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Candlestick Charting

(1) Hammer and Hanging Man (Candlestick Reversal Pattern)

In a Hammer, during a downtrend, there is an initial sharp sell off to new lows. However, by the end of the day, the market rallies to close at or near its high for the day.

The sharp recovery suggests that the bearish sentiment may be beginning to wane and if a move above the high of the Hammer days occurs during the next day's trading there is a stronger risk of complete trend reversal.

In a Hanging man, during an uptrend there is a sharp sell off after the market. By the end of the day, the market rallies to close at or near the high for the day.

This pattern definitely requires confirmation. The recovery in price over the day could mean the bulls are still in control. However, a break to new highs on the next trading day is required to confirm. Alternately, a decline to test the low of the Hanging Man day will suggest a trend reversal.

(2) The Engulfing-Bullish and Bearish

A bullish engulfing candle occurs after a significant downtrend. Note that the engulfing candle must encompass the real body of the previous candle, but need not surround the shadows. Below you will find an illustration of a bullish engulfing candle:

A bearish engulfing candle occurs after a significant uptrend. Again, the shadows need not be surrounded. Below you will find an illustration of a bearish engulfing candle: The power of the engulfing candle is increased by two factors -- the size of the candle and the volume on the day it occurs. The bigger the engulfing candle, the more

significant it is likely to be. A large bullish engulfing candle says the bulls have seized control of the market after a downtrend. Meanwhile, a large bearish engulfing says the bears have taken command after an uptrend. Also, if volume is above normal on the day when the signal is given, this increases the power of the message.

Bearish Harami Pattern is a two-candlestick pattern composed of a small black real body contained within a prior relatively long white real body. “Harami” is an old Japanese word for “pregnant”. The long white candlestick is “the mother” and the small candlestick is “the baby”.

Recognition Criteria :
1. Market is characterized by an uptrend.

2. We see a long white candlestick on the first day.

3. Then we see a black candlestick on the second day whose real body is completely engulfed by the real body of the first day. The shadows (high/low) of the second candlestick do not have to be contained within the first body, though it's preferable if they are.

Explanation:

The Bearish Harami Pattern is a sign of a disparity about the market’s health. Bull market continues further confirmed by the long white real body’s vitality but then we see the small black real body which shows some uncertainty. This shows the bulls’ upward drive has weakened and now a trend reversal is possible.

Important Factors:

It is important that the second day black candlestick has a minute real body relative to the prior candlestick and that this small body is inside the larger one. The Bearish Harami Pattern does not necessarily mean a market reversal. It rather predicts that the market may not continue with its previous uptrend. There are however some instances in which the Bearish Harami Pattern can warn of a significant trend change - especially at market tops.

A confirmation of the reversal on the third day is required to be sure that the uptrend has reversed. This confirmation may be in the form of a black candlestick, a large gap down or a lower close on the next trading day (the third day).

(4) Bullish Harami Cross

Bullish Harami Cross Pattern is a doji preceded by a long black real body. The Bullish Harami Cross Pattern is a major bullish reversal pattern. It is more significant than a regular Bullish Harami Pattern.

Recognition Criteria:

1. Market is characterized by downtrend.
2. Then we see a long black candlestick.
3. Long black candlestick is followed by a doji completely engulfed by the real body of the first day. The shadows (high/low) of the doji may not be necessarily contained within the first black body, though it's preferable if they are.

Explanation:

The Bullish Harami Cross Pattern is a strong signal of disparity about the market’s health. During a downtrend, the heavy selling reflected by a long, black real body; is followed by a doji next day. This shows that the market is starting to severe itself from the prior downtrend.

Important Factors:

The Bullish Harami Pattern is not a major reversal pattern, however the Bullish Harami Cross Pattern is a major upside reversal pattern. Short traders will not be wise to ignore the significance of a harami cross just after a long black candlestick. Harami crosses point out to the bottoms.

A third day confirmation of the reversal is recommended (though not required) to judge that the downtrend has reversed. The confirmation may be in the form of a white candlestick, a large gap up or a higher close on the next trading day.

(5) Inverted Hammer

If you are a regular Swing Trader reader, then the inverted hammer should seem very familiar. However, you may not be able to put your finger on exactly why it looks so familiar.

The reason is that the inverted hammer is identical in appearance to the shooting star, which we discussed in our December 8th, 2003 Swing Trader issue. The difference is that the shooting star occurs at the end of a long uptrend. The inverted hammer, on the other hand, occurs after a significant decline has taken place.

If you examine the inverted hammer carefully, it hardly looks like a bullish candle. Prices opened low and then rallied strongly. By the close of trading, however, the stock has given back almost all of the day's gains. That leaves a small real body and a very large upper shadow. If anything, the candle looks bearish. The bulls could not sustain a rally, so the bears took the stock back toward its lows for the day.

So, why should this candle potentially set up an important reversal? My theory is that the inverted hammer is a signal that shorts are beginning to cover their positions.

Here is my reasoning. Since the inverted hammer can only occur after a sustained downtrend, the stock is in all probability already oversold. Therefore, the inverted hammer may signify that shorts are beginning to cover. In addition, traders who have held long positions in the security, most of whom are now showing large losses, are often quick to dump their shares by selling into strength. This will also serve to drive the stock back down.

With this candle, it is imperative to watch the next day's trading action. If the stock opens strongly and remains strong during the day, then a key reversal is likely in progress.

(6) Piercing Lines

n a downtrend the market gaps open, but rallies strong to close above the previous days midpoint. This pattern suggests an opportunity for the bulls to enter the market and support the trend reversal. The Piercing Line pattern is the opposite of the Dark Cloud Cover.

A long black body followed by a white body.
The white body pierces the midpoint of the prior white body.

Occurs in a downtrend.

(7) Dark Cloud Cover

Recognition :

The market is in uptrend
1st day is a long white body
2nd day is a black body which opens above the previous day’s high
2nd day closes within, but below the midpoint of the 1st day's body

(8) Doji Star

A Doji Star is a trend reversal pattern which is composed of a long black body fol owed by a doji(a pattern with the same opening and closing price).

Recognition Criteria :

Long black day fol owed by a doji.
The doji gaps down from the prior black body.
(Confirmation is suggested.)

(9) Evening Star

Evening Star (Bearish)--a top reversal pattern where the first is a tall real body, the second is a small real body (green or red) which gaps high to form a star. The third is a red candlestick which closes well into the first session's green real body.

(10) Morning Doji Star

When a downtrend market is in place, fol owing by a Doji Star. Like the regular Morning Star, the third day will support the reversal of the trend. It is more significant than the regular Morning Star pattern.

Recognition Criteria :

The first day is a black day which indicates the trend of the market.
The second day must be a Doji day.
The third day is a white day and supports the reversal of the trend.
(Confirmation is suggested.)

(11) Evening Doji Star

An Evening Doji Star is when a Doji Star is in an uptrend fol owed by a long black body. Like the regular Evening Star, the third day will support the reversal of the trend. It is more significant than the regular Evening Star pattern.

Recognition Criteria :

The first day is a white day which indicates the trend of the market.
The second day is a Doji day.
The third day is black day which supports the reversal of the trend.
(Confirmation is suggested.)

(12) Abandoned Baby

Abandoned Baby pattern is similar to the family of Morning Star and Evening Star patterns. It is almost the same as Morning Doji and Evening Doji Star. The difference is the shadows on the Doji must gap below the shadows of the first and third days for the Abandoned Baby bottom.

Recognition Criteria:

The first day shal indicates the prior trend.
The second day is a Doji which gaps above or below the previous day's range.
The third day is the opposite color of the first day and gaps in the opposite direction.
There is no shadows overlapping between the Doji and other two days.
(Confirmation is suggested.)

(13) Trading the Upside Gap Two Crows Pattern

Description :

The Upside Gap Two Crows is a three-day pattern. The upside-gap is created between the long white candle at the top of an uptrend and the small black candle of the second day. The black candle gaps open and pulls back before the end of the day. Even though it has pulled back, it did not fill the gap. The third day opens above where the first black candle opened. It can not hold at these levels and pulls back before the end of the day. Closing lower than the previous day, it has engulfed the small black candle's body. However, it still did not close the gap from the white candle.

Criteria :

1. A long white candle continues the uptrend.
2. The real body of the next day is black while gapping up and not filling the gap.
3. The third day opens higher than the second day's open and closes below the second day's close. This produces a black candle that completelyengulfs the small black candle.
4. The close of the third day is stil above the close of the last white candle

(14) MEETING LINES

Meeting Lines (or Counterattack Lines) are formed when opposite colored bodies have the same closing price. The first Candlestick body is the same color as the current trend. The second body is formed by a gap open in the same direction as the trend. However, by the close, it has come back to the previous day's close. The Bullish Meeting Line has the same criteria as the Piercing Line except that is closes the same close as the previous day and not up into the body. Likewise, the Bearish Meeting Line is the same as the Dark Cloud pattern, but it does not close down into the body of the previous day.

Criteria :

1. The first candlestick body should continue the prevailing trend.
2. The second candlestick gaps open continuing the trend.
3. The real body of the second day closes at the close of the first day.
4. The body of the second day is opposite color of the first day
5. Both days should be long candle days.