Foundations: The Story Behind the Pattern

In today's blog which covers Foundations of Stocks and Options Level 2 Class 6, we are going to discuss what information candlestick patterns can offer. If you remember from last Thursday’s blog, The Story Behind a Candlestick, we ​covered the idea that an individual candlestick tells a story. A story where every part of a candlestick has something to say.

For example, if a candlestick has an extended bottom wick or shadow, then it is indicative of considerable selling pressure throughout the period; however, the selling pressure was not sustainable, and the bulls came roaring back pushing the price point back up. The reverse is true as well; if a candlestick has a long upper wick, then it is indicative of considerable buying pressure throughout the period; however, the buying pressure was not sustainable, and the bears came back pushing the price point down. Finally, if there is little to no wick on a candlestick, then the battle for control of the stock’s price was one-sided as the stock either went up or down in value with little struggle or pressure against the change.

Again, every part of a candlestick has valuable information, and while that is true with just one candle, it exponentially true when it comes to a series of candlesticks or a candlestick pattern.

​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 when you string together multi candles or multiple periods, recognizable patterns can develop. And just like individual candles, many identifiable patterns appear on stock charts.

Thus, when you understand the meaning or story of the patterns, then you can make a 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 they will 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 price of the stock 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 is a reliable indicator of a short-term bullish trend as the price of the stock 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 and is 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 period candle and the last period candle are similar in size and price points. Ultimately this pattern ends up with a second stronger push higher, which makes it a confirmation in the continuation of the current trend upwards.

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.

As always, if you wish to learn more, please consider signing up for our Foundations of Stocks and Options class, which you can do here. Thank you for reading, and we hope to see you next week as we dive into the Foundations of Stocks and Options Level 2 Class 7!