Candlestick Patterns in Stock Market Analysis

What is a Candlestick?

A candlestick is a type of chart used in financial analysis particularly while trading to describe the price movements. The chart has a stout body with an upper and a lower lean extension. The ends of the body indicate the Open (O) & Close (C) price of the stock under trade. The upper & lower extensions are called upper & lower shadow. The upper end of the upper shadow is the high (H) price for the day and the lower end of the lower shadow is the low (L) price of the day. Hence the abbreviation - OHLC.

Bullish Candlestick

A bullish candlestick is generally blue in color. It would have the close price at the top end of the body and the open price at the bottom end of the body. The trade price has seen positive movement during the course of the day and hence the trade is bullish.

Bearish Candlestick

A bearish candlestick is generally red in color. It would have the close price at the bottom end of the body and the open price at the top end of the body. The trade price has seen negative movement during the course of the day and hence the trade is bearish.

Going Long & Going Short

In trading terms, going long indicates interest to buy a stock under trade. Going short indicates interest to sell a stock under trade.

The Stop Loss Price

The stop loss price is an optional input during a trade, indicating the price at which the trader would like to exit the trade. It is representative of the maximum loss the trader would like to bear. For long trade, the stop loss is usually the low price for the day. For short trade, the stop loss is usually the high price for the trade. The trade would exit the position when the stop loss price hits. This ensures that the loss is minimal and the trader is not affected by sudden market fluctuations.

The Target Price

The target price is an optional input during a trade, indicating the price at which the trader would like to exit the trade. It is representative of the maximum profit the trader thinks that can be made.

Candlestick Patterns

• Single Candlestick Patterns

  • The Marubozu

  • Spinning Top

  • Doji

  • Paper Umbrella

  • Shooting Star

• Multiple Candlestick Patterns

  • Engulfing Pattern

  • Piercing Pattern

  • Dark Cloud Cover

  • Harami

  • Morning Star

  • Evening Star

Single Candlestick Patterns

The single candlestick patterns are used to analyze a single day price movements.

The Marubozu

The Marubozu is a candlestick pattern with no upper and lower shadows. It has only the body. Hence the open & close prices are almost the same as the high & low prices.

The Bullish Marubozu

The Bullish Marubozu is a bullish candlestick version of Marubozu. The high is almost the same as the close price and the low is almost the same as the open price. Traders would go long in such a situation, favouring the absolute bullish direction of the price.

The Bearish Marubozu

The Bullish Marubozu is a bearish candlestick version of Marubozu. The high is almost the same as the open price and the low is almost the same as the close price. Traders would go long in such a situation, favouring the absolute bearish direction of the price.

Spinning Top

The Spinning Top is a candlestick pattern with a small body and an equal length upper & lower shadow. The pattern indicates indecision as there are traders leaning on both the bullish as well as bearish direcion. In case of a spinning top at the end of a bullish uptrend, the bulls have slowed down, leaving space for the bears. But only little space, such that the bears are also not in control. Hence the indecision.

Doji

The Doji is a type of Spinning Top, except that the body is not present or minimal in height. The open and close prices are almost equal. This pattern also indicates indecision with the bulls & the bears trying to take control.

Paper Umbrella

Paper Umbrella is a candlestick pattern with a long lower shadow, almost twice the length of the body. It is of two subtypes depending upon a bullish or bearish trend.

The Hammer

Hammer is a type of Paper Umbrella, which usually appears at the end of a downtrend indicating the bulls trying to take control of a bearish trend. They are somewhat successful in setting the close price almost the same as open price. It's an indication that the trend is probably going to reverse direction and traders should prefer buying the stock.

The Hanging Man

The Hanging Man is a type of Paper umbrella, which usually appears at the end of an uptrend indicating the bears trying to take control of a bullish trend. They are somewhat successful in setting the close price almost the same as open price. It's an indication that the trend is probably going to reverse direction and traders should prefer selling the stock.

Shooting Star

The Shooting Star is inverted Paper Umbrella, with a long upper shadow, almost twice the length of the body. Shooting Star usually appears at the end of an uptrend indicating the bears trying to take control of a bullish trend. They are successful in capturing the control and bringing the prices down. It's an indication that the trend is going to reverse direction and traders should prefer selling the stock.

Multiple Candlestick Patterns

Multiple candlestick patterns are used to analyze price movements over a period of time, usually 2-3 days.

The Engulfing Pattern

The Engulfing Pattern is a pattern which evolves over a 2 day trading session. The pattern typically has a small candle in day 1 and a long candle on day 2, which appears to engulf the candle on day 1. The pattern can be of two subtypes based on the bullish or bearish movement.

Bullish Engulfing Pattern

A bullish pattern appears at the end of a downtrend. The pattern starts with a small red candle on day 1 followed by a long blue candle on day 2. While the bears are in control until day 1, the bulls made a strong entry on day 2 and are successful in setting a higher price. This reversal of direction suggests traders for buying opportunities.

Bearish Engulfing Pattern

A bearish pattern appears at the end of an uptrend. The pattern starts with a small blue candle on day 1 followed by a long red candle on day 2. While the bulls are in control until day 1, the bears made a strong entry on day 2 and are successful in setting a lower price. This reversal of direction suggests traders for selling opportunities.

Piercing Pattern

The Piercing Pattern is similar to the bullish engulfing pattern, except that the candle on day 2 doesn't fully engulf the candle on day 1. The overlap is somewhere between the 50-100% range. The suggested action from the tradars is similar to that of a bullish engulfing pattern.

Dark Cloud Cover

The Dark Cloud Cover pattern is similar to the bearish engulfing pattern, except that the candle on day 2 doesn't fully engulf the candle on day 1. The overlap is somewhere between the 50-100% range. The suggested action from the tradars is similar to that of a bearish engulfing pattern.

Harami

Harami is a 2 day pattern, where a long candle appears on day 1 followed by a short candle on day 2. The pattern can be of two subtypes based on the bullish or bearish movement.

Bullish Harami

A Bullish Harami appears at the end of a downtrend. The pattern starts with a long red candle on day 1 followed by a small blue candle on day 2. While the bears are in control until day 1, the stock opens at a higher price on day 2 compared to the closing price of day 1, encouraging bulls to take control of the stock and they eventually succeed. This sudden reversal of direction suggests traders for buying opportunities.

Bearish Harami

A Bearish Harami appears at the end of an uptrend. The pattern starts with a long blue candle on day 1 followed by a small red candle on day 2. While the bulls are in control until day 1, the stock opens at a lower price on day 2 compared to the closing price of day 1, encouraging bears to take control of the stock and they eventually succeed. This sudden reversal of direction suggests traders for selling opportunities.

Morning Star

Morning star is a 3 day pattern, appearing at the end of a downtrend. On day 1, the bears are in control and they set a new low price. On day 2, the stock opened at a much lower price than the closing price of day 1. But during the course of the day, a balance is set and a Doji or a Spinning Top is formed. This sets confusion among the bears and uncertainty kicks in. On day 3, the stock opened at a higher price than the previous day and bulls took control by moving the price up. A blue candle is formed on day 3 suggesting a bullish movement for the next few sessions.

Evening Star

Evening star is a 3 day pattern, appearing at the end of an uptrend. On day 1, the bulls are in control and they set a new high price. On day 2, the stock opened at a much higher price than the closing price of day 1. But during the course of the day, a balance is set and a Doji or a Spinning Top is formed. This sets confusion among the bulls and uncertainty kicks in. On day 3, the stock opened at a lower price than the previous day and bears took control by moving the price down. A red candle is formed on day 3 suggesting bearish movement for the next few sessions.

Conclusion

There are more patterns to highlight, but the above list is a good start and once this base set is understood,a trader can pick up quite well further. As you practice more, you should be able to recognize patterns just by looking at the financial charts.

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