SPECIAL REPORT: CANDLESTICK PATTERN SUMMARY Louise Bedford This Special Report is an extract from the Candlestick Charting Home Study Course. It is a handy, quick reference guide that you can refer to in order to help you remember and confirm the validity of any candlestick pattern that you come across. Part 1 provides you with diagrams of the most frequently occurring candlestick patterns, as well as information on the formation description, location and psychology. Part 2 gives you a chance to practice your skills so that you can ensure correct identification of patterns on a series of charts. This will help you to consolidate your knowledge. Although you may be familiar with the majority of candlestick patterns, this Special Report is designed to act as a refresher. It is not intended to replace the information presented in The Secret of Candlestick Charting. If you have not yet read this book, it is highly recommended that you do so in order to fully grasp the principles behind each candlestick pattern. Available on DVD and video is The Secret of Candlestick Charting Video Program, a one-day course suitable for introductory to intermediate traders. The Candlestick Charting Home Study Course is another more advanced reference for intermediate to advanced traders. Happy Trading! Louise Bedford 1
Index Part 1 - Review Candlesticks Review Part 2 - Analysis Westpac and Lion Nathan Examples Ramsay Healthcare Questions Ramsay Healthcare Answers Disclaimer The material in this publication is of the nature of general comment only, and neither purports nor intends to be advice. Readers should not act on the basis of any matter in this publication without considering (and if appropriate, taking) professional advice with due regard to their own particular circumstances. The author, Trading Secrets Pty Ltd and any relative distributing agents expressly disclaim all and any liability to any person, whether a purchaser of this publication or not, in respect of anything and of the consequences of anything done or omitted to be done by any such person in reliance, whether whole or partial, upon the whole or any part of the contents of this publication. 2
Part 1 Review In this guide, the small bars before and after the candlestick formation show the direction of the preceding and following prices on the chart. Pattern Description Location Psychology Shooting Star This pattern displays an upper tail length that is two or more times the length of the real body. Gaps increase the intensity of this pattern. Black Shooting Stars have greater bearish significance. Shooting Stars appear at the top of a trend. Trading below the body of the Shooting Star is required to confirm this pattern. The upper tail shows seller pressure and rejection of higher prices. The small body shows indecision, and suggests the trend is likely to reverse. Hanging Man This pattern can appear in either colour and displays a long lower tail below the real body. There is likely to be no tail, or a very short tail on the other side of the real body. Hanging Men appear at the top of a trend. Gaps increase the significance of the pattern. Trading below the body of the formation will confirm the effectiveness. The lower tail shows that the bulls' confidence has been shaken, which increases the likelihood of a future downtrend. A black Hanging Man is more bearish than a white Hanging Man. Hammer Hammers can appear in either colour and display a long lower tail below the real body. There is likely to be no tail, or a very short tail on the other side of the real body. Hammers appear at the bottom of trends. Gaps, and trading above the level of the Hammer, especially on heavy volume confirm the efficacy of this pattern. The lower tail shows that buyers are moving into the market, and this may create an uptrend, particularly if heavy relative volume is present. A white Hammer is more bullish than a black Hammer. This is a typical rejection pattern. Inverted Hammer This pattern can appear in either colour and displays a long upper tail above the real body. There is likely to be no tail, or a very short tail on the other side of their real body. Inverted Hammers appear at the bottom of trends. Trading above the level of the body of this pattern shows that the pattern has been effective, especially on heavy relative volume. Gaps increase the significance of the pattern. The upper tail shows that buyers are testing higher prices, and this may create an uptrend, particularly if heavy relative volume is present. A white Inverted Hammer is more bullish than a black one. A Hammer of either colour is more bullish than an Inverted Hammer. Spinning Top Spinning Tops display a small real body. The tail length is largely unimportant and the candle can be either white or black, (white is more bullish, and black is more bearish). This pattern appears at the top or the bottom of a trend. Gaps before and after its formation increase its effectiveness. Gaps, or price movement above (for bottom reversals) or below (for top reversals) suggest confirmation. This represents a state of balance between the bulls and the bears, suggesting a trend reversal. For a trend to continue, an imbalance of bulls and bears must be present eg. buyers must outnumber sellers for an uptrend to continue. 3
Doji The open and close are at the same price (or nearly at the same price) for that period. Doji can be found at the tops and bottoms of trends. Adequate confirmation shows prices reverse quite dramatically after the appearance of the Doji. A Doji is one of the strongest signals as it suggests that this particular price represents a fair value in the minds of the traders. The share will typically reverse it's direction the day after the appearance of a Doji. Bearish Engulfing Pattern The second real body of this pattern (black) totally engulfs the first real body (white) and is a bearish sign as the price has closed lower than it opened for that period. This pattern is found only at the tops of uptrends. Trading below the midpoint of the second candle suggests confirmation. If heavy relative volume is present on the second candle, or the confirmation, the effectiveness of the pattern is increased. The size of the first candle suggests that the bulls are weak. The length of the second candle, in addition to the fact that it closed below the body of the first, suggests that the bears are stronger than the bulls, especially if the second candle has heavy relative volume. Bullish Engulfing Pattern The first candle must be black and the second candle must be white. The second candle must totally engulf and close above the body of the first. These patterns are found at the bottom of downtrends. Confirmation would show trading above the mid-point of the second candle, preferably on increased volume levels. The bulls have outnumbered the bears as shown by the range of the second candle. It is a particularly strong signal if the second candle occurs on heavy relative volume. Dark Cloud Cover The second black candle must penetrate 50% or more into the body of the white candle. This two-candle formation is a top reversal pattern. Trading below the second candle, or at least below the mid-point of the final candle, will confirm the effectiveness of this pattern. A downward gap is also common. The pattern is not quite as significant as the Bearish Engulfing Pattern. In candlestick philosophy, patterns that are more significant display greater penetration levels of one candle into the body of another. Piercing Pattern The 50% penetration level of the second white candle into the body of the first black candle is essential to fulfil the definition of this pattern. This is a bottom reversal pattern that lacks the power of a Bullish Engulfing Pattern. Prices higher than the final candle are required to confirm the effectiveness of the Piercing Pattern. This pattern is usually only effective if it occurs during an existing medium term uptrend, where momentum will help drive prices higher. Increased volume on the second candle will add to the effectiveness of the pattern. Harami The second candle is engulfed by the first. The first and second candle can be either colour, including the same colour. This is a bottom and top reversal pattern that usually suggests a trend softening rather than a violent reversal. Subsequent trading within the body of the first candle suggests the trend is softening. Trading above the pattern confirms a bottom reversal Harami and trading below the pattern confirms a top reversal Harami. The directional implications of the first candle have been confused by the appearance of a small second candle, which indicates indecision. 4
Evening Star 2 1 3 This bearish three-candle top reversal pattern shows a long white real body (1), a small star of either colour (2), then a black real body (3). This pattern is especially significant if there are gaps between each candle. This is a top reversal pattern. Confirmation of this pattern involves trading below the midpoint of the final candle. If a Doji forms the second candle, the strength of this pattern is intensified. This pattern displays 'decision' (shown by the upward direction of the first candle), 'indecision' (shown by the small body of the second candle) and 'confirmation' (depicted by the bearish location of the third candle). Morning Star 1 3 2 This bottom reversal pattern shows a long black real body (1), a small star of either colour (2), then a white real body (3). Heightened volume on (3) will also increase its effectiveness. This is a bottom reversal pattern. Confirmation of this pattern involves trading above the midpoint of the final candle. If a Doji forms the second candle, the strength of this pattern is intensified. This pattern shows 'decision' (shown by the downward direction of the first candle), 'indecision' (shown by the small body of the second candle) and 'confirmation' (depicted by the bullish location of the third candle). Tweezer Top This pattern displays the highs of two (or more) periods that form upper shadows with their peaks at exactly the same price. The candles can be of either colour. The Tweezer Top will be found at the top of uptrends, or within an uptick of an existing downtrend. Either location has a bearish implication. Confirmation is if the subsequent sessions trade below the level of the Tweezer Top. The price has tried to rally at least twice, yet has been unable to sustain this bullish push. Upper shadows were formed as a result. Tweezer Bottom The Tweezer Bottom shows the lower shadows of two or more candlesticks at the same price point before a rally. This pattern appears at the bottom of downtrends. It can also be found within the downtick of an existing uptrend. In this situation, a Tweezer Bottom may demonstrate a pause in the uptrend prior to future bullish behaviour. The lower prices have been tested, and rejected by the market. The colour of the bodies is not significant. The presence of multiple lower shadows creates the pattern. Higher prices are likely to follow, especially if volume is significant on the final candle(s) that forms the Tweezer Bottom. Upside Tasuki The initial white candle is followed by an upward gap to the next white candle. The third session shows a black candle that does not fully close the gap. This pattern will add strength to the existing upward trend. If this gap is closed, it is unlikely that the uptrend will be sustained in the short term at least. A gap indicates a powerful move in market sentiment and can form a strong barrier of support or resistance. The final bearish candle does not close the gap, which forms a level of support. Downside Tasuki The first session is a black candle that gaps strongly down at the opening of the next session. The second candle is also black. The third candle is white and doesn't close the gap formed. The share must already be in downtrend and confirmation consists of trading at or below the level of the second candle. The gap created by the first and third candles acts as resistance. If subsequent trading had closed the gap, the downtrend would be more likely to reverse. 5
Rising Three Three central weak bearish candles are found between two long white candles. The final candle closes above the range of the previous candles. This is a bullish continuation pattern and trading above the midpoint of the final candle suggests that the trend is likely to continue. The strongest candles in this pattern are the first and last ones. This suggests that the overall trend will continue upwards. The placement of the central candles implies a weak bearish downtrend, which is no competition for the strength shown by the bullish candles. Falling Three The first black long candle precedes three smallbodied candles. The placement of these candles implies a weak bullish uptrend, not their colour. The final candle has a long black real body that closes below the body of the initial candle. This pattern appears during existing downtrends. Confirmation is if subsequent prices are below the mid-point of the final candle. The close of the final candle at a lower price level shows that the pattern has made a lower low, therefore it is bearish. The strength of the bearish first and final candle displays the main sentiment behind this pattern. This same information is also available as a full colour, laminated wall chart (A2 size - 594mm x 420mm). You can order The Secret of Candlestick Charting Poster from www.tradingsecrets.com.au. 6
Part 2 - Analysis Have a look at the following charts and identify the main candlestick patterns that are apparent. Feel free to refer to Part 1 of this report to assist you. Take lots of notes as you complete all of the exercises presented. This will assist in improving your retention. There is plenty of room below and around the presented charts for you to do this. For the best results, print out this entire file before continuing, if you have not already done so. Fig 1.1 WESTPAC BANK - Daily 7
Fig 1.2 LION NATHAN - Daily Have a look at how I ve analysed these charts. (This type of analysis is somewhat subjective, so even if you haven t identified exactly the same patterns - that is fine). 8
Fig 1.3 WESTPAC BANK - Daily Dark Cloud Cover & Spinning Top Spinning Top Evening Star Piercing Pattern Bullish Engulfing Pattern Fig 1.4 LION NATHAN - Daily Harami or Shooting Star Bearish Engulfing Hanging Man Doji Harami 9
Let s try that again. Have a look at the chart shown in Fig 1.5 and circle any of the patterns that you recognise. This time, try combining this identification process with some brief comments about the share price direction. To help you do this, I have set out some questions below each chart. Fig 1.5 RAMSAY HEALTH CARE - Daily 1) Is the trend of Ramsay Health Care (Fig 1.5) up or down? What makes you say that? 2) Can you identify any Western based patterns on this chart? (eg triangular patterns, double bottoms etc.) Circle these on the chart, as well as drawing in key support/resistance and trend lines. 3) If the share is likely to maintain its bullish behaviour, where is it likely to retrace to before it meets support? 10
4) Would this share be one that you would be likely to buy? What other information would you like to know about this share before you purchased it? What specific indicator(s) would time your entry? ANSWERS Have a look at the completed chart below (Fig 1.6) and see how you fared: Fig 1.6 RAMSAY HEALTH CARE - Daily Double Top forming a Resistance line Support Bearish Engulfing Pattern Harami Tweezer Top Piercing Pattern Ascending Triangle Hammer Uptrending Line 1) Ramsay is displaying a series of higher lows. This fulfils the definition of an uptrend. It is also displaying a series of higher highs. This also suggests that the trend upwards is quite strong. 2) Of particular note is the ascending triangle and the double top. Traditionally, a double top is only confirmed after the neck-line is broken (ie. after there is trading below the Harami pattern). 11
3) Ramsay is likely to drop to a previous level of support, or even a previous level of resistance. Resistance can be found at the top of a long or dominant candle. Fig 1.7 RAMSAY HEALTH CARE - Daily Resistance along the top of this candle The change of polarity principle suggests that once prices break a significant resistance line, then this line will act as support for future trading activity. Also, once a line of support has been broken, it is likely that this line will act as resistance. This observation will assist with confirming breakouts and pattern detection. It will show the points where the share price action is likely to hesitate in the future, and the location of a potential reversal. The line that initially offered resistance at the top of the white candle, quickly became a level of support as indicated by the Harami. A pattern of previous levels of resistance that become support lines is bullish in nature. This level is likely to provide a springboard for future share price action. If share price action was to tumble through that foundation, it is likely that this price level will once again become resistance. (If this did occur, it would complete the formation of the double top pattern). 12
4) There are two broad maxims in trading. If the share is going up, you buy it. If it is going down, you sell it. The other major success principle is to have proper money management so that you keep your position sizes small enough to handle both a series of small losses, and where one position experiences a catastrophic loss. If it has been difficult for you to answer the question regarding entry triggers, hopefully by the end of the course you will be able to specifically respond and articulate your set-up and entry triggers with clarity. 13
For more information on the training courses and sharemarket services offered by Trading Secrets, check out www.tradingsecrets.com.au. You can also order these other titles by Louise Bedford online at this website. Video Program This course is designed to be a complete introduction to the world of Candlestick Charting. There are exercises to be completed throughout the program and plenty of actual trading examples to help cement your knowledge. Whilst suitable for the novice trader, this course will also take the more experienced trader to a greater understanding of the markets by delving into the psychology behind the price action. On DVD The Secret of Candlestick Charting Poster The Secret of Pattern Detection Poster Valuable quick reference tools for the main charting patterns using candlesticks and technical analysis. Also available from www.tradingsecrets.com.au in the Special Report range: Special Report New Candlestick Patterns Special Report Successful Short Selling 14