The cornerstones to technical studies

The interplay
of the body size and the shadows as well as the open and close of one
or more candles is what produces the candlestick patterns. At the
outset, it should be understood that almost all the candle patterns are
“reversal patterns”. A black candle (bearish) following a white candle
(bullish) would “reverse” the earlier bullishness. A small body candle
(indecision) would reverse the implications of a long bodied candle
(decisiveness) etc. A few candle patterns are continuation patterns.

Most
of the patterns are single candle patterns. There are some two-candle
patterns and a few three-candle patterns. Multi candle patterns
consisting of more than three candles are not very many and are rarely
seen.

One mostly gets to see the single or two candle pattern.
All of them are reversal patterns. Some points relating to this needs
to be understood right at the outset.

Reversal patterns, since
they are seen so frequently, need to be confirmed. In other words, the
market or stock should follow through in the direction of the indicated
reversal. Else, it is to be deemed to have failed. All single and two
candle reversal patterns need to be confirmed. Three candle patterns
and higher do not need confirmation as the multiple candles in
themselves are taken as confirmations.

Reversal patterns must
have something to reverse. Meaning thereby, that any pattern that seeks
to reverse, must be preceded by some directional movement. The extent
of reversal would depend upon the extent of the move – either up or
down – which preceded the appearance of the pattern. It naturally
follows from the above that any reversal pattern seen in a sideways
phase is value less as there is nothing to reverse.

Pattern
failures – in view of the fact that they are so frequent – are seen
very frequently. A lack of confirmation has to be taken as a pattern
failure. One must then look for a reversal of the signal shown by the
earlier pattern. This is a subtler signal and one caught with some
experience of using candlestick.

	HAMMER It is a bottoming candlestick line where a small real body at the top of the trading range with a very long shadows with little or no upper shadow.
	HANGING MAN It is topping pattern where a small real body with little or no upper shadow but a long lower shadow. It is a bearish reversal pattern when appearing during an uptrend.
	SHOOTING STAR It is a bearish candlestick with a long upper shadow with little, or no lower shadow, and a small real body near the lows of the session. It is bearish when seen at the end of a an advance.
	DOJI A candle with no body as open and close is at the same level. It indicates high levels of indecision and is bearish if seen at the end of long upmoves and bullish if seen at the end of long down moves. There are some varieties of Doji such as Long Legged -very long shadows, Gravestone – open and close at the low of the day and Dragonfly – open and close at the high of the day. All have the same implication.

The relation
between two adjacent candles forms these patterns. The second candle is
the one that completes the pattern. Because two candles are involved,
they are slightly more reliable patterns than the single candle
variety. Nevertheless, they too require confirmation. In all two candle
patterns, the second candle will be the opposite color of the first
candle.

	DARK CLOUD COVER I n an uptrend, a long white candlestick is followed by a long black candlestick that opens above the prior white candlestick’s high and then reverses to close around the low of the day. The second candlestick must close well into the first candlestick’s real body- beyond half of the prior candle’s real body. This forms the Dark Cloud Cover (pattern on the left) and it is a bearish pattern. Exactly the opposite situation is the case at the bottom. At the low, it is called Piercing Line.
	ENGULFING PATTERN An engulfing pattern occurs when the price movement for the day completely moves beyond the previous day’s candle. Depending on the position, it is called either a bullish engulfing pattern (at the bottom) or a bearish engulfing pattern (at the top). In this pattern, the stock opens below (above) the previous candle and then proceeds past the previous day’s high (low) and closes near the high (low). Thus it completely “engulfs” the previous candle.
	HARAMI It is a two-candlestick pattern in which a small real body holds within the prior session’s unusually large real body. The harami implies that the preceding trend is getting ready to conclude. The color of the small body candle is not really important in this case. In Japanese the word harami means “pregnant with”. It is similar to the inside day pattern of traditional technicals. A variety of this pattern is a doji in the place of the small body candle. It is then known as a Harami Cross (picture on right). The implication remains the same.
	PIERCING LINE It is the mirror image of the Dark Cloud Cover at the bottom. A long black candlestick is followed by a gap lower during the next session. This session finishes as a bullish white real body, which closes more than halfway into the previous sessions real body. a green candlestick which closes in the prior red’s real body, but still below the middle of the prior session’s real body. One of the varieties of this pattern is the Thrusting Line pattern (shown on the right) where in the candle body marginally penetrates into the previous candle (i.e. less than halfway). There are a couple of more varieties of these called In Neck Line and On neck line where the extent of penetration is up to the low of the previous candle or the body of the previous candle only.

These are
patterns formed of three or more candlesticks. Since one has to wait
for the completion of the pattern across a minimum of three trading
sessions, usually, these patterns do not require a confirmation by
price action. However, it is always prudent to seek confirmation from
the market for all candle patterns.

ADVANCE BLOCK
	It is a three candlestick pattern in which the last two candlesticks show strengthening upside or downside drive but the third candle is a small bodied one which verily halts the move. Usually referred to for the upside but no reason why one cannot also refer to it on the downside.

STAR PATTERNS
Morning Star		Evening Star
Morning Doji Star		Evening Doji Star
The Star patterns are the most common and among the most effective patterns in candlestick. They consist of a three candle pattern. The middle candle is flanked by two long bodied candle of opposing colors. It does not matter what color the middle candle but it must meet two criteria. One it should be small body candle. Two it should leave a gap with the first candle. A gap with the third candle is not necessary but would show strength of the next move if present. The third candle must penetrate significantly into the body of the first candle and should be of the opposing color as the first one. The greater the penetration, the better the pattern. The three together are knows as the Star. Depending upon its position in the trend, it is either known as a Morning Star (at the bottom) or Evening Star (at the top). A variant of this is when the middle candle is a doji pattern instead of a small body. In such a case it is called a Morning Doji Star or an Evening Doji Star. These patterns show an even greater reversal at hand.

3 SOLDIERS & CROWS
3 falling crows		3 White Soldiers

These
are patterns made up of three relatively long consecutive bearish
(Crows) or bullish (soldiers) candlesticks that close near or on their
lows (crows) or highs (soldiers). Each candle will open around the
previous close and in almost all the cases; there will be no body gap.
While the patterns may appear to suggest reversal, it is more often
seen when a new move has been set off. That is, the onset of such a
pattern warns of more moves to come in the same direction. If 3 white
soldier patterns are seen then the next reaction is to be bought, as
the stock is likely to progress into another uptrend after a
correction. Vice versa for the 3 crows pattern. No confirmation
necessary for this pattern.

RISING OR FALLING THREE
Falling 3 (bullish)		Rising 3 (bearish)

These
patterns are comprised of five candlesticks; a long real body
candlestick preceded three small bearish real bodies, which hold within
the first session’s – which is also a long body candle -range. So there
are two long body candles interspersed by three small body candles. The
direction of the small body candle decides the pattern. The subsequent
move is opposite to the direction of the small body candles. The final
candle must be long and should close in the opposite direction to the
small body candles. The color of the small candles is not important.

The
above patterns encompass more or less the main candlestick patterns.
There are many other minor patterns also and more are being identified.
Most of the commercially available softwares manage to do a good job of
identifying the patterns thus making the job of the analyst easier. The
following chart shows three major patterns on the Sensex chart. Right
near the top of the last upmove, the market reversed with a Bearish
engulfing pattern, and then followed this up with an Evening Star that
led to a sharper decline. This moved ended with a bullish engulfing
pattern, which produced a minor rally.

Candlestick
charting proves to be an excellent visual method to study the market.
There are greater nuances involved in interpretation of the Candle
chart that we shall take up when we look at the more advanced
considerations of technical analysis. Applying the candle patterns as
per their rules would give one a decent handle on the trend. Some
simple observations, which can be made to help with, the pattern and
trend identification are as follows :