals. Dozens of candlestick patterns have been identified dating back to the 1700s with Japanese rice futures traders. Japanese traders were able to quickly identify and communicate short-term supply and demand forces in the market with these recurring patterns of price action.
Doji Candlestick
The doji candlestick shown above is one that has significance both by itself and when combined with other candlesticks. Throughout the day, price fluctuates above and below the opening price before closing at or close to the opening price. Even though investors experienced price swings that were both up and down throughout the day, this indicates that the buying and selling market forces were in equilibrium.
The SharpChart of ERIE above illustrates a doji candlestick. The intraday 10-minute SharpChart of this particular doji candlestick below shows the 2.2% price swing from high to low that investors endured during the day. Doji candlesticks are a sign of market indecision which often precedes a trend reversal.
With doji candlesticks, a long lower shadow is considered bullish since buying interest moved the price up from a deep intraday decline before market close. Long upper shadows are bearish for a similar reason; initial buying interest gives way to sellers by market close.
Doji Candlestick Formations
The candlestick patterns above are often present in trend changes. The doji in these patterns illustrate how market indecision often acts as a pivot in trend changes.
Other Important Candlestick Patterns
While there are literally hundreds of candlestick patterns out there, the following candlestick patterns have been found by Thomas N. Bulkowski to be six of the most reliable candlestick patterns based on testing on 4.7 million candle lines.
Note: The gray candlestick bodies in the diagrams indicate that the body color is not relevant for the subject pattern.
Additional candlestick reliability information can be found in Bulkowski’s book Encyclopedia of Candlestick Charts. While Greg Morris’s book Candlestick Charting Explained is a good general introduction to the topic.
In part 17, we’ll cover Comparison Charting.
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