What are candlestick patterns and how to use them to trade stocks? - part 3




What are candlestick patterns and how to use them to trade stocks? - part 3

 In the previous part we talked about combining candlesticks to understand the market better, to identify whether the buyer is in control or the seller is in control. We also discussed about taking into consideration different time frames for candlesticks, so as to get a clear picture of the trend and predict the future price movement. Let's talk about few other important candlestick patterns.

Dragonfly and Gravestone Doji:

If you observe the above candlestick, you will see that it lacks the body and only has the wick. Even though the opening price and closing price for the session is the same, the market is not indecisive. Taking into consideration the Dragonfly Doji, it represents a sign of strength by the buyers. The reason being the sellers were in control and reduced the price but the buyers came back in and again influenced the price, now equivalent to the opening price. This is an indication of rejection of lower prices. Whereas, when we talk about Gravestone Doji, it represents a sign of strength for the sellers. The reason being the buyers were in control and increased the price of the stock but the sellers came back in and again reduced the price to the lower opening price. This shows that there is a rejection of higher prices by the demand-supply situation.

Morning and Evening Star:


If you observe the above pattern closely, it is somewhat similar to the engulfing pattern. In the morning star candlestick pattern, the first candlestick shows reduction in closing price, thereafter, there is an indecision in the market and therefore the opening and closing prices are the same. The third candlestick is a complete reversal and the prices again go to the opening price of first candlestick. This is an example of a bullish reversal pattern.

In the evening star candlestick pattern, the first candlestick shows increase in prices, thereafter, there is an indecision in the market, which is represented by the second candlestick. The opening and closing prices are the same in the 2nd candlestick. The third candlestick though is a complete reversal again wherein the sellers come back in and reduce the closing price to the opening price of first candlestick. This is an example of a bearish reversal pattern.

Tweezer Bottom and Top

Tweezer bottom and top are very efficient indicators of strength. Let me tell you why. In the tweezer bottom, the sellers try to reduce the price all the way to the bottom of the wick, but buyers come back and increase the prices, though not till the opening price. However in the second session, the sellers try to gain control again and reduce prices again, but buyers again come into the picture and increase prices, this time the closing price being higher than the opening price. Why they are efficient is because, tweezer bottom shows two times rejection of lower prices, which is clearly an indication that buyers have the strength right now.

In the tweezer top, the situation is just opposite, instead of rejection of lower prices, tweezer top shows two times rejection of higher prices. In both the sessions the sellers do not allow the buyers to take control. This is an indication that sellers have the strength and the prices may go down in the coming session.

We are now, aware of different kinds of candlestick patterns, but the biggest mistake you would make is to just use the candlestick to predict future. You need to take into consideration the trend, area of value and entry trigger or simply the T.A.E framework, which we talked about in part 1. In the last part of this series (part - 4), we will discuss, how we can use the candlestick patterns in real life to trade stocks. Part-4 will be coming soon.

Thanks for reading!

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Comment on any query you had like me to address.

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