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The Art of Candlestick Charting - Part 4

This article is reproduced with the permission of Investopedia.com.

In Part 1 of this four-part series on candlestick charting we review the components of a candlestick, and in Part 2 we introduce the techniques of analyzing patterns. In part 3, we start to look at some of the more recognizable or perhaps popular patterns that regularly appear on candle charts.

This article focuses on continuation patterns and how they could deny or confirm trends in today's markets, giving the investor a clearer picture of whether or not to hold his or her position or execute a buy/sell order.

The Patterns 
We continue this look at candle charts with some additional patterns on both the bullish and bearish sides of the equation. On the bullish side of the market, show you the 'engulfing pattern', 'harami', and the 'harami cross'. Opposite, on the bearish side, we will have a closer look at the 'engulfing pattern', 'the evening star' and both the 'harami' and the 'harami cross'.

Engulfing Pattern - Bearish
Engulfing pattern (bearish) develops in an uptrend when the sellers outnumber the buyers; this action is reflected by a long red real body engulfing a small green real body.

 

You can see the opening was higher than the previous day, and, during the trading session, the issue sold off with volume much greater than the previous session.

(Please note that the charts in part 3 were black and white. To avoid confusion, you should know that candle charts in many of today's software programs are shown in red [instead of black] and green [instead of white]).

Engulfing Pattern - Bullish
Engulfing pattern on the bullish side of the market is the opposite of the previous pattern and takes place when the buyers outpace the sellers, which is reflected in the chart by a long green real body engulfing a small red real body.


As you can see, this is a chart of an issue in a downtrend that has now lost momentum. The buyers may be coming back into this issue, creating a trend reversal and bottoming out of this downtrend.

Evening Star - Bearish
Evening star (bearish) is a top reversal pattern that is very easy to identify because the last candle in the pattern opens below the previous days' small real body, which can be either red or green and closes deep into the real body of the trading range of the candle two day's prior.

This pattern shows that investors are perhaps losing confidence in the issue and it's direction. This thought process will be confirmed if the next day is another down session.

Harami - Bearish
Harami (bearish) is another very recognizable candlestick pattern that shows a small real body (red) completely inside the previous day's real body.


Technicians will watch very closely now because the harami bearish indicates that the current uptrend may be coming to an end, especially if the volume is light. Students of candlestick charts will also recognize the harami pattern as the first two days of the three inside pattern.

Harami - Bullish

Harami (bullish) is just the mirror reflection of the harami bearish. As you can see in the chart above, a downtrend is in play and a small real body (green) is shown inside the large real body (red) of the previous day. This tells the technician that the trend is coming to a conclusion. The harami implies that the preceding trend is about to conclude. A candlestick closing higher the next day would confirm the trend reversal.


Harami Cross - Bearish
Harami cross (bearish) is a pattern of a harami with a doji instead of a small real body following up on the next trading session.The doji is within the range of the real body of the prior session.

Like the harami, the trend starts out in play, but the market then decides to reverse intra-day with volume being somewhat non-existent and the pattern closing at the same price as the issue opened. The uptrend has been reversed.

Harami Cross - Bullish
The harami cross, whether the bullish or bearish version, starts out looking like the basic harami pattern. The harami cross bullish is the exact opposite of the harami cross bearish and does not require any further explanation. Again, a trend has been reversed.

This four-part series barely scratches the surface of Japanese candlestick charts and the interpretation of the patterns. If you want to gain more in-depth knowledge be sure to read Steve Nison's excellent books on the subject.
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