When it comes to understanding stock patterns and finding new investment opportunities, candlestick patterns play a valuable role. They make it easy to find potential trading patterns at a glance. Those who like to use technical analysis to manage their portfolios will find these charts particularly useful.
What you should know about candlestick patterns
The candlestick system originated in Japan when a man noticed a clear link between the price, supply, demand, and trader emotions surrounding rice. This information then began to grow into an understanding of these trends and how to predict a stock's future.
You have a wealth of information packed into a small design in a candlestick pattern. Traders often look for the 'real body' of the candlestick, which is found in the center, that shows the relationship between the opening and closing prices.
You can see in the diagram here precisely what the different parts of the candlestick mean.
If the body is filled red or black, the closing price is lower than the opening price and it is referred to as a bearish candle. On the other hand, if the body is empty or green, the closing price is higher than the opening price and it is called a bullish candle. The 'shadows' on the top and bottom of the candle show the highest and lowest price ranges in a certain period of time.
As you look at the candlesticks side-by-side, you may see the stock price move sharply up or down when no trading has taken place. These areas of the graph are known as gaps, and can also play a valuable role in helping traders find opportunities.
As a trader, you can use candlesticks patterns to identify key trends and apply specific formulas to develop your predictions. A pattern can include many candlesticks or just a few. Occasionally, in the case of a robust signal, a pattern might include only one candlestick.
Now that you understand the candlesticks a bit more, let's explore a few key patterns you can use in your trading.
Advanced candlestick patterns to recognize
Several candlestick patterns can offer deeper insights but require careful examination so that you can find important trends.
The kicker pattern is often viewed as one of the most reliable candlestick patterns to help traders spot an impending sharp price reversal. You can often see this change with only two candlesticks. With a kicker, there is a gap between the closing price of one trading period and the opening price of a second while no trading occurred between the two.
There are a variety of reasons for sudden price reversals but there are only two types of kicker patterns to look for: bullish and bearish.
Bullish Kicker: The bullish kicker candlestick pattern develops when the price suddenly increases instead of following the previous downward price trend.
Bearish Kicker: The bearish kicker candlestick pattern emerges when the price suddenly decreases after a previously upward trend. This is an indication that you may look to get short.
A kicker will only appear as a gap, but you may also be high trading volume around this shift. To find your entry price, look at the closing price of the last candle before the gap to help you identify an optimal price to enter the market.
A hook reversal pattern is considered a short-term reversal pattern that emerges when there is a higher low and a lower high than the previous day. This change is typically small and occurs quite frequently but can easily be seen as the second candle in the pattern is a different color than the first.
In a bearish hook reversal pattern, you will first see an increasing price trend. Then, it will suddenly be followed by a filled black or red candle that has similar high and low prices, as opposed to large engulfing price changes. In the bullish version of this pattern, you will first see a downward trend, followed by a candle that still has a lower high, but is now green or empty.
However, know your price point for existing investment holdings before moving based on this pattern, as it is common. Therefore, you often want to cross-reference it with other charts and data sources to give you the most accurate information for investing.
Also known as Sanku, a three gaps pattern can help traders predict if there will be a trend reversal in a particular stock. Look for three gaps that occur within an existing trend. These gaps might not be particularly large and can occur with several candles between gaps. However, these gaps can show that a current trend is reaching its exhaustion point and a reversal may develop.
A rising gap occurs when the current price is experiencing an upward trend and falling trend is the opposite. Typically, when the third gap is filled with a candle in the opposite movement, it is seen as a sign of a reversal. Some traders will use this indicator in conjunction with other indicators. For example, you might want to look for a crossover on a moving average for the same stock to detect the best time to make changes to your investment.
An island reversal can be identified by a long trend that includes two gaps, which create a cluster of trading days. The first gap is called a breakaway gap and the second an exhaustion gap. There is usually an increased volume of trading before and after each gap.
The created ‘island’ of isolated trading periods can span over a period of days, weeks, or even months. It’s important to look for both gaps as they can indicate that the trends will likely reverse in the coming days.
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There are two types of island reversal patterns. The bullish island reversal pattern appears in a downtrend and the more common bearish island reversal pattern appears in an upward trend. Note, that in both trends, the isolated trading days may not be consistent in either increasing or decreasing in price.
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