As we know, the technical analysis is an analysis of a security for the purpose of forecasting the direction of the future prices or purely price movement through the study of the past market data, primarily price and volume. And, Candlestick pattern is one of the basic tools used by technical analysts for the purpose.
Briefly, candlestick pattern is a movement in price shown graphically. These prices pattern tend to make some impressions using which a person can predict a specific movement. The recognition of the pattern is subjective, and the programs that are used for charting have to rely on the predefined rules to match the pattern. There are around 42 recognized patterns that can be split into simple and complex patterns.
Generally, most of the traders use three to six patterns that have maximum accuracy. Some of the most used candlestick patterns are discussed below:
Doji is very significant pattern hinting signals of buy and sell separately. Doji is a single candle pattern that helps in understanding the next coming trend of the stock. Doji pattern is formed; when a share price both open and close is virtually equal. The tail of the candle varies from stock to stock, but the resulting candlestick should look like a cross, inverted cross or plus sign.
Doji candle alone could not predict anything as it is a neutral pattern, but the actual time when this candle appears gives a confirmation of a trend.
To understand the pattern, one needs to know the message that the pattern is conveying. Doji conveys a sense of indecision or tug-of-war between the buyers and the sellers. The succeeding candle decides whether the stock price is in the favor of bulls or bear.
Hammer and Hanging Man
Hammer and Hanging man pattern are the examples of Candlestick Reversal Pattern. Reversal signals generally indicate that the current trend will be ending or it will change. This reversal of the candlestick reflects that the security may become flat or move with its current trend or start moving in a different direction. These reversal signals are just the approach to forecast the next trend, but these signals lack 100% accuracy. However, if there are two or more reasons for the reversal trend then this is the best opportunity to grab some profit by using the pattern.
A bullish candle after the hammer pattern confirms the best entry point. On the other hand, a bearish candle after a hanging man pattern will confirms a bearish trend.
The other very strong candlestick pattern is Kicker. It can be bullish and bearish both. The candles do not require any proceeding trend to forecast the stock price of the next day. Analysts believe the pattern is one of the most powerful candlestick signals. The pattern is said to be very effective as it is characterized by a very sharp reversal in the price during the span of two candlesticks.
These kicker patterns generally form because of some recent news or surprising returns. It could be an earnings report, an analyst’s upgrade/downgrade.
The other candle that has the potential to judge the next day price movement is the Shooting star pattern. The Shooting Star signal is found at the top of an uptrend. Generally, the stock represents the sentiments that the bulls had a complete control on the trend. Next day, the buyer tend to move the stock to very high level, which causes a very high tail, and suddenly they realize the stock is now in the overbought territory therefore they hold on waiting for the next day to test the bear’s persistence. Next day, if the bears are able to take the stock lower then bulls go away, eventually leading to a reverse trend.
Dark Cloud Cover
It is a single candlestick pattern found at the top of an uptrend. Generally, here the stock is initially in the uptrend form last few weeks or days, but the next day suddenly a black candle opens above the high of the previous day and closes more than half way into the body of the previous day’s white candle.
The sentiments that the pattern reflects is that after the prices have risen for days, now the prices do not look so much attractive to the buyer. Suddenly, the buyers having maximum holding of the share drop their positions, which causes a sudden fall of the share price.
In the above example, the share is rising from past few days, but the next day a bear candle appeared and overshadows the buyers. Making a fresh sell position is a wise decision in such a scenario.
Following were some of the frequently used candlestick pattern. Apply these in your daily trading to earn higher returns.