1/26/2010

Candlesticks Reversal Patterns

Used for over 300 years, candlestick chart patterns provide viable tools in determining the present and the future nature of the market.
One of the candles most widely tracked is the one called Doji. It is formed when the openings and the closings of the bar are very close to each other, thus forming a cross pattern. They present a very strong warning especially if they are positioned right after a long red or green candle.

Doji is indicative of the weakness of the existing trend. It shows that buyers and sellers are equally matched, thus raising a red flag to anyone expecting the trend to go on. This indecision in the marketplace portrayed by Doji usually results in the change of the market direction. The future bar should be closely watched to see if the market can brake to new lows/highs.
Another reversal patterns consists of the Hanging Man and the Hammer formations. They are both formed when the opening and the closing prices are in proximity of the bar high with the low of the bar being significantly lower. Good criterion for these formations to be valid is if the length of the down leg is 3 or more times larger than the difference between the open and the close.

Hanging Man formation occur in up trends, and after a long up bars are indicative that the market is running out of steam and may reverse. The same but opposite is the true of the Hammer.
The third reversal pattern is called Shooting Star and Inverted Hammer. They are similar to previously stated formation, but the full body of the candle (the difference between open and close) is located close to the low of the bar.

Yet another reversal pattern is Dark Cloud Cover. It is identical to a normally considered reversal bar pattern when after a long up bar, market opens up, establishes a new high, but closes significantly lower than previous bar close. For the reverse signal to be valid, the half of previous bar body has to be pierced. The same but the opposite is true with Piercing Line which signals reversal of down trend.

Please note that these indicators have a better probability of success if they are part of a significant trend. If these patterns occur in a narrow trading range, they tend to be less reliable.

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