Welcome back to our series on trading education and basic technical analysis! Here are the articles in this series so far:
While we have a basic understanding of the candlesticks and learned about individual candle structures, we still need to know about the different patterns these candles can form together. While it’s not an exact science, studying the patterns can help you understand the overall market mood and sentiment.
So, let’s go through some simple Japanese candlestick patterns today. Don’t worry. We will not be doing anything elaborate. Instead, we will just show you three patterns that you can incorporate into your daily analysis.
Three Simple Japanese Candlestick Patterns #1: Engulfing Patterns
The first thing we will be looking into is the engulfing pattern. In this case, there are two candles with opposite sentiments (one bullish and one bearish). The latest candlestick “engulfs” or overwhelms the entire body of the first candle. Based on the nature of the newest candlestick, the pattern could be bullish engulfing or bearish engulfing.
- Bullish engulfing: In this case, the buyers have retaken control of the market to such an extent that they have entirely overwhelmed the bears in the time frame.
- Bearish engulfing: In this situation, the sellers have taken control by completely overwhelming the buyers.
Both of these patterns are incredibly aggressive patterns of bullish or bearish market sentiment and could signal one of the following:
- Trend reversal: The engulfing pattern is a beneficial indicator to know whether the current trend is reversing or not. So, if an asset charts a bullish engulfing pattern during a downtrend, it indicates that the buyers are looking to retake control and reverse the trend. Similarly, vice-versa.
- Trend continuation: Charting a bullish engulfing pattern during an uptrend indicates that a further rise in price is on the cards. On the other hand, a bearish engulfing pattern on the downtrend suggests a further fall.
Let’s check this pattern in action. We are looking at the BTC/USD daily chart.
The Bitcoin price charted a bearish engulfing pattern on July 12, 2021 (the downward pointing arrow). Following this, it dropped from $34,200 USD to $29,800 USD on July 20. Following that, on July 21, BTC charted the bullish engulfing pattern, triggering a reversal in the bearish trend, and the price jumped up to $42,200 by July 30.
Three Simple Japanese Candlestick Patterns #2: The Morning/Evening Stars
Up next, we have the “star” patterns – the bearish evening star and the bullish morning star. Both of these are trend reversal patterns. This is how they work.
Morning star pattern – Bullish
This pattern happens at the bottom of a downtrend and indicates an imminent reversal in the bearish sentiment. This pattern is characterized by three candlesticks.
- First candle: A strong bearish candle that continues the current downtrend., indicating that the sellers are still in control.
- Second candle: The size of the candle is significantly smaller than the first candle. This could be either bullish or bearish. This candle indicates that the sellers have run out of momentum.
- Third candle: Now, the bulls have taken full control. This is indicated by the strong third candle.
Evening star pattern – Bearish
This pattern happens at the top of an uptrend and indicates an imminent reversal in the bullish sentiment. This pattern consists of three candlesticks.
- First candle: A strong bullish candle that continues the current uptrend., indicating that the buyers are still in control.
- Second candle: The size of the candle is significantly smaller than the first candle. This could be either bullish or bearish. This candle indicates that the buyers have run out of momentum. This candle is also known as the “star.”
- Third candle: Now, the bears have taken full control. The strong third candle indicates this.
The following chart shows an evening star in action.
BTC/USD formed the pattern and dropped from $40,500 USD to $31,600 – losing ~$9,000.
Three Simple Japanese Candlestick Patterns #3: Soldiers vs Crows
The soldiers/crows signal trend reversals like the star patterns. The three white soldiers are a bullish signal, while the three black crows are a bearish sign.
Three white soldiers – Bullish
The pattern consists of three consecutive long-bodied green candlesticks at the end of a bearish trend. This pattern basically tells us that the buyers are back in complete control of the market. The candle’s wicks are very small, and they open and close progressively higher than the previous day.
Three black crows – Bearish
The pattern consists of three consecutive long-bodied red candlesticks at the top of a bullish trend. The three black crows signal the start of a bearish downtrend, with the sellers retaking complete control from the buyers. Each candle opens at the previous day’s closing price, but the negative pressure keeps pushing the price down.
Again, let’s check the BTC/USD chart for this pattern.
At the end of a long-running downtrend, the buyers took back control and formed the three white soldiers pattern with $30,750 USD to $33,650. Unfortunately, this didn’t kickstart a bullish rally, with the bears immediately taking back control. This example serves as a reminder for you that technical analysis isn’t an exact science. You must be very careful with your readings and observations.
Conclusion
Today we learned how to combine different candlesticks to form patterns to determine bullish or bearish market sentiment. In fact, these three patterns – engulfing, morning/evening star, and three crows/soldiers – are extremely useful in determining bullish/bearish trend reversal. Combine these patterns along with the lessons you have learned in our other articles to make solid and insightful trades.
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