JAPANESE CANDLESTICKS PART 2
The Hammer/Pin bar Candle
The Hammer/Pin bar candle shows that price initially fell down with sellers in control but through the session buyers regained control and remained stronger at the close of the candle. The Hammer candle is a bullish reversal pattern and known as a hammer because it is “hammering” out a bottom which signifies that the bottom/support is near and price will now start to rise.
In the example you can see the bullish hammer/pin bar rejecting the key area of support. Do not enter the long trade just because the hammer candle has formed, wait for more bullish confirmation before you enter the trade.
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Example of a high probability long setup
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- Trendline break+retest
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- Hammer/pin bar candle on daily
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- Key support held strong
The Bullish Engulfing candlestick formation is when the second bullish candlestick completely engulfs the first bearish candlestick. This indicates that there’s a change in direction or retracement.
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The Bearish Engulfing is where the second bearish candl completely engulfs the first bullish candle. This indicates that there’s a change in direction or retracement.
The bullish engulfing pattern is usually found at the bottom of a downtrend or consolidation range at levels of support. The bearish engulfing pattern usually occurs at the top of a downtrend or consolidation range at levels of resistance.
Practice drawing a rectangle around the engulfing patterns on your charts and they will become very easy to spot, which means you will be faster to trade off the pattern.
The Shooting Star
A Shooting Star is a bearish reversal formation where buyers have tried to push the price upwards but sellers then gained control creating the big wick to the upside and the candle closed bearish. Bearish momentum usually follows this. This can indicate a potential reversal in trend or show that price is hitting a key level of resistance.
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When the shooting star has formed at the top of an uptrend or at a key area of resistance it can create a great selling opportunity.
High probability sell trade
In this example you can see the shooting star highlighted with the blue box is the first indication that sellers are gaining control.
After hitting major resistance with a double top formation and then the formation of the shooting star, we see a break of the trendline which triggers the sell trade. Our stoploss would go 10 pips above the last high and we would be looking for a 1:3 risk reward trade.
The Morning Star formation
The first candle is bearish which shows that sellers are in control, this is followed by a spinning top/doji or a hammer/pinbar. This second candlestick represents indecision in the market.
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The last candlestick will be a green candlestick which has to close within the upper 40% of the first bearish candlestick’s range. This is an excellent opportunity to enter a buy trade. Here you need to place your stops 15 pips below the second candle’s low and set targets accordingly.
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This formation works best on the higher timeframes but can used on any timeframe above an hour.
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Examples of the Morning Star formations
The Evening star also consists of 3 candles.
The first candle is bullish which shows that buyers are in control, this is followed by a spinning top/doji or a shooting star. This second candlestick represents indecision in the market. The last candlestick will be a red candlestick which has to close within the lower 40% of the first bullish candlestick’s range. This is an excellent opportunity to enter a sell trade. Here you need to place your stops 15 pips above the second candle’s high and set targets accordingly.
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This formation works best on the higher timeframes but can be used on any timeframe above an hour.
You can trade off this formation alone with a tight stop loss but I would recommend combining this with the rest of your technical tools and fundamental analysis. For example if you saw an Evening Star at a key area of resistance then instantly we have an even higher probability trade. The more confluences the better.
The inside bar formation/Breakout Strategy
The Inside bar formation is a popular formation of candles and it only needs two candles to present itself. So the inside bar price action is where the second candle completely fits into the range of the previous candle.
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The Inside Bar Setup
This formation indicates a period of indecision where price is consolidating potentially for the next big move. This provides traders with a high probability trading setup with a good risk to reward ratio.
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So firstly establish the high and low of the mother candle and where your buy and sell zones are. A break and close above or below these zones indicates that price is ready to move.
Typically you would look for these Inside bar setups on the daily/4h/1h. When you have your setup ready wait for a clean break and close outside the “mother bar”, then enter the trade. Your stoploss would be 5-10 pips above the “mother bar” if you’re selling or 5-10 pips below the “mother bar” if you’re buying
Rules to trading the inside bar break out strategy
-Make sure you already understand and have studied the pair which you’re looking to trade
-Plot on any key levels, trendlines etc, to make sure you’re not missing anything
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-Find the inside bar, plot on your dotted lines and wait for a break and close outside lines.
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-Wait for the break and close above or below the dotted line
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-Check the risk reward is good on the trade, a minimum of 1:1
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-Work out the amount you’re going to risk and plot your target and stop loss
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-Use risk management lesson to help
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-Finally, document and review your trade
To wrap candlesticks up, you need to make sure you have learnt all the patterns and formations we have discussed, and practiced pointing them out on your charts. Remember that these formations/patterns work best along with all the other technical tools and fundamental analysis.