Basic Technical Analysis Candlestick Patterns

Spot Major Stock Trend Reversals Using the Shape of the Bar

May 8, 2009

There's more to stock trading than simply spotting momentum or following the trend. The open, high, low, and close from one day to the next can be vital clues.

While most technical analysts and stock chart-watchers utilize indicators to spot the next trade-worthy move, the shape of a chart's daily (or weekly, or hourly) bars can hold as much valuable information as any other tool.

The practice of looking at the placement of a stock's opening price, closing price, high trade for the day, and low trade for the day- or OHLC bars- is called candlestick analysis. It is believed the Japanese developed the technique, and named it based on the appearance of a chart's bars- they can frequently appear to be a candle with an extended wick, possibly at both ends.

Though there are dozens of meaningful shapes and patterns in candlestick analysis, a few basic ones will adequately get a trader started with the practice. (Visual examples are provided below.)

Doji

A Doji bar is a very simple pattern and usually indicative of a possible reversal, up or down. A doji consists of an opening price and closing price that are essentially at the same level; both are also at or near the middle of the day's range between the high and low. The shape of the bar suggests equilibrium has been met between the buyers and the sellers, which in turn means the prior trend may be coming to a close.... and a new one beginning.

Hammer

As the name implies, a hammer bar literally appears to be an upright hammer; a small part of the hammer handle is exposed above the head of the hammer, while the bulk of the handle as visible below the head. The head, of course, is the difference between the open and close.

A hammer shape that occurs after a long downtrend is often a signal that the downtrend is over and a rebound is on the way. The basic idea is that the there were no more sellers left by mid-session, and the buyers started to pour back in, pushing the price back up towards the top of the range.

Ideally, the open and close of the hammer bar would be below the open and close of the preceding and following bar. Of course, this means the analyst won't know the hammer is a reversal pattern until the next day's bar is completed.

Shooting Star

A shooting star is essentially an upside-down hammer bar, indicative of a potential reversal from an uptrend to a downtrend. As with the hammer, a low open, a high intra-day price, and then a return trip back to the low/open price suggests that the buying finally faltered mid-session, and the sellers stepped in and started pushing the price lower again.

Ideally, the open and close of the hammer bar would be below the open and close of the preceding and following bar. This is not an absolute requirement, but it does mean a trader will not be able to recognize the reversal until the following day.

Again, note that with all three examples, a trader is best served by waiting until the next bar to confirm a reversal has actually taken place.

The samples above are only a small taste of how OHLC bars can become part of a trading strategy. Learning the more advanced patterns can further enhance a trader's effectiveness.

The copyright of the article Basic Technical Analysis Candlestick Patterns in Investment is owned by James Brumley. Permission to republish Basic Technical Analysis Candlestick Patterns in print or online must be granted by the author in writing.