Showing posts with label Weekend School. Show all posts

Saturday, August 1, 2009

Bursa Chat Weekend School Flag & Pennant

Phil Saturday, August 01, 2009 Weekend School , 0 Comments

CHART EXAMPLES OF FLAG AND PENNANT PATTERNS / COMMODITIES

"BULL" FLAG IN AN UPTREND (BULLISH)

After a sharp rally, this "bull" flag served as a breather before running off again in the same direction. You can see the volume ease up a bit in the beginning of the flag, but then pick up as it nears the top of the formation and blows through it.

"BULL" FLAG IN AN UPTREND (BULLISH)

"Bull" flag in an uptrend. Quick rally, short pause, blast higher. Volume dips in the flag and surges on the breakout.

"BEAR" FLAG IN A DOWNTREND (BEARISH)

"Bear" flag in a downtrend. After a big rout, the flag seemingly presents a chance to re-group before continuing in the same direction (down.) Volume diminishes during the pause and then rapidly expands on the continuation.

"BEAR" FLAG IN THE BEGINNING OF A DOWNTREND (BEARISH)

After a big dump, this "bear" flag sets the stage for another quick and even larger fall. Volume decreases considerably in the flag, but the break to the downside is accompanied by a big increase in activity.

"BULL" PENNANT IN AN UPTREND (BULLISH)

"Bull" pennant in an uptrend. After a month long rally, the market takes a five day breather and continues even higher. Volume dips briefly and then picks up on the breakout.

"BULL" PENNANT IN AN UPTREND (BULLISH)

How's that for a pattern? Remember from the preceding page; 'pennants look very much like symmetrical triangles, but are typically smaller in size (volatility) and duration.' After a near straight up advance, the market takes only three days before resuming the upmove. During those few days, participation drops off a bit, but comes back as the market explodes out of the pennant. (Take a look at all those gaps right before and right after the pennant. Obviously a very strong and convinced market!)

"BEAR" PENNANT IN A DOWNTREND (BEARISH)

"Bear" pennant in a downtrend. This pattern came right after a 'bear' flag breakout. (Can you see it?) This pennant also presents only a brief pause before the market reasserts itself in the direction of the trend (down.) Volume dips in the pattern and jumps as the market breaks out and gaps lower.

"BEAR" PENNANT IN THE BEGINNING OF A DOWNTREND (BEARISH)

"Bear" pennant in the beginning of a downtrend. After a dramatic two day plunge, the market has a short lived consolidation. The rout continues and the market collapses. You can see activity dry up in the pennant. The breakout though, was made on extremely heavy volume.

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Friday, July 31, 2009

The Psychology of Price Movement

Phil Friday, July 31, 2009 Weekend School , 0 Comments

The price of a stock is the result of a decision on the part of both a buyer and a seller. The buyer believes prices will go higher; the seller feels prices will decline. These decisions are represented by a trade at an exact price.

Once the buyer and seller make their trade, their influence in the market is spent — except for the opposite reaction they will ultimately have when they close the trade. Thus, there are two aspects to every trade: 1) each trade must ultimately have an opposite reaction on the market, and 2) the trade will influence other traders.

Each trader's reaction to price movements can be generalized into the reactions of three basic groups of traders who are always present in the market: 1) traders who have long positions; 2) those who hold short positions; and 3) those who have not taken a position but soon will. Traders in the third group have mixed views on the market's probable direction. Some are bullish while others are bearish, but a lack of positive conviction has kept them out of the market. Therefore, they also have no vested interest in the market's direction.

The impact of human nature on futures prices can perhaps best be seen by examining changing market psychology as a typical market moves through a complete cycle from price low to price low.

Classic price pattern
Assume prices trade within a relatively narrow trading range (between points A and B on the chart). Recognizing the sideways price movement, the "longs" might buy additional contracts if the price advances above the recent trading range. They may even enter stop orders to buy at B, to add to their position if they should get some confirmation the trend is higher. But by the same token, recognizing prices might decline below the recent trading range and move lower, they might also enter stop loss orders below the market at A to limit their loss.

The "shorts" have exactly the opposite reaction to the market. If the price advances above the recent trading range, many of them might enter stop loss orders to buy above point B to limit losses. But they, too, may add to their position if the price should decline below point A with orders to sell additional contracts on a stop below point A.

The third group is not in the market, but they are watching it for a signal either to go long or short. This group may have stop orders to buy above point B, because presumably the price trend would begin to indicate an upward bias if point B were penetrated. They may also have standing orders to sell below point A for converse reasons.

Assume the market advances to point C. If the trading range between points A and B has been relatively narrow and the time period of the lateral movement relatively long, the accumulated buy stops above the market could be quite numerous. Also, as the market breaks above point B, brokers contact their clients with the news, and this results in a stream of market orders. As this flurry of buyers becomes satisfied and profit-taking from previous long positions causes the market to dip from the high point of C to point D, another distinct attitude begins working in the market.

Part of the first group that went long between points A and B did not buy additional contracts as the market rallied to point C. Now they may be willing to add to their position "on a dip." Consequently, buy orders trickle in from these traders as the market drifts down.

The second group of traders with short positions established in the original trading range have now seen prices advance to point C, then decline to move back closer to the price at which they originally sold. If they did not cover their short positions on a buy stop above point B, they may be more than willing to "cover on any further dip" to minimize the loss.

Those not yet in the market will place price orders just below the market with the idea of "getting in on a dip."

The net effect of the rally from A to C is a psychological change in all three groups. The result is a different tone to the market, where some support could be expected from all three groups on dips. (Support on a chart is denned as the place where the buying of a futures contract is sufficient demand to halt a decline in prices.) As this support is strengthened by an increase in market orders and a raising of buy orders, the market once again advances toward point C. Then, as the market gathers momentum and rallies above point C toward point E, the psychology again changes subtly.

The first group of long traders may now have enough profit to pyramid additional contracts with their profits. In any case, as the market advances, their enthusiasm grows and they set their sights on higher price objectives. Psychologically, they have the market advantage.

The original group who sold short between A and B and who have not yet covered are all carrying increasing losses. Their general attitude is negative because they are losing money and confidence. Their hopes fade as their losses mount. Some of this group begin liquidating their short positions either with stops or market orders. Some reverse their position and go long.

The group which has still not entered the market — either because their orders to buy the market were never reached or because they had hesitated to see whether the market was actually moving higher — begins to "buy at the market."

Remember that even if a number of traders have not entered the market because of hesitation, their attitude is still bullish. And perhaps they are even kicking themselves for not getting in earlier. As for those who sold out previously-established long positions at a profit only to see the market move still higher, their attitude still favors the long side. They may also be among those who are looking to buy on any further dip.

So, with each dip the market should find the support of 1) traders with long positions who are adding to their positions; 2) traders who are short the market and want to buy back their shorts "if the market will only back down some"; and 3) new traders without a position in the market who want to get aboard what they consider a full-fledged bull market.

This rationale results in price action that features one prominent high after another and each prominent reactionary low is higher than the previous low. In a broad sense, it should appear as an upward series of waves of successively higher highs and higher lows.

But at some point the psychology again subtly shifts. The first group with long positions and fat profits is no longer willing to add to its positions. In fact they are looking for a place to "take profits." The second group of battered traders with short positions has finally been worn down to a nub of die-hard shorts who absolutely refuse to cover their short positions. They are no longer a supporting element, eagerly waiting to buy the market on dips.

The third group of those who never quite got aboard the up-move become unwilling to buy because they feel the greatest part of the upside move has been missed. They consider the risk on the downside too great when compared to the now-limited upside potential. In fact, they may be looking for a place to "short the market and ride it back down."

When the market demonstrates a noticeable lack of support on a dip that "carries too far to be bullish," this is the first signal of a reversal in psychology. The decline from point I to point J is the classic example of such a dip. This decline signals a new tone to the market. The support on dips becomes resistance on rallies, and a more two-sided market action develops. (Resistance is the opposite of support. Resistance on a chart is the price level where selling pressure is expected to stop advances and possibly turn prices lower.)

The downturn
Now the picture has changed. As the market begins to advance from point J to point K, traders with previously-established long positions take profits by selling out. Most of the hard-nosed traders with short positions have covered their shorts, so they add no significant new buying impetus to the market. In fact, having witnessed the recent long decline, they may be adding to their short positions.

If the rally back toward the contract highs fails to establish new highs, this failure is quickly noticed by professional traders as a signal the bull market has run its course. This is even more true if the rally carries only up to the approximate level of the rally top at point G.

If the open interest also declines during the rally from J to K, it is another sign it was not new buying that caused the rally but short covering.

As profit-taking and new short-selling forces the market to decline from point K, the next critical point is the reactionary low point at J. A major bear signal is flashed if the market penetrates this prominent low (support) following an abortive attempt to establish new contract highs.

In the vernacular of chartists, a head-and-shoulders reversal pattern has been completed. But rather than simply explaining away price patterns with names, it is important to understand how the psychology of the market action at different points causes the market to respond as it does. It also explains why certain points are quite significant.

In a bear market, the attitudes of the traders would be reversed. Each decline would find the bears more confident and prosperous and the bulls more depressed and threadbare. With the psychology diametrically opposite, the pattern completely reverses itself to form a series of lower highs and lower lows.

But at some point, the bears become unwilling to add to their previously-established short positions. Those who were already long the market and had refused to sell higher would eventually be reduced to a hard core of traders who had their jaws set and refused to sell out. Traders not in the market who were perhaps unsuccessfully attempting to short the market at higher levels will begin to find the long side of the market more attractive. The first rally that "carries too high to be bearish" signals another possible trend reversal.

With this basic understanding of market psychology through three phases of a market, a trader is better equipped to appreciate the significance of all technical price patterns. No one expects to establish short positions at the high or long positions at the low, but development of a feel for market psychology is the beginning of the quest for trades that even hindsight could not improve upon.

When you analyze charts, approach them with the idea that they reflect human ideas about prices that are the result and the struggle between supply and demand forces. Your attitude and ability to judge market psychology will determine your success at chart analysis. Unexpected occurrences can change price trends abruptly, and without warning. Also, some of the chart formations may be hard to visualize. You'll sometimes need a good imagination as well.

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Saturday, July 25, 2009

Bursa Chat Weekend School- Five Chart Patterns

Phil Saturday, July 25, 2009 Weekend School , 1 Comments

FIVE CHART PATTERNS

1.Profitable Pattern Number One
The Symmetrical Triangle: A Reliable Workhorse

You’ll recognize the symmetrical triangle pattern when you see a stock’s price vacillating up and down and converging towards a single point. Its back and forth oscillations will become smaller and smaller until the stock reaches a critical price, breaks out of the pattern, and moves drastically up or down.

The symmetrical triangle pattern is formed when investors are unsure of a stock’s value. Once the pattern is broken, investors jump on the bandwagon, shooting the stock price north or south.

Symmetrical triangles are very reliable. You can profit from upwards or downwards breakouts. You’ll learn more about how to earn from downtrends when we talk about maximizing profits.
If you see a symmetrical triangle forming, watch it closely. The sooner you catch the breakout, the more money you stand to make.

Watch For:

• Sideways movement, a period of rest, before the breakout.• Price of the asset traveling between two converging trendlines.• Breakout ¾ of the way to the apex.

Set Your Target Price:
As with all patterns, knowing when to get out is as important as knowing when to get in. Your target price is the safest time to sell, even if it looks like the trend may be continuing.For symmetrical triangles, sell your stock at a target price of:
• Entry price plus the pattern’s height for an upward breakout.• Entry price minus the pattern’s height for a downward breakout.

The ascending and descending patterns indicate a stock is increasing or decreasing in demand. The stock meets a level of support or resistance (the horizontal trendline) several times before breaking out and continuing in the direction of the developing up or down pattern.
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How to Profit from Ascending and Descending Triangles
Ascending and descending triangles are short-term investor favorites, because the trends allow short-term traders to earn from the same sharp price increase that long-term investors have been waiting for. Rather than holding on to a stock for months or years before you finally see a big payday, you can buy and hold for only a period of days and reap in the same monster returns as the long-time stock owners.
As with many of our favorite patterns, when you learn to identify ascending and descending triangles, you can profit from upwards or downwards breakouts. That way, you’ll earn a healthy profit regardless of where the market is going.
Watch For:
• An ascending or descending pattern forming over three to four weeks.
Set Your Target Price:
For ascending and descending triangles, sell your stock at a target price of:
Entry price plus the pattern’s height for an upward breakout.• Entry price minus the pattern’s height for a downward breakout.

The first trough is a signal that buying demand is starting to weaken. Investors who believe the stock is undervalued respond with a buying frenzy, followed by a flood of selling when traders fear the stock has run too high. This decline is followed by another buying streak which fizzles out early. Finally, the stock declines to its true worth below the original price.

How to Profit from the Head and Shoulders Pattern
• Short sell as soon as the price moves below the neckline after the descent from the right shoulder.
Set Your Target Price:
For the head and shoulders pattern, buy shares at a target price of:
• Entry price minus the pattern’s height (distance from the top of the head to the neckline).

4&5Profitable Patterns Number Four and Five

Triple and Double Bottoms and Tops: Reversals upon reversals

When you see a W or M pattern forming, you may have just discovered a money-making double bottom or double top pattern. These patterns are common reversal patterns used to suggest the current stock trend may be likely to shift.

But don’t panic if your double bottom or double top patterns do not develop as you had originally thought. You haven’t lost your chance for cash. If your W or M pattern reverses for a fourth time, you could now be working with the profitable triple bottom or triple top.

Double Bottom Pattern

Double Bottom Pattern
A small peak is surrounded by two equal troughs.

Purchase When:

• The price exceeds the middle-peak price.

Watch For:

• A price increase of 10% to 20% from the first trough to the middle peak.
• Two equal lows, not to differ by more than 3% or 4%.

Set Your Target Price:

For the double bottom pattern, sell your stock at a target price of:

• Entry price plus the pattern’s height (distance from the peak to the bottom of the lowest trough).

Double Top Pattern

Double Top Pattern
A small trough is surrounded by two equal peaks.

Short Sell When:

• The price drops below the middle-trough price.

Watch For:

• A price decrease of 10% to 20% from the first peak to the middle trough.
• Two equal highs, not to differ by more than 3% or 4%.

Set Your Target Price:

For the double top pattern, buy shares at a target price of:

• Entry price minus the pattern’s height (distance from the trough to the top of the highest peak).

Triple Bottom Pattern

Triple Bottom Pattern
Three equal troughs amid a series of peaks.

Purchase When:

• The price exceeds the resistance established by the prior peaks.

Watch For:

• A series of three identical troughs at the end of a prolonged downtrend.

Set Your Target Price:

For triple bottom patterns, sell your stock at a target price of:

• Entry price plus the pattern’s height (distance from the resistance to the bottom of the lowest trough).

Triple Top Pattern

Triple Top Pattern
Three equal peaks amid a series of troughs.

Purchase When:

• The price falls below the support that formed from the prior troughs.

Watch For:

• A series of three peaks at relatively the same level.

Set Your Target Price:

For triple top patterns, buy shares at a target price of:

• Entry price minus the pattern’s height (distance from the support to the top of the highest peak).

Now You Know…

The five most profitable stock patterns:

• symmetrical triangle
• ascending and descending triangles
• head and shoulders
• double top and double bottom
• triple top and triple bottom

How to Minimize Your Risk

No investment advisor likes to admit it, but no stock picking system is perfect. Sometimes, the stocks we think will explode, don’t. Sometimes, the stocks we feature lose money.

There may not be a foolproof system to predicting the stock market, but we do have a foolproof system for managing risk. ChartAdvisor follows one of the safest risk reduction systems available.

Using these three simple steps, you can reduce the risk in your stock picking plan:

Three Ways to Take Risk Out of the Stock Market

1. Screen Your Picks. This might seem obvious, but patterns that look like they are developing into predictable trends do not always follow through. After combing over thousands of stock charts a day, ChartAdvisor will often not fetures a single stock.

2. Get In. Get Out. ChartAdvisor preaches setting realistic target exit prices for all stocks. We lock in high returns while the stock is high, and we get out before the market has a chance to change its mind.

3. Set Tight Stop Losses This step is absolutely critical to minimizing your risk in the stock market. If a sure-fire winner turns out to be a fizzled-out dud, your system needs to have a built-in, abandon-ship trigger. That is, you need to know when to cut your losses and move on to brighter prospects.

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Saturday, July 18, 2009

Bursa Chat Weekend School - Price Volume Trend

Phil Saturday, July 18, 2009 Weekend School , 0 Comments

Price Volume Trend combines percentage price change and volume to confirm the strength of price trends or through divergences, warn of weak price moves. Unlike other price-volume indicators, the Price Volume Trend takes into consideration the percentage increase or decrease in price, rather than just simply adding or subtracting volume based on whether the current price is higher than the previous day's price. How the formula is calculated is presented below:

On an up day, the volume is multiplied by the percentage price increase between the current close and the previous time-period's close. This value is then added to the previous day's Price Volume Trend value.
On a down day, the volume is multiplied by the percentage price decrease between the current close and the previous time-period's close. This value is then added to the previous day's Price Volume Trend value.

The Price Volume Trend is helpful in seeing divergences; examples of these divergences are shown below in the chart of AT&T (T):

The Price Volume Trend indicator is usually interpreted as follows:

* Increasing price accompanied by an increasing Price Volume Trend value, confirms the price trend upward.
* Decreasing price accompanied by a decreasing Price Volume Trend value, confirms the price trend downward.
* Increasing price accompanied by a decreasing or neutral Price Volume Trend value is a divergence and is indicating that the price movement upward is weak and lacking conviction.
* Decreasing price accompanied by a increasing or neutral Price Volume Trend value is a divergence and is indicating that the price movement downward is weak and lacking conviction.

High #1 to High #2

AT&T stock made lower highs, but the Price Volume Trend indicator made higher highs. This bullish divergence warned that bulls might be taking control of the stock and shorting AT&T would not be advisable.

Since the Price Volume Trend indicator multiplies positive volume when prices close higher than the previous day's close, the Price Volume Trend indicator could be interpreted as meaning that more volume flowed into High #2 than flowed into High #1. More volume interest by buyers at High #2 signaled that the price move higher had significant strength behind it and it probably was going to continue.

Low #1 to Low #2

The stock price made higher lows, generally considered a bullish signal; the Price Volume Trend indicator confirmed this move higher when it made higher highs as well.

Price Volume Trend is a valuable technical analysis tool that combines both price and volume to confirm price action or warn of potential weakness or lack of conviction by buyers and sellers.

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Bursa Chat Weekend School- Trendlines

Phil Saturday, July 18, 2009 Weekend School , 0 Comments

Trendlines in Forex Trading

7.1. What are Trendlines?

Trendlines are straight lines that connect each successive rising bottom to show an uptrend or each consecutive declining top to indicate a downtrend. There should be 2 price points for the trendline to be drawn. The longer the trendline and the more points it connects the stronger it can support/resist the prices on subsequent tests - because more market participants are aware of it. The steeper the trendline - the more bullish or bearish the market sentiment.

Ideal up trendline

Up-trendline

Ideal down trendline

Down-trendline

The up-trend trenline visible on the 1-day EUR/USD chart (from 29.09.05 to 07.09.2007) provided support to the prices

Click to Enlarge. Chart Source - ProCharts.

Note: All forex charting packages allow to draw the trendlines. Some of them (e.g. Intellichart) can also automatically create trendlines for you.

Most major currencies, like EUR/USD and NZD/USD which are shown below, are characterized by frequent, sustained and well-defined trends. Trendlines can be a very effective tool which you can use to follow and profit from these currency price movements.

Click to Enlarge. Chart Source - ProCharts.

7.2. How to Draw a Trendline?

To draw an up trendline simply connect 2 or more ascending lows. To draw a down trendline do the same with two or more descending highs. Extend the trendline to the right to see where the future support (for an up trendline) or resistance (for a down trendline) levels should be. When drawing a trendline try to connect as many price extremes as possible -peaks of the upper shadows for downtrends and the bottoms of the lower shadows for uptrends. It is also possible for a trendline to pass through candles' shadows or the edges of their real bodies as long as it connects the maximum number of bottoms in uptrends or tops in downtrends. A trendline which connects a maximum number of points will have greatest predictive power for the future price action because it most accurately reflects the underlying market sentiment. Whenever the sentiment changes the new trendline will have to be drawn or the older one redrawn.

Example of Drawing the Up Trendline

Click to Enlarge. Chart Source - ProCharts.

Example of Drawing the Down Trendline

Click to Enlarge. Chart Source - ProCharts.

Note: You can practice drawing trendlines using our interactive currency charts in the Analyze Forex section.

Quote: "Andrews used a trendline that he named the Multi-Pivot line. This is a trendline which runs through more than two pivots. This trendline does not have to run through the exact high or low of each pivot; it only needs to be close to each pivot. Andrews believed that the greater number of pivots through which a trendline runs, the more important the trendline is for finding future support and resistance levels and pivots.", Patrick Mikula in his book "The Best Trendline Methods of Alan Andrews and Five New Trendline Techniques".

7.3. Using Trendlines in Forex Trading.

There is usually more than one trend showing itself in the price action (e.g. a longer-term uptrend being corrected by a shorter-term downtrend). This often results in seemingly meaningless price picture which can be quickly clarified by drawing a few trendlines. Simply draw all the trendlines you can on 3 charts of different time-frame: 1) on a daily chart, using historical data of 1-3 years (for long-term trends); 2) on a 1-hour chart using historical data of 1-3 months (for medium-term trends); 3) on a 15-minute chart, using historical price data of 1-3 weeks (for the short-term trends). You will be amazed how often the prices will respect and "obediently" manoeuvre through the network of trendlines that you have drawn. At times you can feel almost sorry for the price which is constantly getting hit by the various boundaries it encounters. No wonder, when it finally "feels" that it can move feely it easily gets "too excited about the future". The following example demonstrates this principle in action:

Click to Enlarge. Chart Source - ProCharts.

Note: It is a good idea to determine which charts to draw the trendlines on and discipline yourself to check and update these charts continuously. You can specify which charts to review in your daily checklist.

Note: Most bank reports on forex (e.g. KBC's weekly technical report) use trendlines of varying length in their technical analysis.

Quote: "Trendlines reflect hidden market order ", Alan S. Farley in his book, "The Master Swing Trader: Tools and Techniques to Profit from Outstanding Short-Term Trading Opportunities".

Trendlines will reverse their roles if broken - in accordance with the principle that the support and resistance levels will assume opposite roles once violated. An up trendline will often act as resistance to the future price rallies after it is decisively broken. Likewise, a violated down trendline will usually provide support to subsequent price dips. You can take advantage of this rule by extending all of your trendlines (broken or not) as far to the right of your charts as possible, as is shown below.

Click to Enlarge. Chart Source - ProCharts.

Trading strategy using the trendlines is pretty straightforward. Buy on dips toward the up trendline and sell when the prices bounce off the down trendline. You can also add to your position on each successful test. The idea is to stay with the trend (be it a short-term, a medium-term or a long-term trend) and the trendlines help you to do exactly this. As you look for entry levels, it pays to think more in terms of "zones around your trendline" than the "exact price touches" - since many investors will have slightly different trendline positions and, therefore, might not act simultaneously when the price approaches it. For this reason you should try not to use overly tight stop-losses when trading trendlines. When the trendline is decisively broken, you exit all your trade (s) -as is demonstrated in the example below. This exit strategy is similar to closing all your positions at the break of the baseline which confirms the completion of one whole impulse wave.

Click to Enlarge. Chart Source - ProCharts.

Note: Candlestick patterns can help you to quickly determine if the test was successful when the prices test a trendline.

You can also draw a price channel line, parallel to the original trendline so that it passes through the maximum number of price extremes opposite to it (tops of rallies for up trendlines/bottoms of declines for down trendlines) - and take some of your profits when the prices touch this line. The following pictures illustrates this stategy.

Note: Trading strategy using price channels is similar to entering at the start and exiting at the end of the impulse waves of a larger impulse wave.

Alternatively, you can book your profits when the currency prices hit some prominent support/resistance area - like a longer-term trendline, round number level or a fibonacci retracement level of the longer-term trend.

7.4. Mastering Trendlines.

The only way to master trendlines is to draw them continuously.

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Sunday, July 12, 2009

Bursa Chat Weekend School- Japanese Candlesticks

Phil Sunday, July 12, 2009 Weekend School , 0 Comments

Japanese Candlesticks in Trading

1. What are Japanese Candlesticks?

Japanese candlesticks is the charting technique which makes it easy to see the relationship between the opening and the closing prices for specific periods of time (e.g. for a day, an hour or 5 minutes). The thick part of the candlestick is called the real body. It shows the distance between the opening and the closing prices for the period of time the candle represents. If the closing price is higher than the opening price, the body is white. If the closing price is lower than the opening price, the body is black. The thin lines above and below the candlestick body are called shadows.

White or Bullish Candlestick

Bullish Japanese Candlestick

Black or Bearish Candlestick

Bearish Japanese Candlestick

Examples of the bullish and bearish candlesticks seen on the monthly USD/JPY chart.

Click to Enlarge. Chart Source - ProCharts.

Note: Colours for each candle type can vary depending on the forex charting software that you use.

Candlestick patterns provide immediate feedback (once they are completed) on the state of the balance between the buying and selling forces that operate in the marketplace. This benefit makes Japanese candlesticks an ideal tool for staying alert to the frequent sentiment shifts characteristic of the Forex market and is behind their popularity among professional forex traders.

2. Examples of Candlestick Patterns

2.1. Hammer: A hammer is a bottom reversal signal. It has long lower shadow and a small real body (black or white) at its top. There should be a downtrend preceding this formation in order for the hammer to reverse the trend. The stronger the downtrend before it and the longer the lower shadow (ideally twice the size of the real body) - the more bullish this formation is.

Ideal Hammer

Hammer

An example of the hammer which appeared on the daily EUR/USD chart.

Click to Enlarge. Chart Source - ProCharts.

2. Shooting Star: a shooting star is a top reversal signal. It has long upper shadow with a small real body (black or white) at the lower end of its range. Since the shooting star is a top reversal signal, it should appear after an uptrend. Longer upward shadow coupled with a gap from the previous candle's high increase reversal potential.

Ideal Shooting star

An example of the shooting star which appeared on the daily CAD/JPY chart.

Click to Enlarge. Chart Source - ProCharts.

2.3. Doji: a doji can be a top or a bottom reversal signal. It is one of the most important candlestick patterns signalling indecision amongst the market participants. This formation has horizontal line instead of a real body or very small real body (because open and close are the same or almost the same). A doji is more powerful if it appears after a long white candle in an uptrend or a long black candle in the downtrend. It is best to wait for confirmation of this pattern in the form of a long black candle for tops or a long white candle for bottoms. The longer the shadows of a doji the more likely the reversal.

doji

Two Dojis stop the uptrend on the daily USD/JPY chart

Click to Enlarge. Chart Source - ProCharts.

One Doji ends the sharp downtrend visible on the daily GBP/JPY chart

Click to Enlarge. Chart Source - ProCharts.

2.4. Dark Cloud Cover: this is a bearish reversal pattern which appears after an uptrend. Dark Cloud Cover is formed by a black candle closing below the midpoint of the previous white candle’s real body. The lower the second candle closes into the first candle, the stronger the signal. The larger both candles are, the more forceful the reversal is likely to be.

Ideal Dark Cloud Cover

dark cloud cover

The Dark Cloud Cover stops the uptrend in the EUR/GBP

Click to Enlarge. Chart Source - ProCharts.

2.5. Piercing Line: this is a bullish reversal pattern which occurs after a downtrend. The "piercing line" is the opposite of the "dark cloud cover". The higher the white candle "pierces" into the black candle, the stronger the bullish signal.

Ideal Piercing Line

piercing line

Piercing Line ends the downtrend in the CHF/JPY pair

Click to Enlarge. Chart Source - ProCharts.

2.6. Engulfing Pattern: this pattern is a major reversal signal composed of two real bodies of different colour. The real body of the second candle should completely engulf the real body of the previous candle. The larger the real body of the second candle than the real body of the first candle and the stronger the preceding trend the more significant the reversal signal.

Bullish Engulfing Pattern

bullish engulfing pattern

Bearish Engulfing Pattern

bearish engulfing pattern japanese candlestick

Two Bullish Engulfing patterns mark the start of corrections in the long-term AUS/USD downtrend

Click to Enlarge. Chart Source - ProCharts.

Bearish Engulfing pattern reverses the uptrend visible on the daily AUD/JPY chart

Click to Enlarge. Chart Source - ProCharts.

Note: You can practice finding the above candlestick patterns on the live currency charts in the Analyze Forex section.

3. Combining Candlesticks with other Technical Analysis Tools:

Candlesticks are very effective stand-alone analysis method; however, their predictive power can be further increased if you combine them with the other technical analysis tools. Applied in conjunction with tools like trendlines or Bollinger bands candlesticks allow to catch the precise moment when the currency price is "ready" to move in the opposite direction.

3.1. Candlesticks with Trendlines: whenever the prices test a trendline, a reversal candle(s) occuring at the test level increases the odds of the test being successful.

Examples of candlestick patterns occuring close to the up trendlines visible on the EUR/JPY hourly chart (from 06.09.07 to 14.09.07).

Click to Enlarge. Chart Source - ProCharts.

Examples of candlestick patterns appearing close to the down trendlines visible on the EUR/NZD daily chart (from 01.07.05 to 05.12.05).

Click to Enlarge. Chart Source - ProCharts.

3.2. Candlesticks with the Bollinger Bands: candlesticks work very well with the Bollinger Bands. Watch for reversal patterns when currency prices touch or push outside of the top or the bottom band. The further the shadow of the reversal candle (e.g. of a doji or a hammer) shoots through the band and the closer the top and the bottom bands are to each other the higher the probability of reversal.

Two Hammers at the bottom Bollinger band on the 15-minute EUR/USD chart (12-13.09.07) predicted strong upward reversals

Click to Enlarge. Chart Source - ProCharts.

Shooting star pierced the top Bollinger band on the 1-day EUR/CAD chart (17.08.07-25.09.07) predicting the subsequent fall.

Click to Enlarge. Chart Source - ProCharts.

Quote: "I have employed candlestick charts for many years and prefer them to bar charts; they create a clearer picture for me", John Bollinger, creator of the Bollinger Bands, in his book "Bollinger on Bollinger Bands".

3.3. Candlesticks with Retracement Levels: candlesticks are often the first to tell which one of the fibonacci retracement levels (38%, 50% or 62%) will act as support (when the prices retrace after a rally) or resistance (when the currency prices correct after a fall).

The Piercing Line confirmed the 50% retracement of the uptrend in EUR/JPY (from 13.06.06 to 27.02.07) as the support level.

Click to Enlarge. Chart Source - ProCharts.

The Doji, Bearish Engulfing and Dark Cloud Cover appeared close to the 38,2% retracement of the downtrend visible on the daily EUR/USD chart (from 14.03.05 to 04.07.05), resulting in the resumption of the downtrend.

Click to Enlarge. Chart Source - ProCharts.

Note: Various candlestick patterns are often mentioned in combination with the other technical tools in forex bank reports and by the major forex newswires. You can also try finding some of these patterns using the real-time forex charts.

4. Mastering Japanese Candlesticks:

Candlestick analysis is an essential tool for making market timing decisions. Therefore, if you plan to trade on forex - you should consider investing your time in mastering this technical analysis technique. There are a number of ways you can do this. You can take one of the forex trading courses, which include candlesticks in their curriculum; or, you can study this technique from one of the industry-standard books on the candlestick analysis. Once you have learned all the major patterns and their corresponding trading signals you should train yourself to watch for these patterns and take them into account (by including them in your checklist)- when making decisions at which level to enter or exit your trades.

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