Summary
This article explains key candlestick patterns that consist of multiple candles. These formations provide valuable reversal signals in various market scenarios, such as downtrends or uptrends. A solid understanding of these patterns helps traders make informed trading decisions.
- Explanation of essential candlestick patterns for trend reversals.
- Distinction between bullish and bearish formations.
- Helpful insights on interpretation and application in different chart time frames.
Table of contents
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- Important Candlestick Patterns Consisting of Multiple Candles
- Engulfing
- Piercing Line and Dark Cloud Cover
- Harami
- Variations of the Harami Pattern
- Tweezers
- Morning Star and Evening Star
- A look behind the candles
- More articles from the series The secret power of candles - Hidden information in the candlestick chart
Important Candlestick Patterns Consisting of Multiple Candles
As with single candles, the context is also crucial in candlestick combinations. Most combinations or single candles can be found throughout the chart, but they generally carry the most weight after strong movements.
Engulfing
Engulfing combinations are divided into bullish and bearish engulfing patterns. A bullish engulfing indicates a shift to an upward market, while a bearish engulfing signals a shift to a downward market.
The bullish engulfing pattern consists of two candles. The first candle has a black body, meaning the closing price is below the opening price. The following second candle has a white body, indicating the closing price is above the opening price. Additionally, the opening price of the second candle must be below the closing price of the first candle, and the closing price must be above the opening of the first candle. Therefore, the second candle must completely engulf the body of the previous candle. Wicks and shadows are not relevant in this pattern.
The following conditions must be met:
- A downtrend must precede it
- The first candle must be black
- The second candle must open with a gap down to completely engulf the first candle
The bearish engulfing pattern also consists of two candles. The first candle has a white body, meaning the closing price is above the opening price. The following second candle has a black body, indicating the closing price is below the opening price. Additionally, the opening price of the second candle must be above the closing price of the first candle, and the closing price must be below the opening of the first candle. The second candle must therefore completely engulf the body of the previous candle. Wicks and shadows are not relevant in this pattern.
The following conditions must be met:
- An uptrend must precede it
- The first candle must be white
- The second candle must open with a gap up to completely engulf the first candle
Interpretation
Engulfing patterns are among the strongest candlestick signals that can indicate a market reversal.
Piercing Line and Dark Cloud Cover
The piercing line and dark cloud cover patterns are also reversal patterns. They function similarly to engulfing patterns.
A piercing line pattern indicates a shift to an upward market, while a dark cloud cover pattern indicates a shift to a downward market.
The piercing line pattern consists of two candles. The first candle has a black body, meaning the closing price is below the opening price. The following second candle has a white body, indicating the closing price is above the opening price. Additionally, the opening price of the second candle must be below the closing price of the first candle, and the closing price must be above or at the midpoint of the body of the first candle. Wicks and shadows are not relevant in this pattern.
The following conditions must be met:
- A downtrend must precede it
- The first candle must be black
- The second candle must open with a gap down
- The closing price of the second candle must be at or above the midpoint of the body of the first candle
The dark cloud cover pattern consists of two candles. The first candle has a white body, meaning the closing price is above the opening price. The following second candle has a black body, indicating the closing price is below the opening price. Additionally, the opening price of the second candle must be above the closing price of the first candle, and the closing price must be below or at the midpoint of the body of the first candle. Wicks and shadows are not relevant in this pattern.
The following conditions must be met:
- An uptrend must precede it
- The first candle must be white
- The second candle must open with a gap up
- The closing price of the second candle must be at or below the midpoint of the body of the first candle
Interpretation
Piercing line and dark cloud cover patterns, like engulfing patterns, are strong candlestick signals that can indicate a market reversal.
Harami
Bullish and bearish harami patterns are also reversal patterns.
A bullish harami pattern indicates a shift to an upward market, while a bearish harami pattern signals a shift to a downward market.
The bullish harami pattern consists of two candles. The first candle has a black body, meaning the closing price is below the opening price. The following second candle has a white body, indicating the closing price is above the opening price. Additionally, the opening price of the second candle must be above the closing price of the first candle, and the closing price below the opening price of the first candle. This means that the body of the second candle must be enveloped by the body of the first candle. Wicks and shadows are not relevant in this pattern.
The following conditions must be met:
- A downtrend must precede it
- The first candle must be black
- The second candle must open with a gap up
- The closing price of the second candle must be below the opening of the first candle
Interpretation
Harami patterns are also candlestick signals that can indicate a market reversal. However, confirmation should be awaited for this pattern. For a possible entry in a bullish harami pattern, one should wait to see if the high of the first candle is exceeded in the following time period. For a possible entry in a bearish harami pattern, one should wait to see if the low of the first candle is breached in the following time period.
Variations of the Harami Pattern
Harami Cross
The bullish and bearish harami cross patterns should also be mentioned. They are fundamentally identical, but in this case, the second candle is a doji, meaning the opening price is equal to the closing price. All other conditions remain the same.
Homing Pigeon and Bearish Homing Pigeon
The homing pigeon pattern is also very similar to the harami pattern. The main difference is that the second candle has the same color body as the first candle. Here, too, the interpretation remains the same.
Tweezers
Tweezer patterns are characterized by identical high or low prices. There are two patterns: the tweezer bottom pattern is considered bullish, and the tweezer top pattern is considered bearish.
The tweezer bottom pattern consists of two candles. Both candles must have identical low prices. The structure of the candles is irrelevant.
The following conditions must be met:
- A downtrend must precede it
- Both candles must have identical low prices
The tweezer top pattern consists of two candles. Both candles must have identical high prices. The structure of the candles is irrelevant.
The following conditions must be met:
- An uptrend must precede it
- Both candles must have identical high prices
Interpretation
Tweezer bottom and tweezer top patterns are also candlestick signals that can indicate a market reversal. However, confirmation should be awaited for this pattern. For a possible entry in a tweezer bottom pattern, one should wait to see if the high of the first candle is exceeded in the following time period. For a possible entry in a tweezer top pattern, one should wait to see if the low of the first candle is breached in the following time period.
Morning Star and Evening Star
Morning star and evening star patterns come in various forms, but the basic principle is the same across all variations. Therefore, we summarize the variations here.
The morning star indicates a trend reversal from bearish to bullish. This pattern consists of a black candle, followed by a second candle that opens with a gap down and does not reach the previous day’s closing price. The third candle must be a white candle that exceeds the high of the first candle to generate a signal.
The following conditions must be met:
- A downtrend must precede it
- A gap must exist between the first and second candles
- The third candle must exceed the high of the first candle
The evening star implies a trend reversal from bullish to bearish. This pattern consists of a white candle, followed by a second candle that opens with a gap up and does not reach the previous day’s closing price. The third candle must be a black candle that breaks below the low of the first candle to generate a signal.
The following conditions must be met:
- An uptrend must precede it
- A gap must exist between the first and second candles
- The third candle must break below the low of the first candle
The middle candle can have different formations. For example, a doji, a hammer, an inverted hammer. It can be black or white. Depending on the type of middle candle, the formation is given a different name. However, the interpretation of the combination remains the same.
Interpretation
Morning Star and Evening Star combinations are also among the candlestick signals that can indicate a reversal in the market.
A look behind the candles
Candlesticks and timeframes
One of the most important aspects of candlesticks is the timeframes that one considers. The relevance of candlestick formations increases with the timeframe. In a 1-minute chart or a 5-minute chart, candlestick formations or individual candlesticks are less likely to provide reliable signals compared to a daily or weekly chart.
The main reason for this is the number of transactions represented within a single candle. For example, in a 1-minute chart, 100 trades may form the candle, whereas in a daily chart, there are often thousands of transactions.
This is similar to traditional data analysis. A larger dataset tends to have a higher probability of accurately representing the entirety of the system.
Larger datasets are often more robust against outliers or random fluctuations. Individual unusual data points have less impact on the overall results in a large dataset compared to a smaller one.
In this context, one can consider each individual transaction that leads to a price change in the underlying market as a data point.
Many data points provide better robustness against outliers or potential manipulations. Individual deviant data points have less influence on the overall outcome in a comprehensive dataset.
A candle represents the total trading that has occurred within the observed time period. What exactly happened cannot truly be discerned from the individual candle. One can only read from the candle where the opening price was, the high and low of the day, and the closing price.
However, to understand how certain candlestick formations come about and what exactly transpired during that time, it is worthwhile to look behind the candle. The following illustration shows a candle on a daily chart, overlaid with the candles from a 5-minute chart from the same period.
The gray background represents the shape of the daily candle. The smaller candles in the foreground are the candles from the 5-minute chart that formed throughout this day.
From left to right, we observe a market that is trending sideways in the first third. There are slight fluctuations upward and downward. Then follows a downward breakout, which is quickly bought back. This breakout represents the wick in the daily candle. After the breakout is bought back, an upward trend develops, and the day closes almost at the daily high.