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Three Types of Candlesticks Every Trader Should Know

August 15, 2016 by Lior Alkalay 4 Comments

Understanding the various types of candlesticks is one of the first things every novice trader should learn. But the experienced trader should also never forget the candlesticks’ significance. Because sometimes, when you have to figure out what’s about to happen with a certain pair and all other indicators fail, it’s the basics of reading candlesticks that can save the day—just like a sailor who navigates using the North Star when all else fails.

But even when you’re not in the unknown, reading candlestick shapes well lets you figure out the immediate trend quickly and can save time in the long run. So, regardless of your level of trading experience, here are three candlesticks every trader should know.

Hammer Candlesticks

A hammer candlestick, as its name suggests, has a hammer-like form, with the opening and closing price rather close, and the lower shade (or upper shade if it’s a reverse hammer candlestick) substantially long.

Candlesticks

What a hammer signals is a change of momentum. If we examine the bearish hammer, we can see the candlestick’s closing price substantially lower than the highest point. That suggests that selling pressure has been so strong that it pushed for a close that is way below the high; in other words, the sellers have the upper hand. And vice versa for a bullish hammer where the momentum is set to turn bullish from bearish.

Note that each hammer type has a stronger version which suggests the change in momentum will be stronger. If we’re on a bullish trend and the next candlestick is a hammer, where the closing price is not only much lower than the highest price for the candlestick but lower than the opening, then it suggests a much stronger change in momentum.

Nevertheless, the greatest determinant in assessing the strength of the rebound to follow is the shade. The longer the shade of the candlestick compared to the rest of the candlestick, the stronger the change in momentum expected.But on the flipside, beware if the shade is relatively short; the change in momentum might be unreliable.

Doji Candlesticks

A Doji candlestick is a candlestick where the opening price and the closing price are so close they almost align. There are several variations of the Doji candlestick, but these three are the most noteworthy.

Candlesticks

The Standard Doji – The standard Doji candlestick is similar to the general description above, with the opening and closing price aligned (or almost aligned) and the two shades sticking out. What a standard Doji implies is a stalemate between the buyers and the sellers at the opening/closing price. When it comes after a certain trend, down or up, it suggests a pause, and could imply either a resumption of the trend or a change in trend. But that’s not all. Compared to the other two, the standard Doji has a relatively short shade on both sides and that suggests a weaker momentum.

Long Legged Doji – This is perhaps the most interesting Doji candlestick. Just like the standard Doji, the opening and closing price align almost perfectly. But unlike the standard Doji, the shades on both sides are much longer. What it means is that, just like the standard Doji, there is a stalemate between the sellers and the buyers at the opening/closing price. However, unlike the standard Doji, the long shades imply high volatility around the stalemate area. This means that once the stalemate is broken, we can expect a burst of momentum because volatility is high.

Dragonfly Doji – The somewhat exotic name for this candlestick type is a bit misleading. With a long low shadow, the Dragonfly tends to have the same meaning as the aforementioned Long Legged Doji, albeit with a weaker momentum. Because, otherwise, it would be a hammer with a closing price higher than the opening price. (The Gravestone Doji is a reversed Dragonfly Doji, with the same meaning as a bearish hammer and hence only worth this brief mention.)

Engulfing Candlesticks

The engulfing candlestick truly lives up to its name. The candlestick can exist in two forms—a bullish engulfing candlestick and a bearish engulfing candlestick.

Candlesticks

The engulfing candlestick’s clearest distinction is that it engulfs in size the aforementioned candlesticks.

A bullish candlestick will have either a lower opening price than the closing of the previous candlestick or the same price as the previous candlestick closing price but a lower low. But more importantly, the closing price of the bullish engulfing candle is a much higher high. The bearish engulfing candlestick, as illustrated below, is the exact mirror of the bullish engulfing candlestick.

What does an engulfing candlestick signal? A start of a strong trend. Bearish or bullish, when you encounter an engulfing candlestick you should expect a strong move which can be beneficial for momentum traders seeking to ride a strong trend but an engulfing candlestick can also be risky for those who have a position in the opposite direction.

In Conclusion

Obviously, understanding the various candlestick types cannot and should not replace the technical indicators. But recognizing the candlestick types does allow you to quickly figure out what’s coming next, even when in uncharted territory. When the picture cannot be completed by technical indicators, knowing the candlesticks to watch could be your guiding star.

Filed Under: How does the forex market work? Tagged With: candlestick chart, doji, engulfing, hammer

Five Different Dojis

July 26, 2015 by Richard Krivo Leave a Comment

Any doji candle signals market indecision and the potential for a change in direction by price action.  (Always bear in mind that the “potential” for a change is not a guaranteed change in direction.)

Doji’s are formed when the price of a currency pair opens and closes at virtually the same level within the timeframe of the chart of which the doji occurs.  Even though there might have been quite a bit of price movement between the open and the close of the candle, the fact that the open and the close takes place at almost the exact same price is what indicates that the market has not been able to decide which way to take the pair…to the upside or the downside.

doji

Let’s take a look at the doji highlighted on this historical 4 hour chart of the AUDCAD below…

doji 1

At the point where the doji occurs, we can see that price has retraced a bit after a fairly strong move to the downside.  If the doji represents the top of the retracement (which we do not know at the time of its forming) a trader could then interpret the indecision and potential change of direction and short the pair at the open of the next candle after the doji.  The stop would be placed just above the upper wick of the doji.  In this case, that trade would have worked out nicely.

Keeping in mind that the higher probability trades will be those that are taken in the direction of the longer term trends, when a doji occurs at the top of a retracement in a downtrend or the bottom of a retracement in an uptrend, the higher probability way to trade the doji is in the direction of the trend.  In the case of an uptrend the stop would go below the lower wick of the doji and in a downtrend the stop would go above the upper wick.

Dojis are popular and widely used in trading as they are one of the easier candles to identify and their wicks provide excellent guidelines regarding where a trader can place their stop.

Below is an example of a Standard Doji candle…

standard

 

 

The Long Legged Doji below simply has a greater extension of the vertical lines above and below the horizontal line.  During the timeframe of the candle, price action dramatically moved up and down but closed at virtually the same level that it opened.  This shows the indecision between the buyers and the sellers.

long leg

 

The Dragonfly Doji below can appear at either the top of an uptrend or the bottom of a downtrend and signals the potential for a change in direction.  There is not line above the horizontal bar signifying that price did not move above the opening price.  A very extended lower wick on this doji at the bottom of a bearish move is a very bullish signal.

dragon

 

 

The Gravestone Doji below is the exact opposite of the dragonfly.  It appears when price action opens and closes at the lower end of the trading range.  After the open the buyers were able to push the price up but by the close they were not able to sustain the bullish momentum.  At the top of a move to the upside, this is a bearish signal.

grave

 

 

The 4 Price Doji below is simply a horizontal line with no vertical line above or below the horizontal.  This would be the ultimate in indecision since the high, low, open and close (all four prices represented) by the candle were exactly the same.  It is a very unique pattern signifying indecision once again or simply a very quiet market.

4

 

 

 

The basic rules we learned about trading a doji at the beginning of this article would apply to each of these unique dojis as well.

 

 

All the best and good trading…

Richard Krivo

@RKrivoFX

RKrivoFX@gmail.com

Filed Under: How does the forex market work? Tagged With: doji

Understanding Overbought and Oversold

February 26, 2015 by Richard Krivo Leave a Comment

If you are cooking something and you check on it and you see that it is “overdone” or “overcooked”, what is your immediate reaction?  Exactly.  You take the dish out of the oven.  Remove it from what caused its current overdone state and the sooner the better.

Too late for our chicken dinner below…

burned

 

What if your car’s engine is “overheated”?  Same deal…you do what it takes to get the engine cooled down.  Immediately stop doing what caused the engine to become overheated in the first place.

overheat

 

Given these natural reactions, it is easy to see why the initial and almost immediate move by many newer traders to an “overbought” or “oversold” trading scenario is to do the opposite in that case as well.

They reason that since many buy (long) orders moved price up and pushed the indicator into overbought territory, we must do the opposite and take a short (sell) position.  Conversely, if many sell orders caused the price to drop and move into oversold territory we much begin to take long positions.  It’s almost as though they expect price to snap back like a rubber band when it reaches these overextended zones.

Well…what is instinctively the proper reaction for chicken dinners and car engines is not necessarily the proper reaction when trading.

It is important to remember that when an indicator goes into the Overbought/Oversold areas, it can remain there for quite some time.  Just because the RSI or Stochastics indicator reads overbought for example, does not mean that price action on the pair is like a tightly compressed spring that is going to immediately snap back toward the Oversold area.

Let’s take a look at a historical Daily chart of the NZDJPY pair below for an example of this…

overbought chart

Notice on this chart that when Slow Stochastics went above 80 (in the red rectangle) into the overbought area, price continued to go up for another 780+ pips and Stochastics stayed overbought the entire time.  Clearly a trader who went short when it first when into overbought territory would have missed out on a great move.  They also would have gotten stopped out of their short position very quickly.

To see an example of where price retreats  when Slow Stochastics goes into overbought territory we need to look no further than the area labeled “A” on the chart.  In this case the candlesticks around “A”, dojis, spinning tops, shooting star and a hammer, indicate the potential for a pullback.

The point to be made is that either scenario can play out so don’t have a knee jerk reaction to the overbought and oversold areas of an indicator.

Remember…

Only take entry signals from an indicator that are in the direction of the longer term trend.

For example, if the trend has been strong and prolonged to the upside, it stands to reason that the indicator will be in overbought territory since it reflects the bullish push of price action.  To take a short position at that point would to trade against the trend and that would be introducing more risk into the trade.

Good trading,

Richard Krivo

RKrivoFX@gmail.com

@RKrivoFX

Filed Under: Uncategorized Tagged With: doji, hammer, NZDJPY, overbought, oversold, shooting star, short, Stochastics, trend

SPY and Dojis

October 10, 2013 by Shaun Overton Leave a Comment

Everyone here knows that I’m a fan of the dumbest possible strategy. The less complex that rules are, the easier it is to understand when something inevitably breaks.

The SPY and Doji strategy from paststat most certainly fits the bill. The SPY is the ETF that tracks the S&P 500 index.

They tested a simple idea: does a doji on the SPY contain any predictive value? The short answer is a qualified yes.

The dojis offered no predictive value on their own. However, teaming them up with a 200 period moving average showed much better results. Use the location above or below the moving average showed a clear relationship between profit and loss.

SPY Doji

So am I not touting this to all my readers? The biggest problem with a strategy like this is the sample size: there are only 40 trades in the largest sample. Some of the posted results only analyze the outcomes of 12 trades. That’s not a strategy. It’s hardly an observation, either.

What I do like about the idea is that it hightlights something fundamental about how the stock market works. I always think of it as a pair trade. You buy 1 unit of stock for every X dollars of currency.

You’re really pair trading two asset classes: one is a stock, the other is dollars. The flow of the forex market dominates stocks. A surge in dollar strength almost certainly anticipates a down day in stocks.

The fits and starts of the forex market lead stocks to crawl their way upward. Bull markets last for years and years. Unless you’re counting Fed days, there’s no particular move that dominates in stocks.

SPY Strategy Idea

Contrast that with bear moves and the difference is night and day. Everyone knows about the 1987 crash when the market crashed 22% in a single day. Our more recent crisis in 2008 inflicted similar damage over a period of weeks.

Price crossing the moving average is one of my favorite strategies. It’s dummy proof and I’ve seen it work in several markets, especially forex commodity crosses.

The SMA filter that paststat applied in the doji strategy might just make for a better daily trading strategy altogether. I’d even be tempted to ignore the long trades and take short only signals. A simple filter like the put-call ratio might help filter out the worst of the noise trades.

What I like even more is that it’s a strategy that could apply in today’s market:

  • The stock market is trading on record margins of debt
  • Selling the idea of a crisis isn’t hard with the potential US default looming

We’ll have to take a look at this in more detail tomorrow.

Filed Under: Trading strategy ideas Tagged With: default, doji, dollars, forex, leverage, moving average, SMA, SPY

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