Price action Bullish Candlestick Patterns

Bullish Candlestick Patterns Bullish reversal patterns are those that can be identified at the bottom or near the bottom of a bearish trend. These patterns are used to indicate a sign of strength returning to the price and a renewed accumulation of the security on the part of market participants. These patterns can be developed with one, two and even three bars. Typically patterns are considered stronger if they develop over a longer period of time or if they are more pronounced.

One-Bar Patterns


One-Bar Pattern: Hammer

Hammers are extremely common and should be identified at the end of a downtrend. There is no specific amount of time needed for the downtrend to be in motion before the appearance of a hammer or inverted hammer.

Important Keys
Hammer

· Trend: Down prior to appearance


· Description: Shadow must be 2 times the length of the body


· Confirmation: Not necessary


· Stop-loss: Below the shadow

The general psychology behind a hammer is the concept that bears came into the market on the open and forced the price down, but the bulls came back in full force during the day to drive the price back up before the close. This particular pattern can either be open or closed, but some traders do prefer to place more emphasis on an open hammer as the POWER HAMMER, as opposed to a closed hammer (as indicated in the illustration below). The hammer is identified when the body of the hammer is at the top of the shadow and the shadow is at least twice the length of the body. Generally, one should look for a more pronounced shadow to body ratio than simply twice the length.

Hammers do not generally need confirmation, but one should wait for the next day before entering the trade. As a general rule of thumb, if you do enter the trade on the hammer, make sure that your stop-loss is entered below the shadow of the hammer. Typically the following day the market will retest some part of the shadow, which is the reason for your stop being entered lower than the shadow of the hammer. Later on we will discuss the idea of filtering candles with different indicators in order to strengthen or weaken the indicator.




One-Bar Pattern: Inverted Hammer

As for the Inverted Hammer, this is a little tougher to understand psychologically, but it is considered a bullish indication. The idea is that the market opened and the bulls rallied in, but were driven back by the bears later that day. This is a pattern that would require more of a confirmation the following day compared to an actual hammer. You should look for the price to close higher the following day compared to the body of the inverted hammer. The stop-loss should be placed below the body of the inverted hammer if price confirms the following day. Once again, the shadow should be approximately twice the length of the body. As indicated previously, one should look for a more pronounced shadow to body ratio.

Important Keys


Inverted Hammer


· Trend: Down prior to appearance


· Description: Shadow must be 2 times the length of the body


· Confirmation: Next day must close above body


· Stop-loss: Below the body

Generally, one would prefer to see little to no shadow on the top of the hammer or on the bottom of the inverted hammer. However, it does not diminish the strength of the hammer if there does exist a small shadow. This is generally referred to as a hammer without a shaved top (head) or an inverted hammer without a shaved bottom.




One-Bar Pattern: Dragonfly


This particular pattern is essentially a hammer, but a very pronounced hammer. The idea is that the market opened and the bears pushed the price down, but the bulls came back to close the price of the stock at the opening price for the day. There should be little to no shadow on the top of this pattern and this is considered to be less common than an actual hammer or inverted hammer. Remember, the trend must have been down previously for this to count as a bullish reversal pattern.

Important Keys
Dragonfly

· Trend: Down prior to appearance


· Description: Horizontal line with a long vertical line (hammer without a head)


· Confirmation: Not necessary


· Stop-loss: Below the shadow

Two-Bar Patterns

In order to discuss the two-bar patterns or the three-bar patterns, you must understand a simple concept of candles. When a longer-than -normal body is present on the chart, the middle of that particular candle will act as an area of support or resistance. This concept will be discussed more completely in the support and resistance chapter. Just remember that the longer the candle's body, the stronger the middle of that candle is going to be for near-term support or resistance.




Two-Bar Patterns: Piercing Line

This particular pattern requires two bars, which increases the strength of the signal compared to a one-bar pattern. The concept is simply the price of the stock has been trending down and has moved down on a strong day. The following day the price of the stock opens low, but rallies all day to close above the middle of the long black bar of the previous day. Basically, support was tested and was not only held by the bulls, but they were able to rally back the following day. It is critical that the price of the stock closes above the middle of the previous day's body, because this represents confirmation of the pattern. Some traders will wait another day to ensure that the price of the stock is reversing, but it is not required.

Important Keys
Piercing Line
· Trend: Down prior to appearance


· Description: Signal day must close above the middle of the previous down day


· Confirmation: Confirmed on the signal day with the close above the middle of the previous day's trading range


· Stop-loss: Below the middle of the previous day's trading activity




Two-Bar Patterns: Harami

This particular two-bar reversal pattern must have a confirmation of the trend change prior to entering the actual trade. Unlike the piercing line pattern, which is extremely decisive in its change in direction, the harami indicates a change in direction with indecision. The psychological element of this pattern is that the bears have been clearly in control until a small spinning top or doji presents itself. Typically a spinning top or doji represents indecision in the market, which means waiting for the third day for confirmation. The price on the third day needs to close above the body of the spinning top or doji.

Important KeysHarami

· Trend: Down prior to appearance


· Description: Spinning top or doji inside the previous trading day's range


· Confirmation: Next day must close above body of the spinning top or the doji


· Stop-loss: Below the body of the previous trading day's range

Two-Bar Patterns: Bullish Engulfing

    A bullish engulfing pattern is considered a very strong reversal indicator for the current price trend. This pattern does not require any confirmation on the third day due to the nature of the pattern; however, some traders do wait for the third day to close higher than the signal day for further confirmation of the reversal. The underlying psychological element of this reversal pattern is based on the idea of a strong downward movement in the price of the stock with the next day opening up and engulfing the previous day's trading activity, which is referred to as the signal day. Keep in mind that the greater the number of days engulfed by the signal day, the stronger the reversal. As for stop-loss entry, typically one should enter the stop-loss below the middle of the signal day as indicated in our discussion previously on strong days establishing support/resistance in the middle of the range for the day.

Important Keys
Bullish Engulfing

· Trend: Down prior to appearance


· Description: Signal day must engulf the previous trading day's body


· Confirmation: Confirmed on the signal day with the engulfing of the pattern


· Stop-loss: Below the middle of the signal day

Three-Bar Patterns



Three-Bar Patterns: Morning Star

     Three-Bar Patterns: Morning Star This three-bar pattern is one of the strongest patterns and when identified can lead to a strong price reversal. The idea of the pattern is a strong bearish trend with a spinning top on the second day. The spinning top indicates a moment of indecision in the market, which can often be taken advantage of on the following day. The signal day is the third day in which the price closes above the middle of the first day. Ideally, one would prefer to see a gap between the first day, the spinning top and the third day. However, a gap is not necessary and only adds strength to the pattern.

Important Keys
Morning Star

· Trend: Down prior to appearance


· Description: Signal day (third day) must close above the middle of the first day


· Confirmation: Confirmed on the signal day with the close above the middle of the first day's trading range


· Stop-loss: Below the spinning top or the middle of the first trading day

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