Candlestick patterns are one of my favorite aspects of technical analysis. They were created by 18th century rice traders in Japan and have only just become popular in the last 50 years in the US.
If we broke down what candlestick patterns were, we would find that it is basically certain sets of individual candlesticks that when combined, create significant levels of supply and demand. In short, they show us where demand or supply has overtaken the other. These patterns are all reversal patterns (they usually indicate a top or bottom in the short-term chart).
Here are my top 5 candlestick patterns:
1. Piercing Line
This pattern is a retracement of yesterday’s gains/losses by today’s price. Above is a bullish piercing line, but you can simply flip it over and get the bearish version. Today’s price should pull back at least half of the previous day’s move. The piercing line is a reversal pattern and you should combine it along with the next day or two to make sure that a reversal has taken place.
2. Three White Soldiers/Three Black Crows
Here we have an abundance of buying/selling respectively. Three solid days in one direction is a very strong indication that a reversal has taken place and should continue at least in the short-term.
3. Hammer
I’d have to say this is one of my favorite patterns. It is fairly common and is a great indicator if you get one with high volume. The psychology of this pattern is that the bears put on pressure and drove the stock down, but the bulls came back and there was enough buying pressure to cause the stock to pull back close to the highs of the day.
4. Engulfing Line
This is a more powerful version of the piercing line. The stock gapped down to open and then retraced all of yesterday’s move and some. This pattern can happen at a top or bottom and shows an overwhelming force from either bulls or bears depending on the direction.
5. Evening Star
Above is the top version of this pattern. Basically, the stock gapped up one day and then gapped back down the next. This shows a complete depletion of demand and usually will indicate a top. This can happen opposite.
Volume
One thing to note with all of these patterns is the volume. Usually, the bigger the volume the better because it shows that there is strong support for the reversal. Be weary of these patterns that have average to below-average volume. Also, I would suggest allowing a day or two to confirm the patterns.
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