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CANDLESTICKS

Candlesticks charting is a technical tool used for Forex analysis consisting on individual candles that indicate price action. Candlestick charts are popular in day trading for two reasons. They offer a wide range of trading information and their design makes the charts easy to read and interpret the prices action. 

Candlestick charts are among the earliest known forms of technical analysis dating back to trading in the Japanese rice markets in the 18th century. Candlestick charts or just candles for short provide a more visually intuitive representation of price action than you get from simple bar charts. They do this through the use of color and by more clearly breaking out the key price points of each forex trading day open, close high and low. 

 

Various forms of the 'DOJI':

Doji candlesticks have the same open and closing price or at least their bodies are extremely short. A Doji should have a small body that appears as a thin line.

Doji candles suggest indecision or a struggle for turf positioning be- tween buyers and sellers. Prices move above and below the open price dur- ing the timeframe session but close at or very near to the open price. Neither buyers or sellers were able to gain control with a result that is essentially a draw between the bulls and the bears.

There are four special types of Doji candlesticks. The length of the upper and lower shadows can vary and the resulting candlestick gives a formation similar to a cross, inverted cross or plus sign. The word 'Doji' refers to both the singular and plural form. When a Doji forms on your chart, ensure special attention is given to the preceding candlesticks.

Doji candlestick pattern is one of the most important candlestick patterns. Representing the equilibrium between supply and demand in the markets, it is a clear trend reversal signal. Communicating the prices open and close at or near the same level, candlestick Doji indicates indecision of investors. It is therefore very important to recognize Doji. If the Doji makes appearance after a long uptrend, it is a warning to investors that the trend is either close to peaking, or has already peaked in the open markets. But if it is visible after a long downtrend, it means that the prices have been forced down.

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The Spinning Top:

The candlestick with a long upper shadow/ wick, long lower shadow/ wick and small real bodies are called 'spinning tops'. The colour of the real body is not very important as this pattern simply indicates the indecision between the buyers and sellers, bulls and the bears.

The small real body (whether green or red) shows little movement from open to close and the shadows/wicks indicate that both buyers and sellers, bulls and bears were fighting but neither gained the upper hand. Even though the session opened and closed with little change, prices moved significantly higher and lower in the meantime.

If a spinning top or even a series of spinning tops formed during an uptrend, this usually means there are not many buyers left and a possible reversal in direction could occur. If a spinning top or series of spinning tops formed during a downtrend, this usually means there are not many sellers left and a possible reversal in direction could occur.

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Spinning Top Candle Stick

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The Hanging Man:

The Hanging man is bearish candlestick pattern that forms at the end of an uptrend. It is created when there is a significant sell off near the market highs, but buyers are able to push the currency pair back up so that it closes at or near the opening price. Generally the large sell-off is seen as an early indication that the bulls (buyers) are losing control.

As mentioned, this formation is bearish if they occur after a significant up- rend but this pattern occurs after a significant downtrend it is called a Hammer. They are identified by small red bodies (small range between opening and closing prices) and a long lower shadow (the low was significantly lower than the open, high and close)

The Hanging man has little to no higher shadow/ wick and has a lower shadow / wick which is at least two times as long as the body of the candle. Unlike the hammer, the lower shadow / wick which constructs the bottom half of the candle indicates selling pressure. An excellent price action trade setup is when the formation is established at a point of resistance.

Step 1 is simply highlighting the hanging man candlestick formation with the rectangle tool ensuring the highest degree of accuracy at the top wick and bottom wick, extending the box over to the right hand side (allowing price to play out). This becomes the setup chart and you will then have to (view image below).

WEEKLY> DAILY.

DAILY> H4

H4 >H2

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Once the candlestick has been highlighted we then step down to the adequate timeframe (listed above). In this example the hanging man was spotted on the weekly chart so we then step down to the Daily timeframe in order to follow the execution rules (as displayed below) We now have a refined viewpoint of the price action and rather than entering a 50-50 sell trade right after the hanging man has formed, we can simply wait for the M.A crossover and a clear candlestick break below the range. In doing this we have simply awaited a clear sign of a reversal in momentum, the resistance has held firm and the trend is reversing to the downsid

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The Hammer (also known as a Pin bar):

The Hammer and Hanging man look exactly alike but have totally different meanings depending on past price action. Both have cute little bodies (green or red), long lower shadows/ wicks and short or absent upper shad- ows/ wicks. 

 

The Hammer is basically a bullish reversal pattern that forms at the end of a downtrend. It is named a Hammer because the market is 'hammering' out a bottom. When price is falling, a hammer signals that the bottom is near and price will start to rise again. The long lower shadow / wick indicates that sellers pushed the price lower but buyers were still able to overcome this selling pressure and closed relatively near the open price.

As a word of caution, when you see a hammer it does not necessarily mean that that you should go and place a buy order. One will need more bullish confirmation to do so. Use the hammer signal as a warning, a potential upside reversal.

How to recognize a Hammer, the Japanese candlestick reversal pattern? It is fairly easy. The long shadow is about two or three times of the real body. There is little or no upper shadow. The real body is at the upper end of the trading range and the colour of the real body is not too important but a green hammer gives stronger confirmation.

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The shooting Star:

The Shooting formation is created when the open, low, and close are roughly the same price. Also, there is a long upper shadow/ wick, generally defined as at least twice the length of the real body. When the low and the close are the same, a bearish Shooting Star candlestick is formed and it is considered a stronger formation because the bears were able to reject the bulls completely plus the bears were able to push prices even more by closing below the opening price.

The long upper shadow of the Shooting Star implies that the market tested to find where resistance and supply was located. When the market found the area of resistance or the highs of the day, bears began to push prices lower, closing the candle near the opening price. Thus, the bullish advance upward was rejected by the bears.

Ultimately, a Shooting Star candle indicates that the prior uptrend is about to end and may reverse into a downtrend or move sideways and into a period of consolidation. This formation is an excellent trade signal upon the high test of a resistance level by the shadow / wick. You can execute a sell trade upon the close of the candle with a stop loss 10 PIPs above the area of resistance as displayed on the following page.

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Tweezer Tops and Tweezer Bottoms:

The tweezers are dual candlesticks reversal patterns. This type of candlestick pattern could usually be spotted after an extended uptrend or downtrend, indicating a reversal is soon to occur. Notice how the formation looks just like a pair of tweezers.

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The most effective tweezers have the following characteristics:

  • The first Tweezer candle is the same as the overall trend, if price is moving up, then the first candle should be bullish/ green (as displayed in the above left image)

  • The second candle is the opposite of the prevailing trend. If price has been moving up, then the second Tweezer candle should be bearish/ red. (as displayed in the above right image)

  • The shadows/ wicks of the candles should be of equal length. Tweezer tops should have the same highs (roughly) while Tweezer bottoms should have the same lows.

(Tweezer tops/bottoms are high probability price action reversal patterns that can be found on a range of timeframes. This setup is as powerful as the shooting star as it gives a clear indication that the price tried to reach higher on two occasions but was rejected, forming a clear point of resistance. These are best when traded from a point of previous resistance with a stop loss placed 10 PIPs above/below the shadow/wick highs or lows.

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The Marubozu:

The Marubozu candles have no shadows/ wicks attached to the closing price of their bodies. Depending on whether the candlesticks body is green or red (bullish or bearish), the high/ low is in fact the same as its open and close price.

The green/ bullish Marubozu consists of a long green body with no shadows/ wicks at the closing price (TOP). It is seen as a very bullish candle as it indicates that buyers were in control for the length of the candlesticks timeframe. It usually becomes the first part of a bullish continuation move or a bullish re- versal pattern.

The red/ bearish Marubozu on the other hand consist of a long red body with no shadows/ wicks at the closing price (BOTTOM). This is a very bearish candle as it indicates that sellers dominated price action throughout the whole candles timeframe, usually implies bearish continuation or bearish reversal. The larger the timeframe, the stronger the bullish/bearish Marubozu move. The recommended timeframes are the weekly & daily as these give a strong indication that further momentum is expected in the specific direction in which the Marubozu candle is formed.

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Bullish Engulfing Formation:

Bullish Engulfing pattern usually occurs at the bottom of a downtrend or consolidation range at levels of support. It forms when a small red candlestick is followed by a large green candlestick that completely 'engulfs' the body of the previous candlestick.

The Bullish Engulfing pattern indicates a change in sentiment from a bearish decline, to a large green body candle that advances and closes at the highs of the previous candle. Buyers step in after the open and take control of the market. Generally, the greater the engulfing, the more bullish the reversal. Large volume during the period in which the green candle forms, is an important confirmation of the short term reversal.

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Bearish Engulfing formation:

Bearish Engulfing pattern usually occurs at the top of a downtrend or consolidation range at levels of resistance. It forms when a small black candlestick is followed by a large white candlestick that completely "engulfs" the body of the previous day's  candlestick.

The Bearish Engulfing pattern indicates a change in sentiment from a bullish advancement, to a large red body candle that closes at the lows of the previous candle. Sellers take control after the open and dominate price action. Generally, the greater the engulfing, the more bearish the reversal. Large volume during the period in which the red candle forms, is an important confirmation of the short term reversal.

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The Morning Star formation:
The morning star formation is one that consists of three candlesticks. For the

following examples, we will be referring to daily candles for ease of understanding.

The Morning Star starts with a Bearish/ red candlestick which represents selling acceleration. The next candlestick can either be a Spinning Top, a Doji or a Hammer/ Pin bar. This second candlestick represents indecision and a sudden halt to the downside acceleration. The third and final candlestick in this formation is a bullish/ green candlestick that must close within the upper 40% of the first bearish/ red candlesticks range. Upon this bullish confirmation, a buy trade can be executed upon the opening of the next candlestick.

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The Evening star formation:
The Evening star formation again consists of three candlesticks. For the following examples, we will be referring to daily candles for ease of understanding.

The Evening Star starts with a bullish/ green candlestick which represents buying advancements. The next candlestick can either be a Shooting Star, a Doji or a Spinning Top. This second candlestick represent s indecision and a sudden halt to the upside advancements. The third and final candlestick in this formation is a bearish/ red candlestick that must close within the lower 40%.the first bullish/ red candlesticks range. Upon this bearish confirmation, a sell trade can be executed upon the opening of the next candlestick.

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The Inside Bar Formation:

The Inside Bar formation consists of two candles, the second bar is completely contained within the range of the first bar (also known as the mother bar). The formation is a high-probability price action trading strategy that provides traders with a good risk reward ratio since they typically require smaller stop losses than many other setups.

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An Inside bar formation indicates a time of indecision or consolidation. Inside bars typically occur as a market consolidates after making a large directional move, they can also occur at turning points in a market and at key decision points like major support and resistance levels.

The most effective way to trade the Inside Bar setup is to establish the high and low of the first mother candle. The market is likely to break the high or low and continue in the same direction so the most effective way to trade this price action pattern is to set a buy stop order 5 PIPs above the mother candles shadow / wick high and a sell stop 5 PIPs below the mother candles shadow / wick low.

The stop loss should be placed at the opposite end of the mother candle. 15 PIPs above. When the price eventually breaks out, you will be in the trade. You can then cancel the other stop order to prevent it being absorbed if the market reverses. Set your target levels in line with previous support/ resistance levels.

The first step when recognising an inside bar formation is to draw a highlighted box range from the top and bottom wick of the first candle (Mother Bar) as accurately as possible. These formations are brilliant to trade at key levels of support/resistance in order to catch the reversal. Once you have highlighted the formation with the rectangle tool you then step down to the lower timeframe and follow the execution rules. The best inside bar formations are found on the Daily timeframe:

Weekly>Daily | Daily > H4 |  H4 > H2
The example below is a daily timeframe inside bar, so we now step down to the H4 chart.

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Below is the H4 execution chart, stepped down from the Daily inside bar formation. As displayed, we now have a refined viewpoint of the currency pairs price action. The first step is to await the moving average crossover in the direction of the reversal/trend direction. Step 2 is to await a clean breakout & candle close above the box range (in the case of this particular example). You then execute the trade position with the target at the next key level with the stop loss placed 15 PIPS below the opposite end of the rectangle box.

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