5 important single candlestick patterns - Part 1

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As you must have already read about in the previous chapter, candlestick patterns are a great way to identify trading signals. That said, the identification of a candlestick pattern and its subsequent interpretation is very important. That is exactly what this chapter will be focusing on. So, without further ado, let’s jump right in. 

What is a single candlestick pattern? 

The definition is quite self explanatory. A pattern that is generated by just a single candle is termed as a single candlestick pattern. Typically, traders use the 1-day candlestick chart to identify a single candlestick pattern. This is one of the simplest forms of technical analysis and takes very little time. 

Now that you’ve been introduced to single candlestick patterns, let’s take a look at some important patterns that you need to know about.

 

1. Doji   

 

Considered to be one of the most important single candlestick patterns, the doji can give you an insight into the market sentiment. Dojis are said to be formed when the opening price and the closing price of a stock are the same. Since the opening price equals the closing price, these candlesticks virtually have no body. Here’s an example of a doji. 

As you can see, the upper and lower shadows are quite long here, which signifies an increase in volatility. But, in spite of the volatile behavior, the stock has opened and closed at the same price. This essentially indicates that there’s indecisiveness in the market.   

In most cases, the chances of the opening price being exactly equal to that of the closing price is slim, at best. You’ll notice this once you start looking at candlestick charts for Indian stocks. This is why most traders consider a doji to have been formed even when there’s only a thin, minuscule body to the candlestick. 

For instance, say the opening price of a stock is Rs. 50 and it closed at around Rs. 52. In this scenario, traders consider a doji to have been formed even though the candlestick has a thin body to it. A doji in this case would look something like this.

Inference: On its own, a doji may not mean much. Its significance comes into play only when it occurs during a prevailing trend. When a doji appears during either a bullish or a bearish trend, it indicates a pause in the trend and that the market players (buyers and sellers) are uncertain about the price movement. This signal can be construed as a possible impending reversal of the trend. 

 

2. Dragonfly doji 

 

The dragonfly doji is formed when the opening and closing prices of a stock are at the highest point of the day. The dragonfly doji has no upper shadow and a long lower shadow. The candlestick pattern looks like this.

Inference: The pattern indicates that the stock opened at a high, slid down during the day due to selling pressure, and then rose back up with the buyers coming out on top at the end of the day. The dragonfly doji signifies a bullish trend with buyers having a strong grip on the price movement. When you’re reading candlestick charts for Indian stocks, if the dragonfly appears during a bearish trend, it is a good indicator of a reversal signal.

 

3. Gravestone doji  

 

It is the direct opposite of the dragonfly doji. The gravestone doji is formed when the opening and closing prices of a stock are at the lowest point of the day. The pattern has no lower shadow and a long upper shadow.

Inference: The gravestone doji essentially indicates that the stock opened at a low, rose up during the day due to buyers entering the market, and slid back down to its lowest point in the day due to intense selling pressure. This pattern is a classic indicator of a bearish trend with the sellers holding a strong grip over the price movement. The gravestone can be construed as a reversal signal when it appears during a bullish trend.

 

4. Spinning top

 

Similar to the doji, the spinning top is another single candlestick pattern that signifies indecisiveness and uncertainty in the market. A spinning top is formed when the closing price is nearabout the vicinity of the opening price. The structure of a spinning top is similar to that of a doji, but with a small but distinct body. The pattern looks like this.  

       

Inference: The long shadows mean that both the buyers and the sellers are fighting for control, but neither of them have been able to get the upper hand. Hence, the uncertainty in the price movement. When a spinning top appears during a trend, it signifies a loss in momentum and can be interpreted as an indicator of a trend reversal. 

However, you still need to exercise caution when dealing with this pattern. This is primarily because there's only a 50% chance of a trend reversing with a spinning top. Sometimes, the spinning top would merely turn out to be a pause, with the prevailing trend continuing without a reversal. 

Therefore, while reading candlestick charts for Indian stocks, it is advisable to combine this pattern along with the others to confirm the market direction. For instance, a reversal is said to be confirmed if dojis appears alongside spinning tops.

 

5. Hammer

 

The hammer is a single candlestick pattern that appears with a short body on the upper end of a candle and with a long lower shadow. The pattern is still considered to be a hammer if the candle has a short upper shadow. Here’s what the pattern looks like. 

         

According to most traders, for a candle to be classified as a hammer, the lower shadow of the pattern is required to be at least two times longer than that of the candle’s body. 

Inference: The hammer is often regarded as a sign of trend reversal from bearish to bullish. The long lower shadow signifies the sellers trying to take control of the price movement, but ultimately failing to do so with the buyers stepping in to drive the prices back up to close near the highest point of the day. The longer the lower shadow is, the more the bulls are in control. Another point to note is that the hammer can either be green (where the closing price is higher than the opening price) or red (where the closing price is lower than the opening price).  

That said, the hammer bears significance only if it occurs during a downtrend (bearish trend). After the formation of the hammer during a downtrend, the trend is likely to reverse with the prices going back up. 

However, it is a good idea to confirm the reversal trend by tracking the next day’s pattern before going in for a trade. For instance, if the price of a stock opens higher than the hammer pattern’s close, the reversal is said to be impending.

      

Wrapping up

So, these were 5 beautiful patterns formed by candlesticks, isn’t it? Head to the next chapter to discover more such single candlestick patterns and understand what they mean. 

A quick recap

  • A pattern that is generated by just a single candle is termed as a single candlestick pattern. Typically, traders use the 1-day candlestick chart to identify a single candlestick pattern.
  • A doji is formed when the opening price and the closing price of a stock is the same. This essentially indicates that there’s indecisiveness in the market.   
  • The dragonfly doji is formed when the opening and closing prices of a stock are at the highest point of the day. The dragonfly doji has no upper shadow and a long lower shadow. 
  • The dragonfly doji signifies a bullish trend with buyers having a strong grip on the price movement.
  • The gravestone doji is formed when the opening and closing prices of a stock are at the lowest point of the day. The pattern has no lower shadow and a long upper shadow.
  • This pattern is a classic indicator of a bearish trend with the sellers holding a strong grip over the price movement.
  • A spinning top is formed when the closing price is nearabout the vicinity of the opening price. The structure of a spinning top is similar to that of a doji, but with a small but distinct body.
  • When a spinning top appears during a trend, it signifies a loss in momentum and can be interpreted as an indicator of a trend reversal. 
  • The hammer is a single candlestick pattern that appears with a short body on the upper end of a candle and with a long lower shadow. The hammer is often regarded as a sign of trend reversal from bearish to bullish.
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