3. understanding single period chart patterns · pdf filetrading period), usually the end of...

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Line charts are the most basic chart format. They a single data point to represent a whole session (or trading period), usually the end of day Close price. This data point is then connected to the equivalent point of the previous session to form a line.

Bar charts give much more price information than line charts. Containing data for the Open, High, Low, and Close (OHLC) prices, bar charts give a gauge of how price has moved through the whole day.

Candlestick charts again use OHLC but also have different colours to represent up days (or periods) and down days (or periods) for the Open versus the Close. A candlestick has two parts: the Body (the difference between the Open and Close) and the Tails or Shadows. A candle with the Close higher than the Open (i.e. an up day) has a white body, and one with a Close lower than the Open (i.e. a down day) has a black body.

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BEGINNER

3. Understanding Single Period Chart Patterns

Line Charts, Bar Charts and Candlestick Charts

The price chart can be presented in a variety of different ways. The vast majority of analysts use either line, bar or candlestick charts.

high

open

openclose

close

the highest price for the day

the lowest price for the day

closing price

opening price

low

uppershadow

lower shadow

realbody

Inside Days and Outside Days

An “Inside Day” (or inside bar if you are trading intraday) is a signal of uncertainty with the current trend. This is where the entire daily trading range is swallowed up by the previous day’s range. The psychology is that it is an uncertain move and could signal a stalling in the trend. There are two ways to trade Inside Days. Firstly you can put a buy order above the high of the previous day high. A move such as this would signal that following the bout of consolidation the bulls are ready to back the price. Or alternatively, you could put a sell order just under the low of the previous low, signalling that the bears are gaining the ascendency after the consolidation.

An “Outside Day” (or outside bar if you are looking at intraday trading) is a signal that reflects the strength of the underlying trend. It is the complete opposite

to the Inside Day and is where the entire daily range swallows up the previous session. This is then compounded by a close price that is again outside the previous day’s range. If the price is in an uptrend, a bullish outside day will have the close above the high of the previous day’s high. In a downtrend, a bearish outside day will have a close below the low of the previous day low.

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There is much that can be ascertained from the analysis of a single bar. Where the price opens, where the price closes and the size of the daily range are all important in assessing whether it is the bulls that are in control or the bears.

The Open/High/Low/Close bar can reflect the psychology of the market. The single day bars shown below show what can be determined from the close price compared to the daily range. If the price closes

towards the bottom of the range, this would suggest that the sellers have gained control. Alternatively, a close price near the high of the range would suggest that the buyers have ended in control. If the closing price is around the middle of the range this suggests uncertainty with the current move.

However we can also look at the close price compared to the open. The tables below set out the implications of certain moves.


Single Period Bar Chart Patterns

No overall control by the buyers or

the sellers

The buyers are gaining control

The sellers are gaining control

The Inside Day/Bar

The Outside Day/Bar

Buyers strongly in control

Buyers lacking conviction

Buyers beginning to lose control

Sellers strongly in control

Sellers lacking conviction

Sellers beginning to lose control

Additionally, if the open price is towards the middle of the range, this suggests uncertain trading. However where the price closes can suggest who is beginning to gain the upper hand.

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One of the most powerful single bar patterns is the key reversal. Coming at the end of a trend and ideally at either the high or the low of the move, a key one day reversal marks a significant change in sentiment. Key reversals can also work across chart with a variety of different time frames, such as a key one day reversal, key one hour reversal, or even a key one minute reversal.

A bullish key reversal will come at the end of a downtrend. The price makes a new low, below the previous session low, only for the selling pressure to become exhausted and the move to be rejected. The buying pressure then returns during the same session, to result in a close above the previous session high. This suggests a significant swing in sentiment towards the bulls and will often mark the bottom of major downtrends. They can often be traded by going long and placing a stop below the low of the key reversal.

A bearish key reversal is the opposite, coming at the top of an uptrend and marks a culmination in buying pressure as selling pressure is renewed. A bearish key reversal will often mark important reversal towards a new downtrend. The signal can be traded by going short and placing a stop above the high of the key reversal bar.

Key Reversals

The figure below illustrates a both a bullish and a bearish key reversal.

The daily chart of Euro/Dollar shows a series of outside days, inside days and a bullish key one day reversal from February to April 2013. Note how the outside days in February are powerful trend continuation patterns. Then, right towards the bottom in late March there are two consecutive inside days which reflect the uncertainty that is building up. This was then followed by the big trend changing bullish key one day reversal.

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There are literally hundreds of candlestick patterns that have been identified, many of which have weird and wonderful names. Japanese traders love their candlesticks and subsequently, many candlestick patterns have Japanese names, such as “doji” and “marubozu”.

There can be one day candlestick patterns, two day patterns, in addition to three day patterns and multi-day patterns. However, for the demands of space, and to keep it relatively simple, we have listed some of the more common single day candle patterns that traders should be aware of.

Some traders set up their candlestick analysis using different colours, however for the purpose of this document, we shall use white candles to signify a bullish day and black candles for bearish.

A long white candlestick indicates strong buying pressure. The further the close is above the open, the longer the white candlestick is. This shows that prices advanced significantly from open to close and implies that buyers were aggressive. Although long white candlesticks are generally bullish, much depends on their position within the broader technical picture. After an extended decline, a long white candlestick can mark a potential turning point or key support level. A long black candlestick is the opposite pattern and is negative.

A Marubozu candlestick is very potent long candlesticks. The Marubozu has no upper or lower shadows, and the high and low are therefore represented by the open and the close. A White Marubozu forms when the price opens at the low and closes at the day high. This strongly bullish candlestick indicates that buyers controlled the price action from the first trade to the last trade. A Black Marubozu forms when the price opens at the high and closes at the low. This strongly bearish candlestick indicates that sellers controlled the price action from the first trade to the last trade.

Doji candlesticks signal uncertainty with the current trend. They form when the price opens and closes at (or almost at) the same level, and usually around the middle of the candlestick. It shows that the price has tested moves both higher and lower, but indecision has ultimately been the winner. The length of the upper and lower shadows can vary and the resulting candlestick looks like a cross, inverted cross or plus sign. The longer the shadows, the more significant the uncertainty, whilst shorter shadows can represent either equilibrium throughout or a lack of trading (so volume also needs to be checked). Any bullish or bearish bias is based on preceding price action and future confirmation.

Dragonfly doji form when the open, high and close are equal and the low creates a long lower shadow. The resulting candlestick looks like a “T” with a long lower shadow and no upper shadow. Dragonfly doji indicate that sellers dominated trading and drove prices lower during the session. By the end of the session, buyers resurfaced and pushed prices back to the opening level and the session high. It suggests a failed attempt.

Gravestone doji form when the open, low and close are equal and the high creates a long upper shadow. They are the opposite of a Dragon fly doji.

Single Period Candlestick Chart Patterns

Long versus Short

Marubozu

Doji

Dragonfly doji

Gravestone doji

White Marubozu

Black Marubozu

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The Hammer is a bullish reversal pattern that forms after a downtrend. Hammers can also mark bottoms or support levels. The low of the long lower shadow shows that sellers drove prices lower during the session. A strong finish shows that buyers then regained control to end the session on a positive note. However, hammers require additional bullish confirmation as the low of the hammer shows that plenty of sellers remain. Further buying pressure, preferably on good volume, is recommended before acting. Hammers are similar to selling climaxes, and heavy volume can serve to reinforce the validity of the reversal.

The Shooting Star is a bearish reversal pattern that forms after an uptrend. It is the opposite pattern to the Hammer. A Shooting Star can mark a potential trend reversal or resistance level. The candlestick forms when prices move higher on the open, advance during the session but closes well off the high. The resulting candlestick has a long upper shadow and small black or white body. After a large advance (the upper shadow), the ability of the bears to force prices down is a warning. Bearish confirmation is required after the Shooting Star and can take the form of a gap down or long black candlestick preferably on heavy volume.

The Hanging Man is a bearish reversal pattern that acts as a warning signal that can mark a top or resistance level. Forming after an advance, a Hanging Man signals that selling pressure is starting to increase. Even though the bulls regained their poise to push prices back up by the close, the appearance of selling pressure is a warning. A Hanging Man requires bearish confirmation before action is recommended. This could be a gap down or long black candlestick on heavy volume.

The Inverted Hammer looks like a Shooting Star, but forms after a decline or downtrend. Inverted Hammers represent a potential trend reversal or support levels. After a decline, the long upper shadow indicates buying pressure during the session. Although the bulls were not able to sustain the buying pressure and prices closed well off of the high to create a long upper shadow, the warning sign is that the buyers are ready to move once more. Due to the failure of the initial move higher, bullish confirmation is required before action.

Hammer

Shooting Star

Hanging Man

Inverted Hammer

Figure 4: Range trading using the Bollinger Bands on Silver

Risk Warning for Educational Material

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