Candlestick Patterns

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**Candlestick Basics

Candlestick charts are an effective way of visualizing price movements. There are two basic candlesticks:

Bullish Candle: When the close is higher than the open (usually green or white)
Bearish Candle: When the close is lower than the open (usually red or black)

bullish and bearish candlestick chart patterns
Candlestick Parts

There are three main parts to a candlestick:




Upper Shadow: The vertical line between the high of the day and the close (bullish candle) or open (bearish candle)



Real Body: The difference between the open and close; colored portion of the candlestick

Lower Shadow: The vertical line between the low of the day and the open (bullish candle) or close (bearish candle)

Candlestick Patterns

The power of Candlestick Charts is with multiple candlesticks forming reversal and continuation patterns.

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Bearish Engulfing Pattern

The Bearish Engulfing Candlestick Pattern is a bearish reversal pattern, usually occuring at the top of an uptrend. The pattern consists of two Candlesticks:

Smaller Bullish Candle (Day 1)
Larger Bearish Candle (Day 2)

bearish engulfing candlestick chart pattern

Generally, the bullish candle real body of Day 1 is contained within the real body of the bearish candle of Day 2.

The market gaps up (bullish sign) on Day 2; but, the bulls do not push very far higher before bears take over and push prices further down, not only filling in the gap down from the morning's open but also pushing prices below the previous day's open.

With the Bullish Engulfing Pattern, there is an incredible change of sentiment from the bullish gap up at the open, to the large bearish real body candle that closed at the lows of the day. Bears have successfully overtaken bulls for the day and possibly for the next few periods.

The chart below of Verizon (VZ) stock shows an example two Bearish Engulfing




Bearish Engulfing Sell Signal

Three methodologies for selling using the Bearish Engulfing Pattern are listed below in order of most aggressive to most conservative:

Sell at the close of Day 2. An even stronger indication to sell is given when there is a substantial increase in volume that accompanies the large move downward in price (see: Volume).
Sell on the day after the Bearish Engulfing Pattern occurs; by waiting until the next day to sell, a trader is making sure that the bearish reversal pattern is for real and was not just a one day occurance. In the chart above of Verizon, a trader would probably entered on the day after the Bearish Engulfing Pattern because the selling continued.
Usually trader's wait for other signals, such as a price break below the upward support line (see: Support & Resistance), before entering a sell order. However, in the case of Verizon above, the Bearish Engulfing Pattern occured at the same time as the trendline break below support.

An example of what usually occurs intra-day during a Bearish Engulfing Pattern is presented next.

Intra-day Bearish Engulfing Pattern

The following 15-minute chart of Verizon (VZ) is of the 2-day period comprising the Bearish Engulfing Pattern example on the prior page:





Day 1: As is seen in the chart above, Day 1 was an up day, closing near the day's high (bullish sentiment).
Day 2: The open was a gap up, a very bullish sign; nevertheless, the bulls ran out of buying pressure and prices fell the rest of the day, closing near the day's lows (bearish sentiment) and lower than Day 1's lows.

The Bearish Engulfing Pattern is one of the strongest candlestick reversal patterns. Its opposite is the Bullish Engulfing Pattern (see: Bullish Engulfing Pattern).

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Bullish Engulfing Pattern


The Bullish Engulfing Candlestick Pattern is a bullish reversal pattern, usually occuring at the bottom of a downtrend. The pattern consists of two Candlesticks:

Smaller Bearish Candle (Day 1)
Larger Bullish Candle (Day 2)

bullish engulfing candlestick chart pattern


The bearish candle real body of Day 1 is usually contained within the real body of the bullish candle of Day 2.

On Day 2, the market gaps down; however, the bears do not get very far before bulls take over and push prices higher, filling in the gap down from the morning's open and pushing prices past the previous day's open.

The power of the Bullish Engulfing Pattern comes from the incredible change of sentiment from a bearish gap down in the morning, to a large bullish real body candle that closes at the highs of the day. Bears have overstayed their welcome and bulls have taken control of the market.

The chart below of the S&P 500 Depository Receipts Exchange Traded Fund (SPY) shows an example of a Bullish Engulfing Pattern occuring at the end of a downtrend:




Bullish Engulfing Buy Signal

There are three main times to buy using the Bullish Engulfing Pattern; the buy signals that are presented below are ordered from the most aggressive to most conservative:

Buy at the close of Day 2 when prices rallied upwards from the gap down in the morning. A strong indication that the rally on Day 2 was significant and truly a reversal of market sentiment, is if there was a substantial increase in volume that accompanied the large move upward in price (see: Volume).
Buy on the day after the Bullish Engulfing Pattern occurs; by waiting until the next day to buy, a trader is making sure that the bullish reversal and enthusiasm of the prior day is continuing and was not just a one day occurance like a short covering rally. In the chart above of the SPY's, a trader would likely not enter the market long on the day after the Bullish Engulfing Pattern because the market gapped down significantly and even made new lows. A trader using methodology #2, would likely wait for a more concrete buy signals such as the one presented in method #3 next.
After a trader sees the Bullish Engulfing Pattern, the trader would wait for another signal, mainly a price break above the downward resistance line (see: Support & Resistance), before entering a buy order.

An example of what usually occurs intra-day during a Bullish Engulfing Pattern is presented next.

Intra-day Bullish Engulfing Pattern

The following 15-minute chart of the S&P 500 exchange traded fund (SPY) is of the 2-day period comprising the Bullish Engulfing Pattern example on the prior page:





Day 1: As is seen in the chart above, Day 1 was a down day, even closing the day at the low (bearish sentiment).
Day 2: The open was a gap down, very bearish sign; but the bulls appeared to have had enough because the price of the SPY's went up the rest of the day, closing near the day's highs (bullish sentiment) and higher than Day 1's high.

The Bullish Engulfing Pattern is one of the strongest candlestick reversal patterns. Its opposite is the Bearish Engulfing Pattern (see: Bearish Engulfing Pattern).

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Dark Cloud Cover

Dark Cloud Cover is a bearish candlestick reversal pattern, similar to the Bearish Engulfing Pattern (see: Bearish Engulfing Pattern). There are two components of a Dark Cloud Cover formation:

Bullish Candle (Day 1)
Bearish Candle (Day 2)

dark cloud cover candlestick chart pattern

A Dark Cloud Cover Pattern occurs when a bearish candle on Day 2 closes below the middle of Day 1's candle.

In addition, price gaps up on Day 2 only to fill the gap (see: Gaps) and close significantly into the gains made by Day 1's bullish candlestick.

The rejection of the gap up is a bearish sign in and of itself, but the retracement into the gains of the previous day's gains adds even more bearish sentiment. Bulls are unable to hold prices higher, demand is unable to keep up with the building supply.



Dark Cloud Cover Candlestick Chart Example

The chart below of Boeing (BA) stock illustrates an example of the Dark Cloud Cover Pattern:



Dark Cloud Cover Sell Signal

Traders usually suggest not selling exactly when one sees the Dark Cloud Cover Pattern (Day 1 & Day 2) until other confirming signals are given such as a break of an upward trendline or other technical indicators. One reason for waiting for confirmation is that the Dark Cloud Cover Pattern is a bearish pattern, but not as bearish as it could be: part of the gains from Day 1 have still been preserved.

A more bearish reversal pattern is the Bearish Engulfing Pattern (see: Bearish Engulfing Pattern) that completely rejects the gains of Day 1 and usually closes below the lows of Day 1.

Also of interest, the bullish equivalent of the Dark Cloud Cover Pattern is the Piercing Pattern (see: Piercing Pattern).

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Doji

The Doji is a powerful Candlestick formation, signifying indecision between bulls and bears. A Doji is quite often found at the bottom and top of trends and thus is considered as a sign of possible reversal of price direction, but the Doji can be viewed as a continuation pattern as well.

doji candlestick chart pattern



A Doji is formed when the opening price and the closing price are equal. A long-legged Doji, often called a "Rickshaw Man" is the same as a Doji, except the upper and lower shadows are much longer than the regular Doji formation.

The creation of the Doji pattern illustrates why the Doji represents such indecision. After the open, bulls push prices higher only for prices to be rejected and pushed lower by the bears. However, bears are unable to keep prices lower, and bulls then push prices back to the opening price.

Of course, a Doji could be formed by prices moving lower first and then higher second, nevertheless, either way, the market closes back where the day started.


The chart below of General Electric (GE) stock shows two examples of Doji's:

In a Doji pattern, the market explores its options both upward and downward, but cannot commit either way. After a long uptrend, this indecision manifest by the Doji could be viewed as a time to exit one's position, or at least scale back. Similarly, after a long downtrend, like the one shown above of General Electric stock, reducing one's position size or exiting completely could be an intelligent move.

It is important to emphasize that the Doji pattern does not mean reversal, it means indecision. Doji's are often found during periods of resting after a significant move higher or lower; the market, after resting, then continues on its way. Nevertheless, a Doji pattern is a great sign that a prior trend is losing its strength, and taking some profits might be well advised.

Two intra-day examples of how a daily Doji formation is created is presented next.

Intra-day Doji Formation

The first Doji outlined on the daily chart of General Electric on the previous page was a high-low Doji, where prices made the highs for the days first, and the lows for the day second. The intra-day chart (15-minute) of this occurance is given below:


At the opening, the bulls were in charge; however, the morning rally did not last long before the bears took charge. From mid-morning until late-afternoon, General Electric sold off, but by the end of the day, bulls pushed GE back to the opening price of the day.

The second Doji daily chart on the previous page is shown next. In the intra-day chart below (Doji B), the Doji was created the exact opposite way as the chart shown above (Doji A) was created; Doji B made its day's lows first, then highs second.



At the opening bell, bears took a hold of GE, but by mid-morning, bulls entered into GE's stock, pushing GE into positive territory for the day. Unfortunately for the bulls, by noon bears took over and pushed GE lower. By the end of the day, the bears had successfully brought the price of GE back to the day's opening price.

As was presented above, the Doji formation can be created two different ways, but the interpretation of the Doji remains the same: the Doji pattern is a sign of indecision, neither bulls nor bears can successfully take over.


Two powerful versions of the Doji formation are :

Dragonfly Doji
Gravestone Doji

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Two powerful versions of the Doji formation are :

Dragonfly Doji
Gravestone Doji



Dragonfly Doji

The Dragonfly Doji is a significant bullish reversal candlestick pattern that mainly occurs at the bottom of downtrends.

dragon fly doji candlestick chart pattern


The Dragonfly Doji is created when the open, high, and close are the same or about the same price (Where the open, high, and close are exactly the same price is quite rare). The most important part of the Dragonfly Doji is the long lower shadow.

The long lower shadow implies that the market tested to find where demand was located and found it. Bears were able to press prices downward, but an area of support was found at the low of the day and buying pressure was able to push prices back up to the opening price. Thus, the bearish advance downward was entirely rejected by the bulls.


Dragonfly Doji Candlestick Chart Example

The chart below of the mini-Dow Futures contract illustrates a Dragonfly Doji occuring at the bottom of a downtrend:
dragonfly doji at the bottom of a downtrend



In the chart above of the mini-Dow, the market began the day testing to find where demand would enter the market. The mini-Dow eventually found support at the low of the day, so much support and subsequent buying pressure, that prices were able to close the day approximately where they started the day.

The Dragonfly Doji is an extremely helpful Candlestick pattern to help traders visually see where support and demand is located. After a downtrend, the Dragonfly Doji can signal to traders that the downtrend could be over and that short positions should probably be covered. Other indicators should be used in conjunction with the Dragonfly Doji pattern to determine buy signals, for example, a break of a downward trendline.

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Gravestone Doji

The Gravestone Doji is a significant bearish reversal candlestick pattern that mainly occurs at the top of uptrends.
gravestone doji candlestick chart pattern



The Gravestone Doji is created when the open, low, and close are the same or about the same price (Where the open, low, and close are exactly the same price is quite rare). The most important part of the Graveston Doji is the long upper shadow.

The long upper shadow is generally interpreted by technicians as meaning that the market is testing to find where supply and potential resistance is located.

The construction of the Gravestone Doji pattern occurs when bulls are able to press prices upward.

However, an area of resistance is found at the high of the day and selling pressure is able to push prices back down to the opening price. Therefore, the bullish advance upward was entirely rejected by the bears.


Gravestone Doji Example

The chart below of Altria (MO) stock illustrates a Gravestone Doji that occured at the top of an uptrend:
gravestone doji marking end of stock trend



In the chart above of Altria (MO) stock, the market began the day testing to find where support would enter the market. Altria eventually found resistance at the high of the day, and subsequently fell back to the opening's price.

The Gravestone Doji is an extremely helpful Candlestick reversal pattern to help traders visually see where resistance and supply is likely located. After an uptrend, the Gravestone Doji can signal to traders that the uptrend could be over and that long positions should probably be exited. But other indicators should be used in conjunction with the Gravestone Doji pattern to determine an actual sell signal. A potential trigger could be a break of the upward trendline support.

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Evening Star

The Evening Star Pattern is a bearish reversal pattern, usually occuring at the top of an uptrend. The pattern consists of three candlesticks:

Large Bullish Candle (Day 1)
Small Bullish or Bearish Candle (Day 2)
Large Bearish Candle (Day 3)

evening star candlestick chart pattern



The first part of an Evening Star reversal pattern is a large bullish green candle. On the first day, bulls are definitely in charge, usually new highs were made.

The second day begins with a bullish gap up. It is clear from the opening of Day 2 that bulls are in control. However, bulls do not push prices much higher. The candlestick on Day 2 is quite small and can be bullish, bearish, or neutral (i.e. Doji).

Generally speaking, a bearish candle on Day 2 is a stronger sign of an impending reversal. But it is Day 3 that is the most significant candlestick.

Day 3 begins with a gap down, (a bearish signal) and bears are able to press prices
even further downward, often eliminating the gains seen on Day 1.


Evening Star Candlestick Chart Example

The chart below of Exxon-Mobil (XOM) stock shows an example a Evening Star bearish reversal pattern that occured at the end of an uptrend:
evening star candlestick formation at the top of an uptrend



The chart below of Exxon-Mobil (XOM) stock shows an example a Evening Star bearish reversal pattern that occured at the end of an uptrend:
evening star candlestick formation at the top of an uptrend

Day 1 of the Evening Star pattern for Exxon-Mobil (XOM) stock above was a strong bullish candle, in fact it was so strong that the close was the same as the high (very bullish sign). Day 2 continued Day 1's bullish sentiment by gapping up. However, Day 2 was a Doji, which is a candlestick signifying indecision. Bulls were unable to continue the large rally of the previous day; they were only able to close slightly higher than the open.

Day 3 began with a bearish gap down. In fact, bears took hold of Exxon-Mobil stock the entire day, the open was the same as the high and the close was the same as the low (a sign of very bearish sentiment). Also, Day 3 powerfully broke below the upward trendline that had served as support for XOM for the past week. Both the trendline break and the classic Evening Star pattern gave traders a signal to sell short Exxon-Mobil stock.

The Evening Star pattern is a very powerful three candlestick bearish reversal pattern. The bullish equivalent of the Evening Star is the Morning Star pattern

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Hammer

The Hammer candlestick formation is a significant bullish reversal candlestick pattern that mainly occurs at the bottom of downtrends.

hammer candlestick chart pattern



The Hammer formation is created when the open, high, and close are roughly the same price. Also, there is a long lower shadow, twice the length as the real body.

When the high and the close are the same, a bullish Hammer candlestick is formed and it is considered a stronger formation because the bulls were able to reject the bears completely plus the bulls were able to push price even more past the opening price.

In contrast, when the open and high are the same, this Hammer formation is considered less bullish, but nevertheless bullish. The bulls were able to counteract the bears, but were not able to bring the price back to the price at the open.

The long lower shadow of the Hammer implies that the market tested to find where support and demand was located. When the market found the area of support, the lows of the day, bulls began to push prices higher, near the opening price. Thus, the bearish advance downward was rejected by the bulls.



Hammer Candlestick Chart Example

The chart below of American International Group (AIG) stock illustrates a Hammer reversal pattern after a downtrend:
hammer candlestick pattern reversal




In the chart above of AIG, the market began the day testing to find where demand would enter the market. AIG's stock price eventually found support at the low of the day. In fact, there was so much support and subsequent buying pressure, that prices were able to close the day even higher than the open, a very bullish sign.

The Hammer is an extremely helpful candlestick pattern to help traders visually see where support and demand is located. After a downtrend, the Hammer can signal to traders that the downtrend could be over and that short positions should probably be covered.

However, other indicators should be used in conjunction with the Hammer candlestick pattern to determine buy signals, for example, waiting a day to see if a rally off of the Hammer formation continues or other chart indications such as a break of a downward trendline. But other previous day's clues could enter into a traders analysis. An example of these clues, in the chart above of AIG, shows three prior day's Doji's (signs of indecision) that suggested that prices could be reversing trend; in that case and for an aggressive buyer, the Hammer formation could be the trigger to go long.

The bearish version of the Hammer is the Hanging Man formation Another similar candlestick pattern to the Hammer is the Dragonfly Doji

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Hanging Man

The Hanging Man candlestick formation, as one could predict from the name, is a bearish sign. This pattern occurs mainly at the top of uptrends and is a warning of a potential reversal downward. It is important to emphasize that the Hanging Man pattern is a warning of potential price change, not a signal, in and of itself, to go short.

hanging man candlestick chart pattern



The Hanging Man formation, just like the Hammer, is created when the open, high, and close are roughly the same price. Also, there is a long lower shadow, which should be at least twice the length of the real body.

When the high and the open are the same, a bearish Hanging Man candlestick is formed and it is considered a stronger bearish sign than when the high and close are the same, forming a bullish Hanging Man (the bullish Hanging Man is still bearish, just less so because the day closed with gains).

After a long uptrend, the formation of a Hanging Man is bearish because prices hesitated by dropping significantly during the day. Granted, buyers came back into the stock, future, or currency and pushed price back near the open, but the fact that prices were able to fall significantly shows that bears are testing the resolve of the bulls. What happens on the next day after the Hanging Man pattern is what gives traders an idea as to whether or not prices will go higher or lower.



Hanging Man Candlestick Chart Example

The chart below of Alcoa (AA) stock illustrates a Hanging Man, and the large red bearish candle after the Hanging Man strengthens the bears thinking that a downward reversal is coming:

hanging man candlestick pattern is a sign of potential reversal



In the chart above of Alcoa, the market began the day testing to find where demand would enter the market. Alcoa's stock price eventually found support at the low of the day. The bears' excursion downward was halted and prices ended the day slightly above the close.

Confirmation that the uptrend was in trouble occured when Alcoa gapped down the next day and continued downward creating a large bearish red candle. To some traders, this confirmation candle, plus the fact that the upward trendline support was broken, gave the signal to go short.

It is important to repeat, that the Hanging Man formation is not the sign to go short; other indicators such as a trendline break or confirmation candle should be used to generate sell signals.

The bullish version of the Hanging Man is the Hammer formation (see: Hammer) that occurs after downtrends.