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Technical Analysis

Japanese Candlesticks

Click to EnlargeCQG’s candlestick formation study highlights bars on the chart that meet the criteria for 15 candlestick patterns. Candlesticks use the same data points as bar charts for each time interval with a different visual representation.

The individual candlestick line is made up of two components, the real body and the two shadows, shown in the image. The real body is the difference between the open and the close, and the two shadows are the actual high and low, which extend beyond the real body. If the close is above the opening, the body is white. The body is black if the close is below the open.

 

 

 

Candlesticks have grown in popularity since they were introduced to the western hemisphere by Steve Nison, author of numerous books on candlestick patterns including Japanese Candlestick Charting Techniques. The popularity of the candlestick patterns is due to the look of the candlestick line, which highlights the current state of the market in terms of who is winning, the bulls or the bears. A tall white real body indicates that the buyers are in control of the market. A long black body is a sign the sellers are dominating. If the body is narrow, the market is in a neutral state.

A number of bullish and bearish patterns have been determined, ranging from one to three candlestick lines.

Text symbols appear either at the top or bottom of each formation highlighted on the chart. A symbol at the top indicates a bearish formation, whereas a symbol at the bottom indicates a bullish formation (chart 2). However, if the double doji symbol, "DD?", appears at the top of the formation, the question mark (?) indicates that this formation is neither bearish nor bullish in nature.

The following is a breakdown of the patterns by one-, two-, and three-line patterns.

The one-bar formations supported by CQG include:

  • Hammer (HR)
  • Hanging Man (HM)
  • Inverted Hammer (IH)
  • Shooting Star (SS)

Hammer
The hammer formation is a bullish one, and therefore its symbol (HR) will always appear at the bottom of the formation. It represents the opposite of the hanging man formation. The long lower shadow occurs because buyers have stepped in while the market was down, bid prices up, and created a narrow body.

Three criteria establish a hammer formation:

  • The real body is at the upper end of the trading range (body color is not important).
  • A long, lower shadow should be twice the height of the height of the real body.
  • It should have no, or a very short, upper shadow.

This formation requires a value for the trend parameter.

Hanging Man
The hanging man formation is a bearish one and therefore its symbol (HM) will always appear at the top of the formation. It represents the opposite of the hammer formation. The long lower shadow indicates that buyers came in and rallied the market, but if the market declines the next day, then these buyers are left hanging.

Three criteria establish a hanging man formation:

  • The real body is at the upper end of the trading range (body color is not important).
  • A long lower shadow should be twice the height of the height of the real body.
  • It should have no, or a very short, upper shadow.

This formation requires a value for the trend parameter.

Inverted Hammer
The inverted hammer formation is a bullish one and therefore its symbol (IH) will always appear at the bottom of the formation. It represents the opposite of the shooting star formation. An ideal inverted hammer formation is one that occurs after a downtrend or at the bottom of a congestion zone. In addition, the larger the gap between the real body of the formation and the real body of the preceding bar, the stronger the confirmation.

Three criteria establish an inverted hammer formation:

  • The real body is at the lower end of the trading range (body color is not important).
  • A long upper shadow should be twice the height of the height of the real body.
  • It should have no, or a very short, lower shadow.

This formation requires a value for the trend parameter.

Shooting Star
The shooting star formation is a bearish one and therefore its symbol (SS) will always appear at the top of the formation. It represents the opposite of the inverted hammer formation. An ideal shooting star formation is one that occurs after an uptrend or at the top of a congestion zone. In addition, the larger the gap between the real body of the formation and the real body of the preceding bar, the stronger the confirmation.

Three criteria establish a shooting star formation:

  • The real body is at the lower end of the trading range (body color is not important).
  • A long upper shadow should be twice the height of the height of the real body.
  • It should have no, or a very short, lower shadow.

This formation requires a value for the trend parameter.

The two-bar formations supported by CQG include:

  • Engulfing Bearish (EG)
  • Engulfing Bullish (EG)
  • Dark Cloud (DC)
  • Double Doji (DD?)
  • Harami Bearish (HI)
  • Harami Bullish (HI)
  • Piercing Line (PL)

Engulfing Bearish
The engulfing bearish formation is a bearish one, and therefore, its symbol (EG) will always appear at the top of the formation. It represents the opposite of the engulfing bullish formation.

Three criteria establish an engulfing bearish formation:

  • The market has to be in a clearly definable uptrend, even if the trend is short term.
  • Of the two candlesticks in the formation, the second candle's real body must engulf the first candle's real body.
  • The second real body of the formation should be "down" while the first real body should be "up."

This formation requires a value for the trend parameter.

Engulfing Bullish
The engulfing bullish formation is a bullish one, and therefore its symbol (EG) will always appear at the bottom of the formation. It represents the opposite of the engulfing bearish formation.

Three criteria establish an engulfing bullish formation:

  • The market has to be in a clearly definable downtrend, even if the trend is short term.
  • Of the two candlesticks in the formation, the second candle's real body must engulf the first candle's real body
  • The second real body of the formation should be "up" while the first real body should be "down."

This formation requires a value for the trend parameter.

Dark Cloud
The dark cloud formation is bearish, and therefore, its symbol (DC) will always appear at the top of the formation. It represents the opposite of the piercing line formation.

Three criteria establish a dark cloud formation:

  • The formation occurs after an uptrend or, at times, at the top of a congestion band.
  • The first real body of the formation is a strong "up."
  • The second real body's price opens above the prior session's high; however, by the end of the second session, the close has penetrated at least halfway down into the prior session's "up" real body.

This formation does not require a trend or range parameter.

Double Doji
The double doji formation is neither a bullish or bearish formation, but represents a condition in which the open and close for the first session are the same, followed by a second session in which the open and close are again the same. The symbol (DD?) will always appear at the top of the formation.

This formation does not require a trend or range parameter.

Harami Bearish
The harami bearish formation is a bearish one, and therefore, its symbol (HI) will always appear at the top of the formation. It represents the opposite of the harami bullish formation.

Three criteria establish a harami bearish formation:

  • The market has to be in a clearly definable uptrend, even if the trend is short term.
  • Of the two candlesticks in the formation, the first candle's real body must engulf the second candle's small real body (generally, the smaller the second body, the more potent the formation).
  • It is not a requirement that the real bodies of the candlesticks be color opposites (for example, "up" vs. "down").

This formation requires values for both the trend and range parameters.

Harami Bullish
The harami bullish formation is a bullish one, and therefore, its symbol (HI) will always appear at the bottom of the formation. It represents the opposite of the harami bearish formation.

Three criteria establish the harami bullish formation:

  • The market has to be in a clearly definable downtrend, even if the trend is short term.
  • Of the two candlesticks in the formation, the first candle's real body must engulf the second candle's small real body (generally, the smaller the second body, the more potent the formation).
  • It is not a requirement that the real bodies of the candlesticks be color opposites (for example, "up" vs. "down").

This formation requires values for both the trend and range parameters.

Piercing Line
The piercing line formation is a bullish formation, and therefore its symbol (PL) will always appear at the bottom of the formation. It represents the opposite of the dark cloud formation.

Three criteria establish a piercing line formation:

  • The formation occurs after a downtrend or, at times, at the bottom of a congestion band.
  • The first real body of the formation is a strong "down."
  • The second real body's price opens below the prior session's low; however, by the end of the second session, the closing price has penetrated at least halfway up into the prior session's "down" real body.

This formation does not require a trend or range parameter.

The three-bar formations supported by CQG include:

  • Morning Star (MS)
  • Morning Doji Star (MDS)
  • Evening Star (ES)
  • Evening Doji Star (EDS)

Morning Star
The morning star formation is a three-bar bottom reversal pattern and a bullish formation. Its symbol (MS) will always appear at the bottom of the formation. It is the opposite of the evening star formation. An ideal morning star formation would have a gap before and after the second real body; however, a gap between the second and third bodies is rare.

The following criteria establish a morning star formation:

  • The market has to be in a clearly definable downtrend, even if the trend is short term.
  • The first real body of the formation is a strong "down."
  • The second candlestick is a small real body, which gaps lower from the first real body (may either be an "up" or "down" real body).
  • The third candlestick must be an "up" real body whose closing price has penetrated at least halfway up into the first candlestick's "down" real body.

This formation requires a value for the range parameter.

Morning Doji Star
The morning doji star formation is a three-bar bottom reversal pattern and a bullish formation. Its symbol (MDS) will always appear at the bottom of the formation. It represents the opposite of the evening doji star formation.

The following criteria establish a morning doji star formation:

  • The market has to be in a clearly definable downtrend, even if the trend is short term.
  • The first real body of the formation is a strong "down."
  • The second candlestick is a doji (that is, open price is equal to close price), which gaps lower from the first real body.
  • The third candlestick must be an "up" real body whose closing price has penetrated at least halfway up into the first candlestick's "down" real body.

Note: For equities, more latitude should be given regarding criteria #3 (that is, gap does not always exist).

This formation requires a value for the range parameter.

Evening Star
The evening star formation is a three-bar top reversal pattern and therefore a bearish formation. Its symbol (ES) will always appear at the top of the formation. It represents the opposite of the morning star formation. An ideal evening star formation would have a gap before and after the second real body; however, a gap between the second and third bodies is rare.

The following criteria establish an evening star formation:

  • The market has to be in a clearly definable uptrend, even if the trend is short term.
  • The first real body of the formation is a strong "up."
  • The second candlestick is a small real body that gaps above the first real body (may either be an "up" or "down" real body).
  • The third candlestick must be a "down" real body whose closing price has penetrated at least halfway down into the first candlestick's "up" real body.

This formation requires a value for the range parameter.

Evening Doji Star
The evening doji star formation is a three-bar top reversal pattern and a bearish formation. Its symbol (EDS) will always appear at the top of the formation. It represents the opposite of the morning doji star formation.

The following criteria establish an evening doji star formation:

  • The market must be in a clearly definable uptrend, even if the trend is short term.
  • The first real body of the formation is a strong "up."
  • The second candlestick is a doji (that is, open price is equal to close price) that gaps above the first real body.
  • The third candlestick MUST be a "down" real body whose closing price has penetrated at least halfway down into the first candlestick's "up" real body.

Note: For equities, more latitude should be given regarding criteria #3 (that is, gap does not always exist).


 

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