In the stock investing sphere, chart patterns are crucial tools for traders seeking an edge over their competition. As more people recognize the potential for wealth creation through investing, a growing number of everyday Joes and Janes are turning their attention to the securities market. In fact, in recent years, the world has witnessed a dramatic surge in those who select to invest their hard-earned money in stocks.
Accompanying this rise in interest is the proliferation of stock tracking software, which has become the talk of the town among younger investors. That is so because intuitive trading apps have gained immense popularity due to their ability to keep a close eye on investments, track market trends, and help people make informed decisions regarding when to buy and sell securities. From seasoned professionals to novice investors, everyone seems to be leveraging the power of investing software to navigate the complexities of the stock market.
However, the real magic lies in the chart functions these digital platforms boast. Charting enables traders to visualize stock price movements and identify patterns that hold valuable insights, such as red and green candlesticks, bullish flags, symmetrical triangles, etc. Amidst the various pools of established charting techniques, candlestick patterns have gained significant recognition for their ability to provide traders with actionable information.
As most experienced investors know, candlestick patterns, named on account of their resemblance to actual candlesticks, are visual representations of price action over a specific period. These form an interplay of bullish and bearish market forces, revealing critical turning points and trend reversals. By recognizing them, traders can develop effective tactics for entering or exiting positions, setting stop-loss orders, and timing their trades more effectively.
Types of Candlestick Patterns
Without question, candlestick patterns are pivotal tools for technical analysis in trading, as these get formed by the open, high, low, and close prices of an asset within a designated time frame, often represented by a single stick on a chart. They supply essential data that depicts market sentiment, which can assist in accurately predicting price movements.
For those new to stock buying/selling, here are the six most famous candlestick patterns bandied about in this sector. Please note that these are only a few candlestick patterns in technical analysis. In our eyes, they are the most renowned ones, helping traders globally make wiser trades daily. It is vital for everyone to combine them with other technical indicators and examination techniques for comprehensive and accurate conclusions.
Characterized by nonexistent or small bodies, where the opening/closing prices are equal or close, this pattern points to a trend reversal or market indecision. Traders look for it to assess the balance between buyers and sellers and anticipate shifts in market sentiment.
Characterized by a long lower shadow and a small body near the top, the hammer suggests that buyers have come into a market after a decline, and all signs point to a prevailing bearish trend.
Essentially, this is the counterpart of the hammer, as it has a long upper shadow, and a small body near the bottom, telling investors that sellers have appeared following an uptrend, indicating a bearish reversal on the horizon.
When a small candlestick gets engulfed by the candlestick that follows it, that is an engulfing pattern, and a bullish one forms when a larger bullish one appears after a small bearish candlestick, signaling an upward reversal. Conversely, a bearish engulfing pattern warns of a downward reversal.
Here, we have three candlesticks, starting with a long bearish one, followed by a small-bodied candlestick that gaps below the previous close, and concluding with a long bullish candlestick, which tells of a bullish reversal.
As the name suggests, this pattern has a tiny body near the top and a long lower shadow. It resembles the hammer but happens after an uptrend, foretelling a likely bearish reversal.
Candlestick Trading Strategies
Several candlestick trading strategies exist that anyone can employ when making trading choices. That said, the five most famous ones are:
- Harami: The Harami pattern involves a small candle, often called the baby, within a range of the previous more sizable candle. Investors view this as a signal for a trend reversal, especially when the Harami shows up at primary support/resistance levels.
- Bullish/Bearish Engulfing: Here is a tactic entailing spotting a bullish or bearish engulfing pattern where a more visually substantial candlestick 100% engulfs the previous one. Investors read this as a sign of a reversal amidst an ongoing trend.
- Three Inside Up/Down: It looks for a three-candle pattern, where the middle one or second candle is in the range of the first and smaller, and the third candle confirms the reversal via closing above/below the second candle’s range.
- Morning Star/Evening Star: Most commonly used for spotting trend reversals, the Morning/Evening Star pattern features three candles: a long bearish or bullish one, followed by a candle small in stature that gaps in the opposite direction, and lastly, an impressive one set in the reversal’s direction.
- Doji Breakout: Analytic-savvy individuals seek the Doji (where the open/close prices are just shy of identical) followed by a breakout in the next candle. The tactic tells that, as discussed, the Doji indicates a period of indecision, and the breakout side, informs of a change in momentum.
Three Real-World Examples of Using Candlestick Trading to Great Effect
What follows are three historical instances of candlestick patterns getting publicized, leading investors to make trading choices that they otherwise would not have pulled the trigger on if this charting tool had not shown them the way.
2015 – Netflix Bearish Engulfing Pattern
In late 2015, Netflix’s stock captivated the attention of expert candlestick chart watchers. It exhibited a bearish engulfing pattern, which signaled a potential trend reversal. The streaming service’s shares initially opened positively, surging to a new all-time intraday high ($133.37). However, the sentiment quickly shifted as the bears counterattacked, overpowering the bulls and causing a significant downturn.
This bearish engulfing pattern, characterized by a sharp reversal after a final bullish surge, carried significance for traders and experts analyzing the stock’s performance. Notably, the closing price of that particular day fell below both the previous day’s open and the intraday low ($125.75), cementing the pattern as a “key reversal” signal.
Market participants closely monitored potential downside levels, focusing on prior resistance zones and support levels. Key areas of interest included the October and November intraday highs, followed by the November and October lows.
Although a similar bearish engulfing pattern had emerged in February of that year, it lacked the impact factor witnessed in this late 2015 occurrence. The distinctive features of this pattern, coupled with its chief reversal characteristics, made it a significant development in the context of Netflix’s stock performance.
Overall, the bearish engulfing pattern and the subsequent key reversal in late 2015 served as valuable insights for experts and traders, suggesting a potential shift in sentiment and warranting careful consideration of trading strategies and investment decisions.
2016 – Apple’s Harami Cross
In 2016, Apple Inc.’s stock showed an interesting development, with many market analysts showing a harami cross candlestick pattern regarding the company’s share in their tracking software.
The harami cross in this scenario was a two-day formation that emerged as the second candle’s price range fell fully within the bounds of the first one. That indicated a potential trend reversal for the stock, which warranted careful observation.
At that moment in time, Apple’s shares had been experiencing an impressive rally, climbing for seven consecutive sessions and reaching a ten-month high. Nevertheless, the appearance of the harami cross pattern served as a cautionary flare, suggesting a pause or reversal in the stock’s upward momentum.
Further analysis revealed that the second candle in the harami cross pattern was a doji, indicating a bearish reversal. The occurrence, characterized by a closing price ($117.34) nearly identical to the opening price ($117.35), implied a state of equilibrium between demand and supply.
Factoring the magnitude of the recent rally and the presence of the harami cross, industry insiders believed that a change in momentum was in play for the stock of iPhone’s creator.
In terms of price movement, Apple’s shares experienced a 0.3% decline following the harami cross formation, breaking the seven-day winning streak. However, it had surged by 21% in the past three months, outperforming its sector counterparts.
For investors, key support levels to monitor included the previous resistance at around $110 and the late-July and early-September lows at approximately $102.75. These were significant as they could supply support in the event of a decline, representing potential buying opportunities.
The harami cross pattern and its implications on Apple’s stock highlighted the importance of considering technical analysis alongside fundamental factors.
2017 – Apple’s Stock Experienced a Doji Pattern
In February 2017, Apple Inc’s stock displayed an above-average upward trend (soaring 11%), showing a potential reversal signal based on a bearish doji chart pattern.
Technical analysts often consider record highs to be bullish. In Apple’s case, the doji emerged after a significant rally. The stock opened higher but closed near its opening price, indicating uncertainty and potential exhaustion of buying pressure.
Doji patterns are usually regarded as warning shots of trend reversals, particularly after an extended rally. They imply that the support from buyers may weaken, potentially leading to a market downturn. In this instance, the doji happened during an ongoing uptrend and coincided with an overbought reading on the Relative Strength Index, further supporting the reversal scenario.
It is paramount to note that a doji alone does not confirm a reversal but only serves as a cautionary signal. Traders must monitor subsequent candlestick patterns or price movements to validate/invalidate the looming reversal.
On January 11, 2006, Apple’s stock chart presented a similar doji reversal pattern. That happened after a prolonged uptrend and a significant increase in price, with the RSI indicating an overbought condition. Although prices initially rose over the following sessions, they eventually experienced a sharp decline. The stock fell by as much as 40% before hitting a bottom six months later. This historical instance demonstrates the potential importance of doji patterns in indicating trend reversals and subsequent price movements.
To Sum Up
Candlestick patterns are vital in technology-driven trading, giving investors a glimpse into market sentiment and potential reversals of trends. These visual representations of price movements aid in spotting critical turning points and entry/exit opportunities. Popular patterns like Doji, Hammer, and Engulfing offer actionable insights for all, and combining candlestick analysis with other indicators supplies a comprehensive market view.
Real-life examples, like the cited ones here: Netflix’s bearish engulfing in 2015, and Apple’s harami cross and doji patterns in 2016-2017, showcase their practical significance. By comprehending and using candlestick analysis, individuals can make educated decisions that improve their trading success rate.