Candlestick Reversal Patterns (ii) & A Trading Example

<<<<<<< HEAD

Previous...


Blended Candlestick Reversals and their Confirmation

There's such a thing as Blended Candlestick Formations.  These Blends can indicate reversals after a trend, just as the candlestick reversals we've talked about can. They're formed by taking the open of the 1st session and the close of the 2nd session, while taking the high and low of both the sessions and amalgamating them.  The below graphic shows the result of blending 2 candlesticks.

Blended Candlestick Formations and their Reversal Confirmation


The Bullish Engulfing Pattern


Trading with Engulfing Patterns - by Richard Krivo

What qualifies as an engulfing candle is fairly simple: as long as the body of a candle engulfs the previous candle in terms of the body and wicks, it would be considered an engulfing candle (Sometimes you may find trader's don't count the wicks). As such, it can indicate that a move in the opposite direction of the candle that was “engulfed”may take place.

In other words, if a bullish candle is engulfed by bearish candle, the higher probability direction to trade the pair will be to short it. If a bearish candle is engulfed by a bullish candle, the higher probability direction to trade the pair will be to buy it.

Remember, just because a trader sees an engulfing candle does not mean that a move in the opposite direction is assured. As far as being certain goes, a trader can be certain that a candle is an engulfing candle, but we can never be certain of what may transpire on the chart going forward.

Keep in mind, as is the case when interpreting candlesticks, a trader cannot make a decision regarding what a candle might turn out to be until that candle is closed. So, always wait for a candle to close before making a trading decision based on whether it's engulfing or not.

A simple trading strategy is to take a trade when the engulfing candlestick is in the direction of the main trend. In other words, in a correctional take profits retracement we would look for bullish engulfing candles and in a short bullish correction we would look for bearish engulfing candles.

Should the trade be taken, the stop can be placed below the bullish engulfing candle in an uptrend and above the bearish engulfing candle in a down trend. See more on stop/losses in our Module 7

Lastly, as usual, nothing in trading is a certainty and not all engulfing candlestick patterns will lead to a reversal. Testing a system with proper risk management is essential prior to trading
Really only useful if found in a downtrend. We can see the pattern on the left above where the hollow candle body completely engulfs the filled candle body. This pattern doesn’t indicate indecision, but that buyers are back in the market - The short bear candle is running out of steam and being engulfed by a strong long bull candle. The longer the white (hollow) candle against the black (filled) candle the greater the chance of reversal and if there is increased volume we’ll also increase our chances of a reversal. The black candle shouldn’t really be a doji as it’s fairly easy to engulf. If the shadow is engulfed, then this is better, but not necessary and finally the shadows on both candles should be small or non-existent. Again, further confirmation is needed for reversal.

This pattern can also confirm a continuation of trend and continued buying pressure. If seen passing through a resistance level then this may confirm a break of resistance. This pattern is valid as long as the body is engulfed.

The Bearish Engulfing Pattern

Only useful in an up trend and is the exact opposite to the bullish engulfing pattern – it is the 2nd diagram on the left above. The same rules apply here as they did above and we should always look for other confirmation in the form of further price action to the downside (like the three black crows, below) and increased downside volume.

The Piercing and Dark Cloud Cover Patterns

These two blends work in the same ways as the previous two. The Piercing pattern is a bullish pattern where the hollow 2nd candle drives up from below the previous filled candle to above half way of the previous filled candle. Both candles should be fairly large bodied with small shadows. If the white candle doesn’t finish above the black candles middle then this isn’t considered bullish. This is the third diagram above. Again, confirmation is required for reversal. Dark Cloud Cover is the mirror image of The Piercing Pattern.

Three White Soldiers and Three Black Crows Reversal

Solid Confirmation is found if reversed momentum is followed up with strong corroboration – the most famous of these are the three white soldiers and the three black crows. The 3 white soldiers equal 1 long white (hollow) candle and the 3 black crows equal a long black/red (filled) candle. Both these blends can be seen in reversal patterns and are used to confirm that the reversal has taken place

These two formations will be more prevalent after a long trend that is going through a reversal. Ideally the 3 candles should start within the last candle and close near the high (in the case of the 3 white soldiers) or the low (in the case of the three black crows). In the 3 white soldiers chart below the soldiers are the reversal and in the 3 black crows chart the black crows confirm a spinning top candlestick showing indecision.

Three White Soldiers & three Black Crows Reversal

The Use of Other Technical Analysis is Beneficial

Candlesticks provide an excellent means to identify short-term reversals, but should not be used alone. Other aspects of technical analysis can and should be incorporated to increase reversal robustness. For instance support and resistance, Fibonacci retracement and overbought and oversold oscillators can play an important part in any price action trading strategy. Look how support coincides with a bullish engulfing candlestick pattern and how The Stochastic crosses the bullish 50 line below helping to confirm the reversal.

Example of Price Action Combined with other Technical Analysis

How to Trade Candlestick Reversal Patterns

As we've discussed in all of our Candlestick Reversal Patterns, traders must wait for confirmation prior to trading - wait until the candle close (or near the close) to see if the market reverses. This is a potential trade entry point for many.  Combining candlestick confirmation with other technical analysis, i.e, oscillators, moving averages etc...to gain further confirmation may also be prudent as we've seen above.  However If a stock pulls back to an area of demand (support) and there's a candlestick pattern telling us that buyers are taking control of the stock, then that is all the confirmation some traders need.  The choice is yours and all depends on your attitude to risk.

Let's look at an example trade using the engulfing candlestick pattern.  This is a simple day trading system for example only, using the AUD/USD forex pair, so you may want to research other price action/indicator systems.  You also need to back tested all trading systems yourself, to make sure your comfortable with the risks. But I hope you can see how this system can transfer to other candlestick patterns and time-frames?

Bullish Engulfing Candlestick Trade
Example Bullish Engulfing/Moving Average Trading System

Our set up  - a 1 hour chart with a 50-period simple moving average

Our system rules - If price is above 50 SMA we're in an up trend so we buy. In an up trend we're on the look-out for bullish engulfing candlesticks. In a down trend (price below 50 SMA) we look for a bearish engulfing pattern and we sell.

Entry - 1 pip above the high of the bullish engulfing or 1 pip below the bearish engulfing on the next candle

Risk Management - Stop/Loss placed 1 pip below the bullish engulfing in an up trend, or 1 pip above the bearish engulfing in a down trend

Take Profit - We're looking for a reward to risk ratio of 1:1.

So, Price is above 50 SMA, so we need to be looking to go long. I've highlighted the bullish engulfing candle in the yellow oval on our 1 hour chart.  We enter long 1 pip above the bullish engulfing candle on the next candle at 1.0530 (3am, 16th Mar) and place a stop/loss at 1.0508. If our Target take profits ratio is 1:1 then our target price is 1.0552 (i.e the equivalent distance from entry to our risk - 1:1). We reach this at 1pm on the 16th - 10 hours later.

Well, I hope you get the just of how to trade candlestick patterns and begin to see how you can develop your own system? Of course many trades will go against you!  Remember this is a simple system. Yours may incorporate different reward to risk factors and support and resistance etc... See the Trading Flowchart for more ideas.  But you may want to keep it simple - Simple systems do make money.  Visit some blogs and sites to view some other systems.

Technical analysis is not an exact science and although these ideas can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

=======

Previous...


Blended Candlestick Reversals and their Confirmation

There's such a thing as Blended Candlestick Formations.  These Blends can indicate reversals after a trend, just as the candlestick reversals we've talked about can. They're formed by taking the open of the 1st session and the close of the 2nd session, while taking the high and low of both the sessions and amalgamating them.  The below graphic shows the result of blending 2 candlesticks.

Blended Candlestick Formations and their Reversal Confirmation


The Bullish Engulfing Pattern


Trading with Engulfing Patterns - by Richard Krivo

What qualifies as an engulfing candle is fairly simple: as long as the body of a candle engulfs the previous candle in terms of the body and wicks, it would be considered an engulfing candle (Sometimes you may find trader's don't count the wicks). As such, it can indicate that a move in the opposite direction of the candle that was “engulfed”may take place.

In other words, if a bullish candle is engulfed by bearish candle, the higher probability direction to trade the pair will be to short it. If a bearish candle is engulfed by a bullish candle, the higher probability direction to trade the pair will be to buy it.

Remember, just because a trader sees an engulfing candle does not mean that a move in the opposite direction is assured. As far as being certain goes, a trader can be certain that a candle is an engulfing candle, but we can never be certain of what may transpire on the chart going forward.

Keep in mind, as is the case when interpreting candlesticks, a trader cannot make a decision regarding what a candle might turn out to be until that candle is closed. So, always wait for a candle to close before making a trading decision based on whether it's engulfing or not.

A simple trading strategy is to take a trade when the engulfing candlestick is in the direction of the main trend. In other words, in a correctional take profits retracement we would look for bullish engulfing candles and in a short bullish correction we would look for bearish engulfing candles.

Should the trade be taken, the stop can be placed below the bullish engulfing candle in an uptrend and above the bearish engulfing candle in a down trend. See more on stop/losses in our Module 7

Lastly, as usual, nothing in trading is a certainty and not all engulfing candlestick patterns will lead to a reversal. Testing a system with proper risk management is essential prior to trading
Really only useful if found in a downtrend. We can see the pattern on the left above where the hollow candle body completely engulfs the filled candle body. This pattern doesn’t indicate indecision, but that buyers are back in the market - The short bear candle is running out of steam and being engulfed by a strong long bull candle. The longer the white (hollow) candle against the black (filled) candle the greater the chance of reversal and if there is increased volume we’ll also increase our chances of a reversal. The black candle shouldn’t really be a doji as it’s fairly easy to engulf. If the shadow is engulfed, then this is better, but not necessary and finally the shadows on both candles should be small or non-existent. Again, further confirmation is needed for reversal.

This pattern can also confirm a continuation of trend and continued buying pressure. If seen passing through a resistance level then this may confirm a break of resistance. This pattern is valid as long as the body is engulfed.

The Bearish Engulfing Pattern

Only useful in an up trend and is the exact opposite to the bullish engulfing pattern – it is the 2nd diagram on the left above. The same rules apply here as they did above and we should always look for other confirmation in the form of further price action to the downside (like the three black crows, below) and increased downside volume.

The Piercing and Dark Cloud Cover Patterns

These two blends work in the same ways as the previous two. The Piercing pattern is a bullish pattern where the hollow 2nd candle drives up from below the previous filled candle to above half way of the previous filled candle. Both candles should be fairly large bodied with small shadows. If the white candle doesn’t finish above the black candles middle then this isn’t considered bullish. This is the third diagram above. Again, confirmation is required for reversal. Dark Cloud Cover is the mirror image of The Piercing Pattern.

Three White Soldiers and Three Black Crows Reversal

Solid Confirmation is found if reversed momentum is followed up with strong corroboration – the most famous of these are the three white soldiers and the three black crows. The 3 white soldiers equal 1 long white (hollow) candle and the 3 black crows equal a long black/red (filled) candle. Both these blends can be seen in reversal patterns and are used to confirm that the reversal has taken place

These two formations will be more prevalent after a long trend that is going through a reversal. Ideally the 3 candles should start within the last candle and close near the high (in the case of the 3 white soldiers) or the low (in the case of the three black crows). In the 3 white soldiers chart below the soldiers are the reversal and in the 3 black crows chart the black crows confirm a spinning top candlestick showing indecision.

Three White Soldiers & three Black Crows Reversal

The Use of Other Technical Analysis is Beneficial

Candlesticks provide an excellent means to identify short-term reversals, but should not be used alone. Other aspects of technical analysis can and should be incorporated to increase reversal robustness. For instance support and resistance, Fibonacci retracement and overbought and oversold oscillators can play an important part in any price action trading strategy. Look how support coincides with a bullish engulfing candlestick pattern and how The Stochastic crosses the bullish 50 line below helping to confirm the reversal.

Example of Price Action Combined with other Technical Analysis

How to Trade Candlestick Reversal Patterns

As we've discussed in all of our Candlestick Reversal Patterns, traders must wait for confirmation prior to trading - wait until the candle close (or near the close) to see if the market reverses. This is a potential trade entry point for many.  Combining candlestick confirmation with other technical analysis, i.e, oscillators, moving averages etc...to gain further confirmation may also be prudent as we've seen above.  However If a stock pulls back to an area of demand (support) and there's a candlestick pattern telling us that buyers are taking control of the stock, then that is all the confirmation some traders need.  The choice is yours and all depends on your attitude to risk.

Let's look at an example trade using the engulfing candlestick pattern.  This is a simple day trading system for example only, using the AUD/USD forex pair, so you may want to research other price action/indicator systems.  You also need to back tested all trading systems yourself, to make sure your comfortable with the risks. But I hope you can see how this system can transfer to other candlestick patterns and time-frames?

Bullish Engulfing Candlestick Trade
Example Bullish Engulfing/Moving Average Trading System

Our set up  - a 1 hour chart with a 50-period simple moving average

Our system rules - If price is above 50 SMA we're in an up trend so we buy. In an up trend we're on the look-out for bullish engulfing candlesticks. In a down trend (price below 50 SMA) we look for a bearish engulfing pattern and we sell.

Entry - 1 pip above the high of the bullish engulfing or 1 pip below the bearish engulfing on the next candle

Risk Management - Stop/Loss placed 1 pip below the bullish engulfing in an up trend, or 1 pip above the bearish engulfing in a down trend

Take Profit - We're looking for a reward to risk ratio of 1:1.

So, Price is above 50 SMA, so we need to be looking to go long. I've highlighted the bullish engulfing candle in the yellow oval on our 1 hour chart.  We enter long 1 pip above the bullish engulfing candle on the next candle at 1.0530 (3am, 16th Mar) and place a stop/loss at 1.0508. If our Target take profits ratio is 1:1 then our target price is 1.0552 (i.e the equivalent distance from entry to our risk - 1:1). We reach this at 1pm on the 16th - 10 hours later.

Well, I hope you get the just of how to trade candlestick patterns and begin to see how you can develop your own system? Of course many trades will go against you!  Remember this is a simple system. Yours may incorporate different reward to risk factors and support and resistance etc... See the Trading Flowchart for more ideas.  But you may want to keep it simple - Simple systems do make money.  Visit some blogs and sites to view some other systems.

Technical analysis is not an exact science and although these ideas can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

>>>>>>> c0fd65f8ac5b5830dc3df1d307fcababd602b3a9
Comments