Candlestick patterns by Teresa Appleton @ TradeWithLogic.com
Several similar and very common patterns on candlesticks are ones that focus on market reversals. However, these patterns can also set the market up for just a retracement move without fully reversing. Which is good for a shorter term trader to focus on and capitalize on, leaving longer term traders on bigger trading time frames to see these same patterns. Intraday the patterns setup throughout the day to give trading opportunities, but also to help manage existing trades. Once in a trade seeing the patterns can allow movement of a stop loss to avoid a trade snapping back on you or start to reduce position size by scaling off and using trailing stops.
Dark Cloud Cover - A two candle bearish reversal pattern where the first candle is a strong white candle and the second is a dark candle that opens above the first candle, but engulfs part of the previous white body after an uptrend. Ideally a dark cloud cover should close below the midpoint of the prior white candle. Without this the pattern is considered an incomplete dark cover. As a general rule the lower the close on the dark cloud cover on the white candle the more bearish the signal. The psychology of the move is the market is moving up clearly and then leaves a swing high with a big down candle. Pay attention to volume on these bars as well. The heavier the volume the more power the pullback will have off the swing high.
The Piercing Pattern - A two candle bullish reversal pattern where the first candle is a strong dark candle and the second is a white candle that opens below the first candle, but engulfs part of the previous dark body after a downtrend. This is the opposite of the dark cloud cover. The piercing pattern is a white body that closes within the prior black body. This shows buying is happening at lower levels. Ideally the white candle should close above the midpoint of the prior dark candle. The deeper the candle is the stronger the bullish signal is. Volume should come in heavier on the turn up and shake the bears off the downside move. The up candle not only can show a reversal but also give anyone short a reason to tighten up stop losses. A nice retracement back to the upside should be watched for when the pattern sets up, but also a full reversal is possible.
Engulfing Patterns - An engulfing pattern is a two candle pattern. A bullish engulfing pattern is formed when, during a downtrend, a white body wraps around a black body. A bearish engulfing pattern is formed when, during a rally, a black body envelops a white real body. The strictest definition of an engulfing pattern would be if the first candle is small and the second candle very large, and the second body wraps around the entire first candle—including its shadows. The next part of the definition would be if the shadows of the second candle exceeded the shadows of the first candle, meaning the second candle of the engulfing pattern, the market made a higher high and a lower low. Which leaves an inside bar prior to the engulfing bar and of opposite color. Often these bars appear after an exhausted move in one direction for an extended period of time. Also off of gaps on the opening, the first bar will be smaller and then a larger engulfing follows to get things moving after the opening.
Learning to see the pattern is far more important than memorizing the names. The general psychology for each is the market is moving in one direction and shifts the focus with a bar in the opposing direction altering the tone of the market. Using candles can help to sharpen your trading skills and avoid getting in too early or become a top/bottom picker. By applying the patterns to the prior just candlesticks in preview articles the trade becomes clearer and accuracy improves.
This is #3 in a series of 4 candlestick articles. View PART ONE and PART TWO.
