Candlestick Patterns

Umbrella Lines

If an umbrella line emerges during a downtrend, it is a signal that the downtrend should end. This umbrella line is known and labeled as a hammer, as in “the market is hammering out” a base.

If an umbrella line emerges after a rally, it is a potential top reversal signal, called a hanging man.

The hammer and hanging man can be recognized by three criteria:
1. The real body is at the upper end of the trading range. The color of the real body is not important.
2. It has a long lower shadow (wick) that should bee at least twice the height of the real body.
3. It should have no, or a very short, upper shadow (wick).

There are three aspects that differentiate the hanging man from the hammer, specifically:
– Trend: a hammer must come after a decline. A hanging man must come after a rally.
– Extent of the move before the candle: a hammer is valid even if it comes after a short-term decline, but a hanging man should emerge after an extended rally, preferably at an all-time high.
– Confirmation: a hanging man should be confirmed, while a hammer need not be.

Hammer

The hammer’s long lower shadow and close at, or near, the high of the session graphically relays that the market sold off sharply during the session and then bounced back to close at, or near, the session’s high. This could have bullish ramifications.

Hanging Man

The hanging man has the same shape as the hammer; the only difference is that a hanging man comes after an advance. It is especially important that one wait for bearish confirmation with the hanging man. The reason for waiting for a close under the hanging man’s real body is that if the market closes lower the next day/session those who bought on the open or close of the hanging man are now left “hanging” with a losing position.

Engulfing Pattern: Bullish and Bearish

There are three criteria for an engulfing pattern:
1. The market has to be in a clearly definable uptrend (for a bearish engulfing pattern) or a downtrend (for a bullish engulfing pattern), even if the trend is short term.
2. Two candles comprise the engulfing pattern. The second real body must engulf the prior real body (it need not engulf the shadows).
3. The second real body of the engulfing pattern should be the opposite color of the first real body.

Some factors increasing the likelihood that an engulfing pattern could be an import turning signal are:
1. If the first day of the engulfing pattern has a very small real body and the second day has a very long real body.
2. If the engulfing pattern appears after a protracted or very fast move.
3. If there is heavy volume on the second real body of the engulfing pattern.

A prime use of the engulfing pattern is utilizing them as support or resistance. The high becomes resistance and the low becomes support.

Dark-Cloud Cover

Some factors intensifying the importance of dark-cloud covers include:
1. The greater the penetration of the black real body’s close into the prior white real body, the greater the chance for a top.
2. If the second candle of the dark-cloud cover opens above a major resistance level and then fails.
3. If, on the opening of the second candle, there is very heavy volume, then buying blow off could have occurred.

Piercing Pattern / Piercing Line

For the piercing pattern, the white real body pierces, but does not wrap around, the prior black body. Int the piercing pattern, the greater the degree of penetration in the black real body, the more likely it will become a bottom reversal.

The piercing pattern’s white candlestick should push more than halfway into the black candlestick’s real body.

Morning Star

The lowest of the three lines that form this pattern should be support. An ideal morning start would have a gap between the second and third real bodies.

A limitation with the morning star is that since this is a three-candle pattern, one has to wait until the close of the third session to complete the pattern.

Evening Star

Some factors increasing the likelihood that an evening or morning star could be a reversal would include:
1. If there is no overlap among the first, second, and third real bodies.
2. If the third candle closes deeply into the first candle’s real body.
3. If there is light volume on the first candle session and heavy volume on the third candle session.

Shooting Star

Since the shooting star is a bearish reversal signal, it must come after a rally. An ideal shooting star has a real body that gaps away from the prior real body.

Inverted Hammer

The inverted hammer needs bullish confirmation. This confirmation could be in the form of the next candle opening above the inverted hammer’s real body or especially a close the next candle over the inverted hammer’s real body.

The reason for the required bullish verification of the inverted hammer is because its long upper shadow gives the inverted hammer a bearish hue.