Foundations of Trading: A Trader’s Journey [Part 6]

Welcome to part six of our blog series: A Trader's Journey, where we are covering the second level of the Foundations of Trading class program. Today's blog will cover the teachings in level 2 class 1, and if you wish to review our previous blogs regarding this program, please click on the Foundations of Trading blog category on the right-hand side of the page. That will instantly bring up all the blogs from this series for you to read. As for today's topic, we will take a look at the three main categories of chart or candlestick patterns.

Candlestick Patterns

A candlestick pattern is a grouping of candles next to each other, which form a recognizable pattern. A single candle will show a possible sentiment change throughout one period, but recognizable patterns can and do develop when you string together multi candles or multiple periods. And just like individual candles, many identifiable patterns appear on stock charts.

Thus, when you understand the meaning or story of the patterns, you can make more informed trading decisions or plans regarding the stock in question. However, even with all the various patterns which can be found on a stock chart, the information they provide falls into two categories. They will either indicate a stock is coming up on a price reversal or forecast a continuation of the current pattern.

Reversal Pattern

A reversal pattern predicts or forecasts a change in the price direction of a stock. A prime example of this is the Bullish Piercing Pattern.

The Bullish Piercing Pattern is made up of two candles and is found in a current downtrend. The first candle is a bearish candle that clearly shows the sellers are in firm control as the stock price closed lower than it opened. The second candle is bullish in nature and usually starts lower than the closing price of the previous period; however, buyers push the price of the stock back up to the middle of the previous candle. These two candles next to each other are a reliable indicator of a short-term bullish trend as the stock price starts to climb higher.

Continuation Pattern

A continuation pattern predicts an extension of the stock's current price direction. An excellent example of this is the Rest After Battle pattern.

The Rest After Battle pattern is a bullish continuation pattern that can be found in an upswing. It is composed of a large white candle in the first period followed by two or more smaller candles, which more or less trade sideways. These smaller candles will stay within the range of the first white candle as they fail to drive the price lower than the opening price of the first candle. Finally, a large white candle will appear to complete the pattern. The first and last period candles are similar in size and price points. Ultimately, this pattern ends up with a second stronger push higher, which confirms the continuation of the current trend upwards.

​Consolidation Pattern

Sometimes the push for a reversal or a continuation pattern fails to solidify as the stock in question stays within a defined price range of historical support and resistance lines. When this happens, a stock has entered a consolidation period where the stock bounces between two defined price points but fails to break out either higher or lower than its historical support and resistance. A consolidation period is neither good nor bad; it is just a period where a stock's movements will be more along the lines of maintaining instead of significant swing moves. You can trade the channel as the stock moves between support and resistance and make small returns; however, looking for a big price move might be hard to find due to the lower than normal trade volumes which usually accompanies a stock that found itself in a consolidation period.

In closing, an identifiable pattern of candlesticks is a clear indicator of growing support for either a reversal or a continuation in a stock's performance and being able to recognize these patterns will provide any trader reliable information from which they can trade. Thank you for reading, and join us next week, where we dive into Foundations of Trading Level 2 class 2.