A Guide to Single Candlestick Patterns: If you want to become a successful stock market trader, it is very important that you learn to read and understand candlesticks or candles. These candlesticks are basically a style of technical chart used to describe price movements of a stock, derivative, or currency. Understanding candlesticks and their patterns can help you to decide the entry and exit points for your trades.
“I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime.” – Jim Rogers
In this article, we are going to discuss what are candlesticks and then look into the popular single candlestick patterns that every trader should know. Let’s get started.
What are Candlesticks or Candles?
Candlesticks are the most common form to gauge the market trends, historical analysis, forecasting future. They are the most potent form of technical indicators. Just like a burning candle throws light to present and future, candlesticks with their patterns throw light on the present and goes a long way in understanding the future trends.
A simple candlestick shows the events which transpired within the selected timeframe. It shows us the open, high, low, close of the day (within the timeframe selected). The length of the candle helps us in understanding the volatility of the day. The longer the length of the candle, the more volatile the day and shorter the candle, the less volatile the day.
The candlestick can be said to be a historical indicator as the candlesticks are formed on the already happened market action. But the candlesticks formed goes a long way in understanding the future trends and price patterns.
Before we start understanding the various candlesticks patters, I would recommend keeping the following factors in mind:
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- “Trend is your friend.” Avoid going against the trend.
- One should be very flexible with his views. Stubbornness generally leads to disasters.
- Historical data analysis goes a long way in understanding future price patterns.
- Avoid taking directional trades on small size candles. Generally, trends are formed after substantially long sized candles.
Single Candlestick Patterns
In simple words, a single candlestick pattern is formed by just one candle. Here, we do not look into multiple or group of candles and the trading signal is generated based on a single day’s trading action. The following are some of the popular Single candlestick patterns we would be discussing in this article: The Spinning top, The Marubuzo, The Doji, The Hammer, The Hanging Man, The Shooting Star.
— The Spinning Top
The Spinning Top unlike any other candlestick formation does not give any clear direction of the trend but has a lot of price action associated with it. A Spinning candle looks like the candle shown below:
Following are the initial observation looking at the candle:
- The body of the candle is very small compared to upper and lower wicks.
- The wicks on both sides are generally of similar size.
The spinning although looks like a plain candle but has a lot of price action associated with it. The small main body would imply that the open and close of the candle are very close to each other. Because the open and close are so close to each other, the colour of the candle usually does not signal any trend.
The upper body shows the high for the day. This simply signifies that the bulls did make an attempt to go up but to no avail.
The lower body has similar characteristics like the upper body. This simply signifies that the bears tried to push the market down but were not successful in doing it.
— The Marubuzo
The Marubuzo is again a single candlestick pattern. It is probably the only candlestick pattern in which the prior trend is not given much importance. Only the last candle is given importance.
The green line above explains Bullish Marubuzo and the red line represents Bearish Marubuzo.
— Bullish Marubuzo
In Bullish Marubuzo, the open of the candle is low for the day and the close of the candle is high for the day. There are no wicks in this candlestick pattern. This candlestick can also be said to be a trend changing one. The intensity of the buying is so high that the traders are willing to buy the stock at the high of the day. This candlestick patterns simply implies that the buying will continue for the days to come. The recommended buying price is the closing price of the Marubuzo candle.
Theoretically, the open should be low and the close should be high. But in reality, a little bit of variation is allowed.
Let us understand it with the help of a hypothetical example: The XYZ company share price has formed a Marubuzo candle with: Open = 403, High = 450, Low = 400, Close = 449.
Now the trader’s risk profile defines the time of execution of the trade. A Risk-taker would be taking the trade on the day the Marubuzo is formed. So how does this Risk-taking trader gets confirmation about the formation of Marubuzo? The trader basically does that by taking the trade very close to the end of the day.
On the other hand, a Risk-averse trader would be taking the trade the next day once the trend is confirmed. So, a risk-averse trader entry price might be higher than the risk-taking trader but has a better assurance about the pattern formation.
One very important thing to be kept in mind is that one has to be very mindful of the fact that the trade has to be executed with a stop loss in mind. Stop loss helps the trader to minimize the losses because of the inherent risks associated with the trade.
— Bearish Marubuzo
In a Bearish Marubuzo, the open of the candle is high for the day and the low of the candle is close for the day. A bearish Marubuzo indicates that the selling pressure is so high that the trader is willing to sell the share at the lows of the day expecting more negativity in the price of the share. This candle indicates a change in momentum and this changed momentum is set to last over some time.
One should bear in mind that this kind of trades are generally not meant for scalping purposes, they are to held until the trade reaches its desired price. Trailing stop losses is the best strategy.
— The Doji
The Doji is a candle formation that does not have a real body. It just has wicks on either side. So, the opening and closing price of the candles are one and same.
The Doji pattern can sometimes be similar to a spinning top except for the fact that Doji does not have any real body. Dojis are generally momentum changer or momentum halter. These candles clearly show the indecisiveness amongst the traders about the momentum and the direction of the market. Let’s examine it with the help of the following situation.
Say the market is in a bullish momentum and has had green candles over a series of days. So, if a Doji candle is formed, it could simply imply the dwindling momentum in the market or could mean an end in current momentum and signal trend reversal. Therefore, it is advisable in this scenario to be cautious and exit the long position or at least one should have stop losses in place. This is generally a time to wait and watch before entering new trades.
— The Hammer
The Hammer pattern is one of the most convincing trading patterns simply because of its formation pattern.
The hammer pattern occurs when the candle opens at high but is not able to sustain there and it falls considerably but with continuous buying interest is able to recover and the candle closes in green and near the opening price. The length of the wick here has to be at least twice the size of the body.
In the diagram above, a bullish hammer has formed at the bottom of the bearish trend and the momentum changes significantly after the hammer formation. One Important thing to be kept in mind is that the hammer can be of any colour (green to red) as long as it meets the body to wick ratio. Few characteristics of hammer trade:
- The hammer formation generally gives a bullish or a long trade.
- The execution time of trade depends on the risk appetite. A risk-taker would execute the trade on the same day and a risk-averse will wait for the confirmation of the trade.
- The Stop loss for this trade is generally below the low of the hammer candle.
— The Hanging Man
According to Investopedia, “A hanging man uptrend and warns that prices may start falling. The candle is composed of a small real body, a long lower shadow, and little or no upper shadow. The hanging man shows that selling pressure is starting to increase”.
One important criterion for a candle to be called as a hanging man is that the market has to be in a bullish trend. Just like Hammer, a Hanging man can be of any colour as long as it meets the body to wick criteria. The Stop Loss for the short trades executed via hanging man pattern is the high of the candle.
— The Shooting Star
As the saying goes, save the best for the last. Probably the most influencing of the single candlestick pattern. The shooting star just looks like an inverted hammer or hanging man. It gives very strong trend reversal signals.
The basic characteristics of the Shooting star are:
- The shooting star candle has a long upper wick. Generally, the size of the wick is twice the size of the candle body. The longer the wick, the stronger the pattern.
- The shooting star is a bearish reversal pattern, so the preceding trend is bullish.
- In general, the shooting star happens on the day when the existing bullish trend is expected to continue.
- Once a shooting star candle is formed, it is advisable to exit the long trades or at least put a stop loss and if possible reverse the long positions.
- One has to be bias-free when trading this type of formation.
In conclusion, the above discussion should give us a clear picture of the various single candlestick patterns. All the patterns have their individual strengths. One has to be very aware of the basic mantra in the market: “Trend is your friend, always trade bias-free and always trade with a proper stop loss to be a long survivor in this marathon of trading”.
In the next article, we will be talking about Multi candlesticks patterns along with examples. “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!