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Candlestick Trading Strategies Beginner's Brief
An Introduction to Japanese Candlestick Technical Analysis Introduction
As a form of technical technical analysis, analysis, a Japanese Japanese chart chart and candlestic candlestick k pattern analysis analysis can benefit anyone who wants to have another tool at their disposal. This is a tool that will help sort out and control the constant disruptions and continued outside influences to stocks, futures, and Forex market analysis. What does a Japanese chart offer that typical Western high-low bar charts do not? As far as the actual data displayed is concerned — nothing. Just like bar charts, Japanese Candlestick charts display the open, high, low and close of a given period of time. However, when it comes to visual recognition of data, and the ability to see data relationships and investor sentiment easier, candlesticks on a Japanese chart are exceptional. Bar charts have little meaning by themselves whereas candle charts combine them into groups and use pattern analysis to determine the probability of market movement.
This is possible because the psychological analysis of the investor or trader becomes an important factor. Japanese candlesticks reveal quick insight to the recent trading psychology and investor sentiment. After a small amount of practice and familiarization, Japanese candlesticks will likely become part of your technical analysis methods. Japanese candlesticks offer a quick view into the current trading atmosphere and investor sentiment. Candlesticks study the effect of of a given market and security. Japanese candlesticks are strictly about technical analysis, and as such are not always 100% accurate because they measure the effect of market forces, including price, fundamentals and others. When used correctly, Candlesticks are a great tool that can help you determine potential market direction. Candlesticks quantify what the traders are doing and thinking. We cannot ignore the fact that prices are very often influenced by fear, greed, and hope. Some form of technical analysis must be used to analyze the changes in these psychological factors. Japanese candlesticks read the changes in the market’s determination of value, otherwise known as investor sentiment.
Japanese candlesticks show the interaction between buyers and sellers, which is reflected in price movement. As such, Japanese chart provides insight into the financial markets that is not readily available with a bar chart. Candlesticks work best with stocks, commodities, and Forex. This introduction to Japanese candlestick charting and technical analysis will also provide information about the usefulness of Japanese candlestick patterns as a technical analysis tool. All methods of technical analysis and all assumptions will be open and visible. You will learn the specifics of the most popular candlestick patterns, how to spot them, and what to do with them. While daily analysis is the most common, Japanese Candlestick technical analysis can be used in any time frame, in any market. You will discover some differences in the Forex markets, as they don't have a specific closing and opening time during the week, since it is a 24-hour market. Benefits of Candlesticks? Easy to Understand
Japanese Candlesticks visually provide a clear and easy to identify set of patterns that are highly accurate in predicting market trends. Using Japanese Candlesticks, along with some basic Western technical analysis, you can easily begin to start seeing patterns emerge in the market and start taking advantage. Japanese candlestick charting doesn't take months or years to master. With practice, the patterns can be memorized in a few short weeks and you will begin to see the patterns reveal themselves on the charts at a glance. Early Reversals
While most charting methods are reactive in nature, Japanese Candlesticks can help to identify early reversals of direction that may be missed on other chart methods. This sets Candlesticks apart as predictive. Proven Techniqu e for 250 years
Candlesticks are generally first attributed to a Japanese rice trader in the 1700s named Munehisa Honma. Honma began trading in the rice market in 1750, in the city of Sakata. For this reason, you may often hear reference to “Sakata’s Methods” or “Sakata’s Rules”. Homma analyzed decades of rice prices, comparing them with yearly weather conditions, and over time became a legend in the rice trading industry. It is from his methods of trading in the rice markets that candlesticks evolved into the methods currently used in Japan.
Considering this, Japanese Candlestick analysis has been used in some form since the mid-1700s, giving it a history of around 250 years. Q u i c k l y A n a l y z e A n y M a r k e t an an d A n y T i m e Fr Fr a m e
With a Japanese candlestick chart and technical analysis, the patterns becoming instantly recognizable. You will no longer have to spend as much time analyzing a single chart or market to have an understanding of the current price action and the general likely trend. Japanese Candlesticks and a Japanese chart work in any market over any time frame. Since it takes much less time to study a chart in candlestick form you can cover more charts in less time. What Are Japanese Candlesticks? Candlesticks are an ancient form of predicting trends in trading markets.
A Japanese Japanese Candlestick Candlestick chart is a price price plotting plotting technique technique that offers offers a quick quick and easy method of identifying the price movement of a security. Even though it’s been around for hundreds of years it's still hard to find anyone, except the experts, who understand it well. Most traders use candlesticks for trend predictions because it quickly shows the strength and action of the bulls and bears over the price of a security.
There are two primary ways to use Japanese Candlesticks. The first way is to read the data in an individual candlestick. The second method is a pattern identification process of using Japanese candlesticks in particular combinations. Both methods provide useful information to the trader. Japanese candlestick charting is easy. It doesn't involve complicated formulas or extensive calculations to master the method. It is also powerful and accurate. Used alongside other market indicators you can build a method that works for you and which can help you to be successful. Will you profit on every trade? No. Japanese Candlesticks, however, can help you become successful and profit more frequently because, when read correctly, Japanese candlesticks will show you investor sentiment for any given market.
Bodies Wicks and Shadows How To Read A Japanese Candlestick
While bar charts are useful, Candlestick charts are much more visual and therefore it is easier to spot patterns within the charts. Both types of charts provide the same information; open, close, high and low prices. But the Candlestick chart creates a box between the open and close values, visually reducing possible rare extremes to the prices. In other words, the box (or body) formed between the open and close is where the real price action occurs, whereas the prices outside the box (the highs and lows) are considered fluctuations in the price with less significance. Candlesticks display the high, low, open, and close for a given security or market. It is different from a bar chart in that a narrow line - called the shadow or wick - shows the day's price range. This is the high and the low price of the day. Last, there is a body, which is called the "Real Body", which shows the actual range of pricing from the open to close prices. Candlesticks are formed using the open, high, low and close prices of the time period: A market price price closing closing higher higher than where where it opened opened will will produce a hollow - or white candle. A market price price closing closing lower lower than where where it opened opened creates creates a solid solid - or black - candle. candle. A wide body body - or box box - marks the the area between between the open open and the the close, referred referred to as the Body or Real Body. The thin lines poking above and below the body display the high or low range and are called wicks or shadows. The top of the upper wick/shadow is the “high”. The bottom of the lower wick/shadow is the “low”.
The best way to explain is by using a picture:
what colors you choose for your charts. You could use the In reality, it doesn’t matter what color red for the Bear candle - meaning price went down - and green for the Bull candle - meaning price went up. Whatever you choose to use, it gives a dramatic visual indication of the day's market price movement. Candlestick trend analysis is easy to use, thus great for beginners, but powerful and accurate; that's why even the professionals use them often. The signals and patterns are easy to see. Memorizing the Japanese Candlesticks names and descriptions of the candlestick trading formations is not necessary for successful trading. The patterns are what are important. Fortunately, out of the many, many patterns available, there are only about a dozen major patterns that you need to know.
Basic (One Candle) Candlesticks Hammer (bullish)
The Bullish Hammer Pattern is a single candlestick pattern. It is similar to the Bullish Dragonfly Doji Pattern, as they both have long lower wicks. However, the Bullish Hammer Pattern has a small real body at the upper end of the trading range instead of a flat line. The opposite signal is the Hanging Man The Hammer signal is an important signal, even if it is a weak signal. It is very easy to spot since it really does look like a hammer. The body is fairly square, there is little or no wick on top, and the lower shadow should be at least twice the length of the body. The Hammer is a single candle. At the bottom of a downtrend, the trade opens near or slightly below the previous day's close, drops down during the day to some value, and closes slightly above or below the open. This is an indication that the buyers are stepping in and that it may be the beginning of a price reversal. If the close is higher than the open, this is a slightly stronger indication of a reversal than if the close is lower than the open. To be sure, it is wise to wait another day to make sure the trend has really reversed. Identification:
Market: Hammers are best identified in a Downtrend Candle: Short to Medium Body. Color is irrelevant, but white has more bullish implications. The real body is at the top end of the trading range. The lower shadow must be at least two times the length of the body. There should be little or no upper wick.
Potential Signal Strengtheners:
The longer the lower shadow, the higher probability of a reversal. The shorter the upper wick, the higher probability of a reversal. The smaller the body, the higher probability of a reversal. While a white body is slightly stronger, it is not required to signal the reversal. A gap below the previous candle’s close indicates a stronger reversal if the following day after the Hammer opens higher. Large volume volume trading on the Hammer day indicates that the reversal may be occurring.
Variations:
Single candlesticks rarely have any variations, however, if the body of the Hammer is extremely small it becomes a Doji
Confirmation:
While the Hammer is a potentially strong bullish reversal signal, it should have some confirmation that it is a true reversal and not just consolidating. A reasonable confirmation would be a white candle the next period, where the low does not drop below the body of the Hammer candlestick.
General Analysis and Investor Sentiment:
The market trend was on its way down. The price opens and moves down as investor sentiment is still in sell mode. The buyers step in and start pushing the price back up, thinking they have hit the low end and it’s time to buy. The price moves back up to the top of the trade range, closing either slightly below or slightly above the opening. This shows the sellers could not maintain control and the downtrend is slowing down or ending. The upward rally of the price starts the sellers thinking that the decline is over. If the next day opens higher, this indicates the sellers have given control back to the buyers, and the reversal is likely to be continued.
Chart Example(s):
In this daily chart of XLE, we can see the distinctive Hammer formation on July 1, 2010. This Hammer formed after a strong pullback and downward trend over a 2 week period. Afterwards, Afterwards, the price price steadily steadily rose, returning to prices shown before the the original original downward trend prior to the Hammer. Following that trend up, assuming entry above the Hammer: We can see that this move would have been good for around a 10% gain in just over a month. Notice the Dragonfly Doji, followed by the Doji, near the end of the upswing. This indicates strong indecision in the trend, and a potential drop in price. At this point, care must be given as to how to handle the trade. Longs should take steps to protect their positions. With the strong indecision, potentially near resistance, taking the profit and getting out is never wrong.
Afterwards, Afterwards, notice the decline, decline, followed followed by another Hammer Hammer candlestick candlestick..
Let’s see what happens here:
In this particular case, XLE made a consistent and dramatic rise following the Hammer. Using good money management and trading techniques, this move would have gained another 30% over the course of 6 months.
Candlestick Combination:
None
Trading Technique(s): A Hammer appearing near support may be more likely to indicate a true reversal. Let’s take a look at a weekly chart of JPMorgan Chase:
You can see a fairly strong downward trend during 2005. During that move, support near 33.25 was tested three times, with the third time showing a strong Hammer pattern. The two weeks just prior to the Hammer also showed patterns very close to Hammers. With this Hammer occurring right at a line of support, and using the following candlestick as confirmation, a long position would have had excellent results. In addition, placing a stop loss directly below the low of the Hammer would have protected against a turn against the reversal. As you can see, the risk/reward ratio was very favorable.
Now, let’s take a look at this chart:
As we can can see, there there are two Hammers Hammers at the end of what what looks to be a downward downward trend. However, is it near any reasonable support? Let’s see what happens after this…
We can see, because there was no substantial support near the Hammers, it was less likely to be a true reversal. In this particular case, the downward trend that started off the peak continued, and the price declined with a dramatic fall.
Shooting Star (bearish)
The Shooting Star Signal is a one candle pattern appearing in an uptrend. The Shooting Star warns of a potential top of an uptrend, however it is not a major reversal signal. The opposite signal is an Inverted Hammer. Ideally, a Shooting Star should gap up from the prior candlestick, but it isn’t necessary to do so. The shadow (or tail) should be at least two times the length of the body. This shows an inability of the bulls to maintain control, and is potentially slipping as the Bears take over. If the shadow is too short, it loses the strength of a Shooting Star and just becomes a short day with little significance. The color of the body is not important, although a black body has slightly more Bearish implications. A black body would show that the Bears had more control by the end of the day than the Bulls did. Identification:
Market: Uptrend. Candle: Short to Medium Body. Body. The real body is at the lower end of the trading range. The color of the body is not important although a black body should have slightly more bearish implications. Ideally, a gap up from the previous candle is preferred. The upper wick should be at least two times the length of the body. There should be very little or no lower shadow.
Potential Signal Strengtheners:
The longer the upper shadow, shadow, the higher the potential of a reversal occurring. An opening gap up from the previous candle’s close sets up for a stronger reversal move provided the day after the Shooting Star signal opens lower. Larger volume volume on the Shooting Star day increases the probability that a sell-off sell-of f day has occurred and a reversal is possible. If the upper shadow is near resistance levels, this increases the likelihood of a reversal occurring.
Variations:
One variation on the Shooting Star could be if the price closed at or extremely near the opening. This would result in a Gravestone Doji, which is also a bearish indication when seen at the top of a trend, especially near resistance levels.
Confirmation:
Further confirmation is required to indicate a reversal signal. The following day needs to confirm the Shooting Star signal with a black candle or even better, a gap down with a lower close.
General Analysis and Investor Sentiment:
After a strong strong uptrend uptrend the Bulls Bulls appear appear to still be in control control with price opening opening higher, higher, but by the end of the day the Bears step in and take the price back down to the lower end of the trading range, creating a small body for the day. After a gap up, with the price returning near its open after a strong push up, investor sentiment begins to turn bearish. The long upper shadow represents that the Bears had started shorting at these levels. Even if the Bulls may have been able to keep the price positive by the end of the bar (as seen with a white candlestick), the Bears made a good showing. Lower trading the next day reinforces the probability of a reversal.
Chart Example(s):
Here is a good example of two Shooting Stars. In the first Shooting Star, it was confirmed with a gap down down and black candle following it. After a couple of weeks, weeks, we saw a rise back up almost to the original level. Then we see another Shooting Star, and the price once again fell, giving potential to get gains on short positions, or at the very least it is warning us to protect long positions. Below, another prime example of a Shooting Star, confirmed, with a definitive downward trend afterward.
Candlestick Combination:
Since the Shooting Star is a single candle pattern, there is no candlestick combination. However, if we include the previous candlestick, we can see why confirmation is desired: By looking at the previous candlestick and combining it with the Shooting Star, we can see that the resulting combination still shows a potentially bullish period. Another black black candlestick candlestick following following the star, especially especially if it closes below the open of the candlestick prior to the Shooting Star, may be confirmation of the reversal.
Trading Technique(s):
The upper shadow of a Shooting Star could be used to help determine a resistance level. Since the Bulls were unable to push the price up any further, and the Bears pushed it back down, it is reasonable to assume that the upper shadow may show us where the upper price limit is for the security. Taking our example from Sprint again:
If we were to enter a short position after confirmation of the first Shooting Star, we could use the upper shadow as potential resistance, setting our stop loss just above the top of that shadow (above the high for the day). Even when the price rallied a few weeks later, we can see that it never broke through our potential resistance zone. Indeed, the second Shooting Star upper shadow remained below our stop loss, and continued the downward push afterward.
In the following chart, we see a potential Shooting Star that has formed at the top of a reasonably strong upward trend:
This could be telling us to think about protecting any long positions we might have. If the reversal hits, we would want to capture as much of the profits as we can. In this particular case, it might be prudent to move any long position stops just below the previous candlestick low:
While this may look like a perfect opportunity to capitalize on an impending reversal and take some short positions, here is what happened:
As we see, see, this Shooting Shooting Star occurred occurred right right after a break through through recent recent resistance. resistance. While it could be a false break out, it could also easily continue to the upside, which is exactly what happened. The Shooting Star would have been a confirmed reversal if the next day had closed down, especially if it had filled the gap and taken out the previous candle stick. Since it didn’t, it would not have been a good time to take short positions. In this case, the Shooting Star was most likely just a short term consolidation after the breakthrough of resistance. Checking different time frames will usually provide additional information to help in determining signal validity.
Take this example of EQT Corporation:
We see what might be considered a Shooting Star (5) following the recent uptrend (4). Prior to that, there was a downtrend (1), with a gap down (2), then a good size one day drop (3). Can you spot the problems with using this Shooting Star candlestick for predicting direction? First, the body of the Shooting Star candlestick is right at the level of resistance/support. The question is, which side is it on? In this case, it is almost impossible to tell. Second, the upper shadow of the Shooting Star is much too large. While the upper shadow should be at least twice as long as the real body, this particular shadow is more than 14 times the size of the real body. This indicates something much more going on than a change in investor sentiment and a potential reversal.
Finally, let’s take a look at a shorter time frame, to see how that Shooting Star was generated:
This is a 1 minute chart of the Shooting Star day. We can see that the entire range of trading that day, the high and the low, was done in the first 2 minutes after open. If we ignore the first 2 minutes of the day, we would see the candlestick resolve like this:
This is still a potentially bearish indication, but much less so than a true Shooting Star.
And if we ignore the the first hour hour of the day:
Again, this may still be considered considered bearish, bearish, but but is even less predictable predictable of of a potential potential reversal. Indeed, it appears as if there was a significant jump in price during afterhours trading. The market opened, and the price spiked, then began to consolidate. By the end of the day, the price started to continue to move up. While it closed down from the open, I would suggest that the upward trend will likely continue. The lesson here is that we can’t believe everything we see. Sometimes we have to dive deeper to see the whole truth. The killer Shooting Star that we saw on the daily chart was due to a 2 minute opening volatile spiking, which did produce the Shooting Star candlestick, for the wrong reasons.
Inverted Hammer (bullish) The Inverted Hammer is similar to a Hammer as it appears in a downtrend and implies a weakening or reversal of trend. This is a very weak signal and not much significance is placed on it, unless it is followed by a confirming candlestick.
The upper shadow should be at least two times the length of a small body. The real body is at the lower end of the trading range. There should be no lower shadow or a very small lower shadow. Identification:
Market: Downtrend. Candle: Short to Medium Body. Body. The real body is at the lower end of the trading range. The color of the body is not important, although a white body should have slightly more bullish implications. The upper wick should be at least two times the length of the body. There should be no lower shadow, or a very small lower shadow.
Potential Signal Strengtheners:
The longer the upper shadow, shadow, the higher the potential of a reversal occurring. A gap gap down from the previous day's close sets up for a stronger reversal move provided the day after the Inverted Hammer signal opens higher. Larger volume volume on the Inverted Hammer day increases the probability that a sell-off day has occurred and a reversal is possible.
Variations:
One variation on the Inverted Hammer could be if the price closed at or extremely near the opening. This would result in a Gravestone Doji, which would indicate even less potential for a reversal.
Confirmation:
Further confirmation is required to indicate a reversal signal. The following day needs to confirm the Inverted Hammer signal with a white candle or even better, a gap up with a higher close. Because the closing price is near or at the low for the day, confirmation is important. The reason is because the price action that creates the Inverted Hammer is still very bearish in reality. It shows that while the Bulls tried to rally the price, they could not
maintain it and it fell by the end of the period, clearly in control of the Bears. If the following day is bullish, that may confirm the action.
General Analysis and Investor Sentiment: The market trend was on its way down. Investor sentiment is bearish. The price opens and starts to trade higher. The Bulls have started buying at the low prices but cannot take control. By the end of the period, the Bears keep the price down to the lower end of the trading range. If the price remains strong after the Inverted Hammer day, the reversal may be confirmed.
Chart Example(s):
Here was a steady downward trend prior to a good gap down which looks like it created an Inverted Hammer candlestick. However, the upper shadow is not at least twice as long as the body, but we can keep an eye on it anyway. The day following confirmed the potential upward move and as we see, it has slowly continued up over the next week. Even though it was not quite an Inverted Hammer, it still gave us some potential upward gain. In this particular case, the downward move was weak and small, and while the signal looks like an inverted hammer, it fails to provide the long upper shadow. Even though the price did move back upward after that candlestick, it appears to just be filling the
gap, and the upward momentum stopped into the bearish channel that was created just before.
On WLK we see a clear downward trend approaching support levels. An Inverted Hammer appears which is confirmed the following day with a strong white candle.
On this chart from General Electric, we can clearly see the Inverted Hammer at the end of a nice downward downward trend. This is an excellent example of an Inverted Hammer, even if the upper shadow is perhaps a little too long. Notice how the bottom of the Inverted Hammer is slightly below the large black candlestick from the day before. This shows the Bulls are now coming into power as the Bears falter.
Candlestick Combination:
Since the Inverted Hammer is a single candlestick pattern, there is no candlestick combination. However, if we include the previous candlestick, we can see why confirmation is desired: By looking at the previous candlestick and combining it with the Inverted Hammer, we can see that the resulting combination still shows a potentially bearish period. Another white white candlestick candlestick following following the star, especially especially if it closes above the open of the candlestick prior to the Inverted Hammer, may be confirmation of the reversal.
Trading Technique(s):
Since the Inverted Hammer is such a weak signal, there are no trading techniques until confirmation is made. However, we should think about protecting any short positions we may be holding, and there there may be a possible long position we could enter. Let’s take the example of General Electric we saw earlier:
This Inverted Hammer could be telling us one of two things. First, it could be signaling the end of the recent downward move, and anybody holding short positions may want to consider protecting their profits by entering a stop loss above the shadow of the Inverted Hammer candlestick. Should the trend reverse, shorts would get stopped out without having risked the profits they generated on the downward move.
Second, it gives a possible signal to a reversal much sooner than many traders might see, which would give an opportunity to actually get into a long position at the bottom of a new upward trend. In this case, a long position could be entered almost immediately following the Inverted Hammer, with relatively little loss potential:
1) For short positions, a stop loss could be entered just above the long upper shadow of the Inverted Hammer. If the trend should continue down, the trade is still active and the profit potential is not affected. However, if the trend should reverse, as it did here, the protective stop loss keeps the trade in the profit range, preventing the loss of profit, or even a potential loss on the trade overall. 2) At this point, the day did trade above the p potential otential stop loss, closing out the trade. The next couple of days the price did track back down, but then the major upward move continued, verifying the reversal. Anybody short on this stock would gladly take the profit from the stop loss rather than losing it all on the new push up. 3) For potential new long positions, entry could be made at open the following day, with a stop loss placed just below the bottom of the Inverted Hammer. Notice the following day gapped up, and finished out the day recovering most of the drop from the day before the Inverted Hammer. Even if the price had continued the downward move after the Inverted Hammer, the loss would have been very minor, and the potential gain was quite large. With such a large risk/reward ratio, this could be a trade not to pass up. However, if we saw this in the middle of a range instead of near/slightly below recent support, the trade may not be as agreeable.
Hanging Man (Bearish)
Another very very strong strong single candle indicator indicator is the Hanging Hanging Man. It is very similar to the Hammer, but at the top end of an uptrend. If you see the correct indication of the Hanging Man signal, your probability of being on the right side of a trade increases dramatically. The Hanging Man is a single candle. It is identified because it looks like an unfinished game of Hangman at the top of an upward trend. It has a small body at the top of the trading range, with the lower shadow being at least two times greater than the body length.
Identification:
Market: Uptrend. Candle: Short to Medium Body. Body. The real body is at the upper end of the trading range. The color of the body is not important, although a black body should have slightly more bearish implications. The lower shadow should be at least two times the length of the body. There should be little or no upper wick.
Potential Signal Strengtheners:
The longer the lower shadow, the higher probability of a reversal. A gap above the previous day’s close indicates a stronger reversal , if the period following the Hanging Man opens lower. Large volume volume trading on the Hammer candlestick indicates that the reversal is occurring.
Variations: One variation on the Hanging Man could be if the price closed at or extremely near the opening. This would result in a Error! Reference source not found. , which would indicate even less likelihood for a reversal.
Confirmation:
Further confirmation is required to indicate a reversal signal. The following day needs to confirm the Hanging Man signal with a black candlestick or even better, a gap down with a lower close.
Because the closing price is near or at the high for the day, confirmation is extremely important. The reason is because the price action that creates the Hanging Man is still very bullish in reality. It shows that while the Bears tried to turn the price, they could not maintain it and it rose by the end of the period, clearly in control by the Bulls. If the following day is bearish, that may confirm the action. It is preferable to see a black candle that closes well into the lower shadow of the Hanging Man, if not below.
General Analysis and Investor Sentiment: The market trend was on its way up. The price opens higher than the previous time period but starts to move lower. This indicates that the buyers have topped out of the market. The sellers move the price lower, but the buyers step in and the price moves back up to close in the higher end of the trading range. This creates a small body and a long tail. Even though the buyers have pushed the price back up, this indicates strong activity from the sellers which implies that investor sentiment is changing. If the next day shows a lower open, or a black candle by close, this reinforces that sellers are taking control and a reversal is very likely or has begun. This is an especially good indicator if the market is overbought, at the top of an uptrend or near strong resistance levels, and provides the information necessary for interpreting the reversal.
Chart Example(s):
Here we see a Hanging Man signal at the top of a trend. In addition, it happens to be near recent resistance. As shown, following the Hanging Man, the Bears wrestled control from the Bulls and the price dropped over the following week or two, potentially gaining traders a profit of around 10%.
While not the best of the “ideal” Hanging Man signals, we can see one here following some choppy prices. The first two are more like Dragonfly Doji candlesticks, which are a variation of the Hanging Man. Then, following a long white candlestick, we see a good Hanging Man candle, which was then followed by a gap down, and a downward move.
In the second group, we see what appears to be a good Hanging Man signal at the top of a solid upward trend. The next candlestick confirms the Hanging Man, but as we see, the price actually retraced back up to its prior high levels. Candlestick Patterns will show probabilities of a trend or direction, but as with almost anything else, there are no guarantees.
Candlestick Combination:
Since the Hanging Man is a single candlestick pattern, there is no candlestick combination. However, if we include the previous candlestick, we can see why confirmation is desired: By looking at the previous candlestick and combining it with the Hanging Man, we can see that the resulting combination still shows a potentially bullish period. Another black candlestick following the Hanging Man, especially if it closes below the low of the candlestick prior to the Hanging Man, may be confirmation of the reversal.
Trading Technique(s):
You can use the top of the Hanging Man as a potential resistance point, placing a stop loss just above the high for the period. Since the Hanging man should be at the top of a trend, if it is a true reversal indication, it should not hit the stop. If it does, it should be a minimal loss.
Notice the price did temporarily move above the top of the Hanging Man candlestick. However, extending a line out from the top of the prior peak (i.e. a potential point of resistance), we would see that it didn’t break that level prior to dropping down. When determining stop losses for a short trade off of a Hanging Man, it is wise to consider such things like areas of resistance.
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