You know the very first thing that gave me early success in the markets?
It was a simple candlestick pattern: the bullish or bearish ‘engulfing’ candle.
Now this only came after I’d been through the mill a bit…
Yes, I’d fallen prey to various ‘magical’ combinations of moving averages, overbought signals on oscillating indicators and all that stuff.
I was well and truly searching for the Holy Grail of trading methods (you know, the one that NEVER loses) with some pretty horrible results, it must be said.
And don’t worry if you’ve been there yourself – you might even be even there at the moment. It seems to be a phase all traders go through as they learn the craft.
(You do know, of course, as human beings we’re prone to be a bit lazy, to look for the very easiest way to do things.)
So I’m making no judgments here – I know full well personal experience is often the only way you’ll accept if something works or if it doesn’t.
But if you are going through a ‘Holy Grail’ of trading phase, my advice is keep plugging away and get it out of your system as soon as possible…
Keep your risk to the barest minimum and let the market prove to you – as quickly as possible – what does and doesn’t work.
You can then focus your attention on understanding the inner workings of the market and get busy honing your ‘edge’. Because remember, you don’t have to be right on every trade. Nudge your ego out of the way… you just need to make more money when you win than you give up when your trades make a loss.
THAT’S the magic formula!
Anyway, I thought I’d show you that simple engulfing pattern I learnt to look for. And while we’re at it, I’ll show you two more reliable candlestick patterns you can go to work on.
Now, I’m sure you’ve seen Candlestick charts before. They were originally developed and used in eighteenth century Japan to track the price of rice contracts but they’ve become the chart of choice for many modern day Forex traders.
They really are very simple to understand and use. I’m going to cover 3 price patterns here but if you do need more information on the history of candlestick charting and a bit of insight into some more complex patterns, I’ll also show you best book to refer to.
So here they are…
My top 3 Candlestick patterns
1. The Engulfing Pattern
A bullish engulfing candle is formed in a downtrend when a bullish candle (one that closes higher than it opened) ‘engulfs’ a smaller bearish candle that immediately precedes it.
And in just the same way, a bearish engulfing candle is formed in an uptrend when a bearish candle (one that closes lower than it opened) ‘engulfs’ a smaller bullish candle that came first.
There are also three things suggesting a higher probability of the engulfing pattern marking a key reversal point in the market:
a) The candle that does the engulfing has a very long, strong, real body and the candle being engulfed has a comparatively small real body. This marks a change in dominance between the buying and selling forces at work in the market.
b) The engulfing pattern is formed after a very fast move in the market. This can mark a reversal of directional bias as quick profits are taken and the initial impetus is absorbed and overwhelmed.
c) Heavy volume comes in on the engulfing candle. Easiest to see on stock or futures charts where accurate volume figures are displayed on the chart. This again marks a deeper interest in the immediate change of direction.
And here’s what an engulfing pattern looks like on the chart:
Gold – 60 minute chart 09/04/14
So we got this one on the hourly chart of Gold on Wednesday 9th April. You can see that downward move lasting 8 hours beforehand. The move starts to fizzle out as we see those two candles with small bodies.
And then, BOOM! Buyers step in with intent.
The bullish engulfing candle is our cue to sit up and pay attention, and sure enough, the market rallies over the next 24 hours.
2. Doji
The Doji marks a time period in which the opening price and the closing price are the same (or almost the same). It can be a reliable indicator of a forthcoming reversal, or at least a stall in the current trend. It illustrates a matching of buying and selling power in the market.
So, for example, if the market was previously heading in a strong uptrend, it can be significant to see sellers suddenly step in and equalise the buying strength. It makes sense to be on standby for a potential reversal as the bears put in their appearance.
Two other factors can be taken into account to indicate a higher-probability Doji signal…
a) You can build in subsequent candles as confirmation of the Doji’s warning. You might let the Doji put you on standby and actually enter your trade off the next bearish engulfing candle.
b) Pay particular attention when the Doji appears in an otherwise Doji-free market. If there are lots of Doji’s printing, take less notice. That may just be the market churning its way through a choppy spell.
Here’s a bit of Doji price-action on the chart:
GBPUSD 5-Minute
We’re on the Pound against the US Dollar for this one (5 minute chart).
A – We get a first warning of a forthcoming reversal/stall with that blue Doji bar.
B – The Bulls have another run to the upside but the bears have put them back in their place by the time this candle comes to a close. Another (very bearish) Doji – you’d be sat to attention at this point at a minimum.
C – A last feeble push upwards is overwhelmed as the bears wade-in. The bearish engulfing candle now becomes your confirming signal to go short (sell).
D – You can ride the wave down until a new Doji grabs your attention. A bit of cage rattling happens here from both sides. Buyers and sellers are both trying to get a toe hold but this bar closes at par. Nevertheless, this is your sign that the bear’s strength is exhausted, for the short term at least. It’s time to rake your chips off the table.
3. Tweezers
Tweezer tops occur when we get two (or more) bars with matching upper extremes. This can be matching ‘wick’ highs or matching real-body highs.
At the other end, tweezer bottoms are made by matching lower extremes – either the wick lows or the real-body lows.
And really, it’s just another way of illustrating the matching of market forces as the short-term trend starts to lose strength.
It’s nice to see the candles print prominently above/below the recent range of bars – hence the two-bar ‘tweezer’ image.
Let’s have a look at an example on the chart:
EURUSD – 15 Minute
Euro against the Dollar for this example and you can see the tweezers pattern circled.
A – We get matching highs on the real bodies, the candles stand prominent above the preceding price action, and the fact both candles have those little wicks that suggest failed upside action adds to the bearish nature of this pattern.
B – If you got yourself into a short position, here’s your first warning of buyers coming in – Bullish engulfing candle.
C – If you managed to hang on through B, the bulls come in again at C with another engulfing candle. The market has not really managed to extend the downward move suggesting bearish weakness. It’s time to take your profits!
So there are three simple reversal patterns for you. None of them use any complicated formulas or anything and they all have logical price action justifying their importance.
The key of course, is spotting the potential reversals in real-time!
But that’s where I think research time is well invested.
Rather than trying to come up with a new invincible combination of lagging indicators, could you spend some time calibrating your eye to these opportunities?
Especially since they’re happening right under our noses, every single day.
And if you wanted to deeper into candlestick pattern analysis, here’s that book I mentioned:
The Candlestick Course (Steve Nison)
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Be Prepared: Market moving data coming this week (London time):
Wednesday 16th April:
09:30 GBP Claimant Count Change
10:00 EUR CPI
13:30 USD Building Permits
17:15 USD Yellen Speaks
Thursday 17th April:
15:00 USD Philly Fed
Friday 18th April:
All Day Good Friday Holiday
Monday 21st April:
All Day Easter Monday Holiday
Tuesday 22nd April:
15:00 USD Existing Home Sales
I hope you found those candlestick patterns useful. And don’t forget to check out my Profit Band Binaries betting strategy. This is perfect if you want a very simple way to profit from the forex markets.
