This article originally appeared on Traders Reserve.
By Steve Nison
A candlestick chart is a style of bar chart that displays the high, low, open and close for a security each day over a specified period of time. Originating in Japan, this Eastern candle charting technique can be a very powerful trading tool when combined with Western technical analysis.
But remember that candlestick charting techniques are tools and not a system. For example, one must view a candlestick pattern within the context of the surrounding technical picture. Without doing so would be, as the Japanese proverbs says, “Like leaning a ladder against the clouds.”
With candle charts, one can use candle charting techniques, or Western techniques, or a combination of both. This union of Eastern and Western techniques provides traders with uniquely effective tools to help enhance profits and decrease market risk exposure. (See my article on trading seasonal effects with candlestick charts.)
There have recently been books, articles, and seminars from so-called “candlestick experts” who make no reference to where they found their information about candlesticks. Even more troublesome is that they are making up their own candlestick signals without any historical basis.
Conversely, all of the candlestick patterns and signals I follow have been confirmed by more than one Japanese source (Japanese traders, Japanese books, etc.). From my vast array of candlestick resources, there is absolutely no mention of many of these “new” patterns I see tossed around by other writers and speakers.
Once you have the basics under your belt, here are seven candlestick patterns every trader should know:
This pattern consists of two candles. A bullish engulfing pattern is when a white real body engulfs (hence the name) a small black real body during a downtrend. It doesn’t mean a stronger rally on a candlestick chart, but it does increase the likelihood of that being excellent support and could be the start of an ascent. But be careful. The dual bullish engulfing patterns have nothing to do with how far the market will ascend. These additional support points are a great advantage when candlestick trading.
This pattern is an important bottoming candlestick line. The hammer and the hanging man (see below) are both the same line. That is a small real body (white or black) at the top of the session’s range and a very long lower shadow with little or no upper shadow. When this line appears during a downtrend, it becomes a bullish hammer. For a classic hammer, the lower shadow should be at least twice the height of the real body