Understanding Candlesticks – Multi Candle Patterns
Multi Candlesticks Patterns: Hi traders! In the previous article, we discussed the various single candlestick patterns and their importance in understanding the pricing patterns. Here, in this article, we will be talking about various multi candlesticks patterns.
These are patterns generated by a series of prior candles. Single candlesticks patterns along with multiple candlestick study goes a long way in understanding and giving better trade signals in the market.
Here is a list of Multi candlesticks patterns we will be having a discussion on in this chapter: The Engulfing Patterns (Bullish Engulfing pattern and Bearish Engulfing patterns), The Piercing pattern, The Dark cloud cover, The Harami Pattern (Bullish Harami & Bearish Harami), The Candles Gaps, The Morning star, The Evening star, Three White soldiers & Three Black crows.
The Engulfing Pattern
The Engulfing pattern is the most basic two candlestick pattern. The first candle is a relatively small one and the second candle is a bigger one as it engulfs the first candle. If this pattern happens at the bottom of a trend, then it’s called bullish engulfing and if this happens at the top of a trend then it’s called bearish engulfing.
— Bullish Engulfing
Here are a few characteristics
- The Bullish engulfing pattern shows Long (buy) trade
- The prior trend should be bearish.
- The prior candle should be Red.
- The engulfing candle should be bigger than previous and covering the whole body of a red candle and should be green.
In the figure above we see bearish trend prior to the engulfing green candle. Once the engulfing pattern took over, we saw a long bullish trend. One important point to observe here is that the engulfing candle attempts to continue bearish pattern but constant buying and rejection at lows brings in more buyers and ultimately the candle closes green.
The trades to be taken here depends on one’s risk appetite. A risk-taker will execute the trade on the day the trend is made but the risk-averse will wait for confirmation and execute his trade the next day. The Stop loss for this trade has to be below the body of the engulfing candle. In the figure above, the trader with both kinds of a risk appetite would have made a substantial profit.
— Bearish Engulfing
As the name suggests, the bearish engulfing pattern gives an opportunity for short trades. The prior pattern here has to be a bullish one and the engulfing pattern candle should also give an indication of continuing bullish pattern but due to constant selling pressure, the sellers eventually take over and the candle closes red. The engulfing red candle has to bigger than the prior green candle.
The buying pressure gets exhausted by constant selling. It is advisable to exit long trades when this pattern happens and enter fresh short trades. The risk-taking trader enters short trade on the same day while the risk-averse trade waits for the pattern confirmation and enters into trade the next day. The figure shown below is a classic example of Bearish Engulfment with the engulfing body bigger than previous green candle and substantial bearish trend post that.
The Piercing Pattern
The Piercing pattern is very similar to a bullish pattern with a minor difference. In the case of the piercing pattern, the size of the green candle should be between 50-100 % of the red candle. Say if the size of the red candle is of 100 points, then the piercing candle length should be more than 50 points but less than 100 points. This candlestick pattern has a similar characteristics like Bullish engulfing but the confidence level on trades via piercing pattern is little lesser compared to bullish engulfing.
The Dark Cloud Cover
A mini version of the Bearish Engulfing pattern. A bearish pattern indicator and uptrend halter. Here, unlike the bearish engulfing pattern, the red candle size should be between 50-100 % of the previous green candle. Say, if the size of the green candle is 150 points, then the dark cloud candle should be anywhere between 75-150 points.
The Harami Pattern
I know what comes to mind when you hear the word ‘Harami”. But Harami here is a Japanese word meaning Pregnant. This is generally a trend reversal pattern. The first candle is a big one followed by a candle with a small body. And the color of the second candle is generally different from the first candle. If the second candle turns out to be a Doji candle, the chances of reversal increases.
— The Bullish Harami
In the figure above, we see a bullish Harami encircled. It is a two-day pattern. Following are some of its characteristics:
- The prior trend of the market is bearish and on the previous day, the market has made a new low.
- On the next day, the candle opens in green as against the expected red candle and hence the panic and shorts start to get covered and the day ends with a green or a Doji candle.
- The idea here is to go long at the formation of this pattern.
- The risk-taking trader can go long near the close of the day and the risk-averse trader can wait for pattern confirmation and go long the next day.
- The Stop Loss for the trade is below the low of blue or Doji candle.
- In an ideal scenario, it is always best to keep trailing stop loss and ride the reversal move.
— The Bearish Harami
In the figure above, we can notice that the bearish Harami in a squared box. It is a trend reverser. The strong bullish trend is halted and a new bearish trend starts. Few characteristics of this pattern:
- The prior trend is a strong bullish trend.
- The prior candle makes a new high and the next candle opens low against an expectation of new high and hence the panic selling.
- One should look to exit his existing longs and enter fresh short trades.
- The risk-taker will execute the trade close to the end of the day and the risk-averse trader will wait for the confirmation and enter a trade on the next day.
- The stop loss for the trade will be the high of the first red candle.
- Here also one should keep trailing the stop losses and ride the full move.
The Candle Gaps
The Gaps are formed when the candle for the next day opens significantly opens up or below the previous day closing.
If the market gap ups, it shows buyers enthusiasm. They are willing to pay a higher price. The Image above shows Nifty gaps up and buyers are willing to pay a higher price and the momentum continues. This pattern emerges when we see some overnight positive news and the markets react with a gap up. If the share price of some company gap ups, it usually means some positive management news or good quarterly results or firm receiving some substantial orders, etc.
Similarly, in the case of a Bearish Gap down, we see the market opening below the previous day’s close and selling pressure. In the figure above we see a bearish gap down in nifty index and continued negative momentum post that.
One important thing to keep in mind is that candle gaps are more news-driven or event-based but it has a strong bearing on changing the technical set up of the market.
The Morning Star
The Morning star is a bullish candlestick pattern. It’s a three candlestick pattern. This pattern usually indicates a trend reversal. A sustainable bullish trend is on cards.
Following is the pattern setup:
- The market is in a bearish trend and it’s continuously making new lows.
- In the image above, we can see the first candle in the circle is a red candle and a new low is formed.
- The next candle starts by making new lows and looks set to go down. But with regular buying, the candle closes by making Doji. It starts to set panic amongst the bears.
- The next candle starts above the close of the Doji candle (Gap up opening) and shorts start to exit their position and fresh long positions re-initiated in the market.
- The best way to trade this pattern is by entering the market near the close of the third day and by then the trend reversal confirmation is also given by the market. The Stop Loss for this trade is the low of the third candle. Trailing Stop losses is the best strategy to ride this move.
The Evening Star
The evening star is the exact opposite of Morning star. It’s a strong bearish reversal pattern. Similar to the morning star, evening star is also a three candlestick pattern.
- The market is in a bullish trend and it’s continuously making new highs.
- In the image above, we can see the first candle in the circle is a green candle and a new high is made.
- The next candle starts by making new high and looks set to go higher. But with regular selling, the candle closes by making Doji. It starts to set panic amongst the bulls.
- The next candle starts below the close of the Doji candle (Gap down opening) and longs start to exit their position and fresh short positions are initiated in the market.
- The best way to trade this pattern is by entering the market near the close of the third day and by then the trend reversal confirmation is also given by the market. The Stop Loss for this trade is the high of the third candle. Trailing Stop losses is the best strategy to ride this move.
Three White Soldiers
The three white soldiers is a bullish reversal candle. The trend prior to the formation of this pattern is bearish. This trend has three green candles formed. The opening of every candle is slightly below the previous days close and it closed above the previous day’s high. One can exit their existing short positions and enter fresh longs to initiate a new trade.
A risk-taking trader can execute trade before the close of the third candle and a risk-averse can execute his trade after the confirmation of the trend. The stop loss for this trade is the low of the first candle.
Three Black Crows
Three black crows is a bearish reversal pattern. The prior trend is a bullish trend with new highs been made every day. The opening of the candle is slightly above the previous day but the closes is lower than the previous day low. Fresh shorts can be initiated with stop loss over the high of the first candle. One should keep trailing his stop losses as the trade starts to move in their favor.
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From the discussion above, we see various multi candlesticks patterns which can be useful barometers in the trade execution. There are some patterns that are frequent and followed more regularly and other not so frequent but very reliable patterns.
But by no means, these technical indicators to be followed blindly. One should see the technical factors going around and use informed judgment in executing their trade. “Happy Trading and Money Making!”
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!
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