Candle formations in Forex

Traders around the world are constantly trying to identify the moods and trends in the market: upwards and downwards, while at the same time a large group of investors are enjoying the profits made or increasing the volume of positions to earn even more. They are able to use small hints visible in the charts, which are interpreted using technical analysis. While some investors focus only on line charts, candlestick charts are much more popular with professional speculators. While classic technical patterns are applicable in both cases, Japanese candlestick patterns generate a much wider range of signals. Due to their design, they provide more information about the price.

Candlestick patterns can be divided into two groups: trend reversal and continuation. In this lesson, we'll look at both cases in more detail.

Basic candles

Before we get into specific patterns, it's worth taking a look at the underlying candlesticks that often appear on the chart every day. These undeniably include doji and marubozu candles, which we briefly describe below.

Doji:

Doji are extremely important candlestick patterns that can be treated as a separate formation or part of multi-candlestick signals. Doji occurs when a given financial instrument opens and closes in the same or a similar place. The length of the top or bottom shadow (wick) can vary, resulting in the doji candle taking the shape of a cross, inverted cross, or a plus sign. Single doji candles are considered neutral signals - but when combined with other candles and market trends, they can indicate an impending bullish or bearish move.

Marubozu:

In turn, marubozu candles confirm the strength of opposing sides - buyers and sellers. They do not have lower or upper shadows, and the high or low of a given interval (candlestick) is represented by the opening or closing price. A marubozu growth candle is formed when the low of the session coincides with the opening and the peak with the close. This gives a clear signal that demand controlled the course of the transaction from the first to the last position entered. On the other hand, a bearish marubozu candle is formed when the top of the session coincides with the opening and the bottom with the close. This indicates that the supply controlled the course of the session from the first to the last transaction.

A trend reversal pattern

Candlestick reversal patterns indicate a weakening of a given trend and a possible return. For example, when we invest in EURUSD and identify a specific reversal pattern, we can expect a correction in the near future. However, it should be remembered that most of these types of patterns require additional confirmation. If, however, after the occurrence of such a signal, there is no correction, then it is negated.

Below is a list of the most popular trend reversal patterns:

• Bullish and bearish engulfing patterns
• Upward and downward harami
• Hammer and inverted hammer
• Evening and morning star
• hangman
• Falling star

If the trader manages to identify any of the above patterns on the chart, he should wait for the next candlestick to mark the signal. For example, if the EURUSD pair recorded an increase and a bearish engulfing system appeared at the local peak, then it is worth waiting for the next candle to draw and close - if it is falling, it will confirm the strength of the signal. This is one of the basic principles that apply to all candlestick patterns.

A bull market and a bear market

The engulfing patterns are technical reversal patterns and can take either an upward or downward trend, depending on whether they occurred in an uptrend (bear engulfment) or a downtrend (bullish engulfment). The first candle should be completely within the contour of the second candle that "embraces" it.

Upward and downward harami

Harami is a two-candle system that is the reverse of an embrace pattern. In this case, the second candle has a small body, and the mother candle is in the first position, completely embracing the next candle (with the opposite direction).

Literature also distinguishes the so-called harami crosses, for which the design is very similar. The only difference is that the second candle takes the form of a doji with a very narrow body.

Hammer:

The hammer pattern appears on the chart as the price of the financial instrument moves down dynamically right after opening, but reverses before the session close, clearly above the low lows. As a result, the resulting candle resembles a square lollipop with a long handle. If such a pattern occurs during downturns it is referred to as a hammer. Such a pattern appearing on dips is called a sledgehammer, while an inverted hammer is called a shooting star as illustrated below.

Evening and morning star:

The morning star is a bullish reversal pattern consisting of three candles - with a long body of a downtrend candlestick, a short center candlestick downward, and another bullish candlestick that closes above half the body of the first candlestick.

The evening star, on the other hand, is a mirror image of the morning star, representing a trend reversal pattern. The first candle suggests a continuation of the bull market, the second one has a small body and also shows an increase, and the last one is heading south and closing below half of the body of the first candle.

For both patterns, the middle candle can also take the form of a doji. It doesn't really matter much for the probability of the direction of the pattern, it just looks different on the graphical side of the chart.

Hangman:

The hangman pattern occurs when a given financial instrument moves downwards dynamically at the opening, but reverses the initial move in the following hours of the session and closes clearly over previously drawn lows. As a result, the candle looks like a square lollipop with a long shank. If the pattern is formed during an uptrend, it is known as a hangman. It does not automatically mean that buyers have lost control of the market, but it can be an early signal of slowing down momentum and an impending trend change or at least a correction. As you can see, the formation is very similar to a hammer. But what makes them different? The only question is the nature of the trend in which the patterns will appear. If the chart moves upwards and suggests dips are coming, then the system is called a hangman in the reverse situation.

Falling star:

Another major trend reversal is a shooting star that may suggest the end of an uptrend. Shooting stars are single-candle systems with a small body and a very long upper shadow. The candle can be supply or demand, but a stronger sell signal is generated in the case of downtrend (supply) candles. For a candle to be identified as a falling star, the pattern must be in an uptrend and the distance between the high of the session and the opening price should be at least twice the width of the candle body.

The long top shadow of the shooting star suggests that the market has tested resistance levels that have proved to be too strong a barrier for buyers and that sellers may soon go on the offensive, at least in the short term.

Trend Continuation Patterns

The trend continuation patterns are used by traders to confirm future market movements in line with the current momentum. They often appear after a long period of stabilization, correction or consolidation. Identification of such a technical system, as in the previous examples, should be confirmed by another candle that follows the main trend.

Below is a list of the most popular trend continuation patterns:

• Three white soldiers
• Three black crows
• Tasuka's up and down gap
• Formation at the neck and around the neck
• Three is bearish and three is bullish

Three white soldiers:

The three white soldiers is a formation of three growth candles with a similar structure. Each of them closes higher than the previous one, and when the candles are wickless, the buy signal is stronger.

Three black crows

The reverse of the formation of the three white soldiers. In this case, the trader is dealing with three bearish candles with a similar design. Each of them closes lower than the previous one, and when they are devoid of wicks then the sell signal is stronger.

Tasuka's upward and downward gap:

Tasuka's upward gap consists of three candles - an output gap appears on the chart after the first. If it does not close, it means that the uptrend is maintained, while when it closes, it most likely means the end of increases.

At the same time, Tasuki's downward gap is a continuation pattern with a long bearish candlestick followed by a supply gap and another downward candlestick. Failure to close the gap is a signal of continuation of the trend, while its closing suggests its ending.

At the neck and around the neck

Neck is a two-candle pattern that usually follows a downtrend. The supply candle is the first one, while the next one is rising. At the same time, its closing is close to the closing of the first candle. The neck layout is one of the easiest to identify on the chart.

The formation on the neck looks very similar, confirming the downtrend. Unlike under the neck, the second candle closes slightly above the first candle's close. At the same time, it should be remembered that the effectiveness of the neck system is not as high as the neck formation.

Three is bearish and three is bullish

Bearish and bullish triples are undoubtedly one of the most interesting formations which are highly effective, but unfortunately appear relatively rarely. The formation begins with a long candlestick in an ascending or descending direction followed by three candles with small bodies pointing in the opposite direction. The fifth candle, however, continues the movement of the first candle, closing above or below the range of the entire system.

A drop in the sea of all candle formations:

Candlestick patterns are gaining more and more popularity as they often provide interesting trading signals. They are also an important technical analysis tool to understand market emotions. Thanks to them, the investor can identify potential turning points, which is why they are such an important point in virtually every strategy. However, it is worth noting that the above article presents only a few of the most popular of the many available systems. However, the investor does not need to know each of them - just focus on a few that most often generate accurate signals.