[Candlestick Patterns] Just need to know these three!

4 апр. 2022 г.

#Candlestick #CandlePattern #Tocademy #Tutorial
Hello traders from all over the world, this is Tommy =)
I was unexpectedly surprised by many of you who liked and supported my last post about the basic concept of TA(Technical Analysis). Today I prepared a brief lecture about the Candlestick Pattern, one of the most fundamental phenomenon and behaviors that traders must be well-informed. In fact, we should be very familiar with these textbook contents and interpret it in a glimpse on the technical chart unconsciously. Just like we don't pay direct attention about each breathes when breathing, like we don't care each and all of the alphabets when we speak, or like we don’t perceive location of each keyboards every moment as we type, this very technique should be performed automatically and quickly by observing dominant formations of candlestick bars.

As a matter of fact, comprehending market trends and price actions only by referring to the candlesticks is yet too spurious. It should be used in such a way to weight on certain scenarios in a macroscopic view, rather than deriving precise and specific PRZ(Potential Reversal Zone)s and distinguish the accurate market trend. It’s never like ‘The price must go up because this pattern just appeared’. Furthermore, I strongly believe that the reliability of the candlestick pattern strategy is declining especially in recent financial market, where we encounter countless non-traditional and abnormal situations that were not very common in the past. Hence among the existing ‘Textbook’ candlestick pattern strategies that can easily be found on Google, there are particular patterns that are still very reliable on current market and there are ones that are not as reliable as it used to be. So here, I will organize everything very clearly for you guys.



The technical chart is well known as sort of a map tracing the mob-psychology of all the stakeholders in the market. Investors’ sentiments such as FUD(Fear, Uncertainty, and Doubt) and FOMO(Fear of Missing Out) that often cause panic buy/sell are visualized as data. Those with a clear understanding of the fundamental nature of how candlesticks are being formed, don’t even need to memorize these patterns one by one. As I emphasized at my previous post, candlesticks should be interpreted as a whole structure, unlike the line chart expressed in one-dimensional. Candlesticks are newly formed in each time interval and we can choose the timeframe for the chart that we are about to analyze. For instance, each candlestick in a daily chart is formed every day while each candlestick in a 5minute chart is formed every 5 minutes. Higher the timeframe of the chart is, longer-term the scope within the chart is. It is important as a TA analyst to start from macro-perspective with higher timeframe first, then go deeper to lower timeframe and find short-term factors.

There are four independent prices composing a candlestick: open, high, low and close price. Open price indicates the starting point while close price indicates the ending point of a candlestick. Just like the wording, high/low prices are formed at the highest/lowest price during the time period of candlestick being formed. A bullish candlestick is when the closing price is above the opening price (i.e., when the price rises), while a bearish candle is when the closing price is below the opening price (i.e., when the price is falling), and the two are expressed in different colors (green & red or red & blue). The thick part between the opening and closing price is called the ‘Body’, and the thin part is called the ‘Tail’ (Wick or Shadow).



Typically, the length of the body implies the strength of an ongoing trend. We learned from the textbook that the candlesticks with a longer body means stronger trend and those with shorter tails mean clearer trend. Back in the days, there was time when we could detect if whales are involved and deduct impulsiveness of ongoing trend when distinctly long bodied candlesticks with relatively high trading volumes take places. I am afraid to tell you that it is better to erase that memory. First of all, it is too obvious and cliché to announce that the long candlesticks with high volumes mean strong market trend. This criterion itself is quite vague and not 100% reliable to identify future trends or find insightful signals. Moreover, in recent days (especially in Crypto), whales like to deceive retail traders with a strong faith of trading volumes and since the future markets are becoming bigger, giving too much weight on trading volume paired to each candlestick is not as effective as it was when textbook used to work very well. I am not saying textbook is wrong. It just needs slight updates since the market we are dealing with keeps changing over time.



In TA world, closing price of a candlestick carries a great meaning and thus closing prices at higher timeframes should very well be monitored to become a successful trader. Sometimes whales even battle aggressively right before a major closing time often causing a weird ‘scam’ moves with a high volume. As shown below, we usually find the price and time when certain TA variables (such as top/bottom of trendline, channels, pivot levels, and other indicators) are broken, meaning if the price has penetrated those variables successfully, in order to find breakout entries, stoplosses, and target prices, etc. This whole concept of breaking above or below is quite vague, subjective, and relative idea. So, what we traders refer to as a reliable criterion is confirming whether the candle closed above and below the factors. For instance, let’s say that we are seeking and waiting for the breakout of the downward trendline. Well sometimes it’s not as easy as expected to precisely spot and determine whether the price has successfully pierced through the trendline. There are times when price breaks the trendline, but ends up coming back below leading close price of the candlestick to be formed below the trendline like the case 2 below. In this very case, it’s difficult to determine whether the breakout happened successfully or not. Nevertheless, like case 3, when both closing and high prices are formed above the trendline, we can clearly confirm and weight more on the breakout scenario, expecting more bullish rally.



Okay let's get to the point. In recent financial trading market, it's enough to know just these three.
1. Engulfing
2. Doji
3. Long Tailed Candlestick

As mentioned above, there’s nothing hard if you understand the essential concepts and principles of the above patterns and phenomena. The engulfing candlestick is a phenomenon in which the body of the previous candle is consumed by the body of the next candle, that is, a larger body than the previous one comes out. In other words, if a new bullish candle closes higher than the previous open price or if a new bearish candle closes lower than the previous open price, we say ‘the new candlestick engulfed the previous one’. If we look closely, this pattern implies the circumstance where the new candle completely overwhelms the trend of the previous candle and reverses it into a new trend despite closing the price from above or below. However, the appearance of an engulfing candle does not mean that the trend is unconditionally reversed. It is often the case that engulfing candles take place consecutively, with the second candle taking over the body of the first candle, the third’s taking over the second’s, the fourth’s taking over the third’s and so on. As the price fluctuates up and down, it creates a Widening or Broadening pattern also known as expanding sort of shapes, making it difficult for traders to figure out the current trend. In this circumstance, the entry prices, stop loss prices, target prices, or average prices of many participants in the market tend to be located relatively nearby. This price range or region is called a HVP(High Volume Profile or Peak) or an Orderblock and I will cover details about this concept later on another post. Anyway, there are numerous methods to derive Orderblock and one of them is to spot bodies of the consecutive engulfing candlesticks.



The tail(wick) of a candlestick can be interpreted as a sign of the fierce battle between the bulls are bears. Longer tail signifies bigger collision between buying and selling forces. The longer the upper tail, the more the bulls trying to raise the price up but the bears rejecting them eventually sellers ending up being dominant and vice versa for the longer the lower tail. Generally, when the long upper/lower tails are formed at a relative higher/lower part of the wave structure or at a distinctive pullback as a PRZ this can be a possible signal of trend reversal. Due to my personal trading experience, it doesn't matter much in recent TA market whether the long-tailed candlestick is a bullish or bearish. In other words, regardless of the color of Hammer or Shooting star (which are both long-tailed candlestick pattern), it’s better to check if the next following candlesticks are being formed opposite direction of the tail. Personally, I don't think the Inverted Hammer and Hanging Man are not as necessary as it used to be in the old days.



When the length of the candlestick’s body is relatively short meaning if the open and close prices are very close, forming a cross like shape, it’s called a Doji. Since Doji has a short body, the upper and lower tails tend to come out longer and thus can be considered as evidence of a tense confrontation between the bulls and bears that eventually ends up reaching a balance. Similar to the long-tailed candlestick, Doji is also known as a sign of a PRZ depending on the next appearing candlesticks. When Dojis are observed after swing high or low, it can be a possible indicator that the on-going trend is overheated and you might want to anticipate some pullbacks. However, it is too risky to directly assume that the top or bottom is near just because of Doji. Especially in the market these days, Dojis also appear frequently in sideways and sometimes confuses traders searching for a clear trend.

As emphasized above, as with other technical techniques, theories, and indicators, always remember to weight more to the emergence of patterns in higher timeframes and longer-term perspectives. The higher timeframe people globally refer to, the more the reliability the TA will be. Just think about it for a second. Which timeframe do you think that people consider more significantly about the closing price, a 5 minutes chart or a daily chart? I would obviously say that the price signals from the daily cart is relatively more representative and reflect longer-term than those of the 5 minutes chart. Keep in mind is that you also need to understand market trends from a macro perspective before approaching towards short-term perspective. It is always recommended to recognize long-term trends or situations in advance from the candlestick of a higher timeframe, and then look at more detailed and microscopic elements step by step.

All right. I will wrap up now. Thanks for reading my post.
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