Foundations of Trading: A Trader’s Journey [Part 9]

Welcome back to part nine of our blog series: A Trader's Journey. Today's blog will cover Josh's teachings from level 2 class 4. If you wish to review our previous blogs covering the Foundations of Trading classes, 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 review. For today's blog, we will cover a few candlestick patterns you can find on your candlestick chart.

Remember, a single candlestick will quickly tell you the opening price point of a stock, the lowest price point, the highest price point, and the closing price of the day's trading session. The candle's color shows if the stock closed higher or lower than its opening price, and the wicks on the candle show how high or low the price went during the time period of the candle. Grant, this is essential information, but when you string together multiple time periods, patterns will start to emerge, and these patterns can provide a stronger sense of market sentiment than a single candlestick would.

Shooting Star

The Shooting Star candlestick is a particular type of spinning top candlestick pattern, and the physical attributes of this candlestick make it easy to spot in a candlestick chart. For starters, it has a very long upper wick or shadow, which is usually two to three times the size of the candlestick's body formation. This represents the price of the stock that opened during the period and went higher in a strong move. However, the candlestick body's size is smaller than an average candlestick and reflects the failure of the bull's price push to hold its ground, and in response, it fell back, ending the period slightly above where it started.

Finally, there is little to no lower wick or shadow, which means even though the bulls failed to retain much of the ground they moved during the period, the bears' counterattack had a minimal effect against the stock opening numbers; the bulls stood their ground.

Regardless of the candlestick's color, as it can be either black (red) or white (green), the candlestick's meaning as a bearish reversal signal remains the same. Below is an example image of a Shooting Star where the market closed up for the period.

A Shooting Star candlestick is a strong bearish reversal signal. However, the position of the candlestick in a candlestick chart is of utmost importance as it needs to be found after an upswing or upward trend to be considered a reversal signal. If you are currently in a long position trade, it is recommended you tighten your stops to lock in your profits and prepare for a drop in the security's price. ​If you are looking for a short trade, you might want to keep your eyes on this stock's activity in the next period to confirm a short sale.

​Hammer

The Hammer candlestick is a subset of the Spinning Top candlestick. A Hammer candlestick's body can be either black (red) or white (green) in color and is usually small in stature. The small candlestick body signifies the stock's opening price, and the stock's closing price was close in value. The Hammer candlestick has little to no upper wick or shadow and has a very long lower wick or shadow, usually two to three times the size of the candlestick's body formation.

This represents the price of the stock dropping lower after it opened. However, the candlestick's body's size is smaller than an average candlestick and reflects the failure of the bear's price drop to hold its ground, and in response, the bulls pushed the price back up again.

Hammer candlesticks are found at the bottom of a downswing or bearish trend and are a strong bullish reversal signal. They are a sign the market is finding the bottom of its current move and looking to reverse course. Thus, if the next candlestick's price action is up and confirms the reversal signal, you might want to apply a little technical analysis to see if a long trade is right for you and your trading plan.

​Doji

The Doji candlestick is recognized by the candle's open and close prices, which are usually the same. This produces an easy to identify small to nonexistence candlestick body that resembles a cross or plus sign and can be either black (red) or white (green) in color. The absence of a candlestick body signifies a price struggle among buyers and sellers, which failed to produce a clear winner.

Usually, a Doji will have a long upper and long lower wick, which shows a price movement during the period. However, both the buyers and the sellers failed to move the market in either direction, and the result is typically a continuation pattern. Below are a few examples of the various types of Doji candlesticks.

A Doji is typically a continuation pattern unless found at the top or bottom of price trends. Then it can be the harbinger of an impending price reversal. If you find a Doji at the end of a downward trend which is a known line of support, it could be a bullish reversal signal. The opposite is true as well; if you find a Doji at the top of an upward trend that lands on a known line of resistance, a bearish reversal could be next. As always, you should confirm the price action of the next candle breaks above or below the Doji before entering a reversal trade.

In closing, there are more patterns that we can learn, but even getting a few of them in your toolkit will benefit you on your trading journey. After all, everything on a candlestick chart tells a story, and once we learn to read the chart patterns, we can begin predicting what will happen next. Because if life is an indicator of anything, it is human behavior is predictable.