7 Candlestick Formations Every Binary Options Trader Must Know

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Marcio

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Hammer is usually a bullish pattern which means it is a very important signal when looking to buy call options. This is mainly because the outcome of this pattern is that the market prices are usually expected to move upwards and thus a trader should feel free to buy call options with the expectations of the prices moving to higher values.

Since a hammer is a bullish pattern, it means it forms after a previous downward trend and this should always be considered when a trader is trading after the formation of a hammer. Also the trader should also note that the formation of a hammer is followed by bear candlesticks which are usually trying to take the lows of the hammer and in the process provide the trader with the point to enter buy call options.

Identifying a Hammer

The hammer is a type of a candlestick and the most central item to look at is the fact that for a candlestick to be referred to as a hammer the candlestick analyze the candlestick, measure the length of its body and also measure and compare the body to the tail which is also commonly referred to as the shadow of the candlestick.

For a candlestick to be referred to as a hammer, the tail should have a minimum length of twice the actual length of the body of the candlestick, irrespective of whether it is a bull or bear candle. As a trader even if the tail appears to be longer than the body of the candle, you should seek to find out if the tail is twice or more as long as well the body before making a conclusion that it is a hammer.

The hammer is a powerful signal for a reversal. Therefore traders should be careful to identify them in the market so as make informed trading decisions.

Hammer as a Simple Bullish Pattern

Sometimes in the financial markets, there may be opposing forces between the factors pushing the prices up and the factors pushing the prices down. The market at such times seems to be undecided since it makes a huge move in one direction and then retraces back to the other side leaving very long tails therefore resulting to the formation of a type of candlestick known as a hammer.

In actual sense, a hammer shows a battle between a bullish trend and a bearish trend, as the bears try to dominate and bulls are also doing their best to outdo the bears.

Therefore, after the formation of a hammer, the trader should not anticipate to witness a rapid movement in prices since the bears are usually not ready to give up their bearish trend and they are eager to push the market prices below the already established lows in the hammer candle.

Squaring of a Short Position

It is also worth noting that in trading currency Markets, a trader should understand that the market is normally dominated by traders who are usually pushed to take certain actions. For instance, a trader may decide to trade short for a whole week and on Friday he or she wants to find a good point to exit the market. For the trader to close the short position, he or she will have to buy and a squaring of a short position is normally seen as a strong upward candlestick that might look like a reversal candlestick.

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This simply implies that trades should avoid trading hammers which are normally formed on Friday, but instead wait for the coming Monday so that they can open a trade. If the trader surely eels that the prices are great for placing a trade, the he or she should ensure that the expiration date is well set so o avoid the losses that can be attached to the hammer being a fake one and especially on Fridays.

The trader should keep in mind that the larger the timeframe that the he or she is using, the better it is for the purposes of analysing the implications of a pattern as well as a reversal.

Bulls vs Bears – Waiting for a Retracement

In the currency markets, it is usually a battle of bullish candlesticks and bearish candlesticks. When bearish candlesticks form over a long time,the trader should look for a retracement so as to buy a call option. In short, the trader should wait for a hammer to form; retracement comes a short time after the formation of the hammer is completed.

For example, if a trader is trading on a daily chart and a hammer is formed, then the trader should wait for the retracement to come in the early hours of the following day. The retracement does not come on the same day the hammer is formed.

If a trader is trading a call option and the market prices breaks the lows that were established by a previously formed hammer, then the trader should look at reversing the trade so that he or she can trade on a put option. This is because the previous pattern becomes invalid and the reasons that had caused the trader to place a call option are no longer valid. But in such cases the trader should split his or her investments into options with short term expiration periods since the market is still very much volatile and it is dominated by short bull and bear candlesticks. From the results obtained from the short term expiration options, the trader can then make up his or her mind on which type of option to place.

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10 Price Action Candlestick Patterns You Must Know

Are you using candlestick charts as your default chart type for price action analysis?

Most likely, the answer is yes. In that case, why not make the most out of it by mastering candlestick patterns?

According to Thomas Bulkowski’s Encyclopedia of Candlestick Charts, there are 103 candlestick patterns (including both bullish and bearish versions). While the encyclopedia is great for reference, there is no need to memorise the 929-page compendium.

Simply learn these 10 candlestick patterns for an illuminating foundation.

Basic Sentiment Candlesticks

Reversal Candlestick Patterns

1. Doji

What does it look like?

It looks like a cross, with the same opening and closing prices.

What does it mean?

Simple. In a Doji candlestick, price is essentially unchanged. Hence, it represents market indecision. It’s like an area of congestion compressed into one candlestick.

How do we trade it?

  1. Trade it like a reversal signal (if there is a trend to reverse)
  2. Treat it as a signal to stand aside (if there is no trend to reverse)

2. Marubozu

What does it look like?

A Marubozu is the polar opposite of a Doji. Its opening price and closing price are at the extreme ends of the candlestick.

Visually, it is a block.

What does it mean?

A Marubozu that closes higher signifies powerful bullish strength while one that closes lower shows extreme bearishness.

How do we trade it?

The Marubozu is more useful as a learning tool than as a pattern for trading. Together with the Doji candlestick, they highlight the extremes of the candlestick spectrum.

If you must trade the Marubozu pattern, consider the following.

  1. Continuation pattern in a strong break-out aligned with the market bias
  2. Part of another candlestick pattern (discussed below)

3. Harami Candlestick

What does it look like?

Just remember that Harami means pregnant in old Japanese. The first candlestick is the mother, and the second candlestick is the baby.

Focus on their bodies. The body of the baby bar must be entirely within the body of the mother bar.

Typically, in a bullish Harami, the first bar closes lower than it opens while the second bar closes higher. Similarly, in a bearish Harami, the first bar closes higher than it opens while the second bar closes lower.

What does it mean?

It means that the market has come to a muted reversal.

The candle body stands for the real price change of the candle regardless of its intra-candle excursions. Hence, it represents the real and conclusive movement of the candlestick. The smaller candle bodies point to decreased volatility. Thus, it is not surprising that many Harami candlestick patterns are also inside bars.

Compared with the Engulfing candlestick pattern below, it is a weaker reversal pattern.

How do we trade it?

  1. In a bull trend, use the bullish Harami to pinpoint the end of bearish retracement.
  2. In a bear trend, use the bearish Harami to pinpoint the end of bullish retracement.

4. Engulfing Candlestick

What does it look like?

Simply flip a Harami pattern horizontally and you will get an Engulfing pattern.

The body of the second candle completely engulfs the body of the first.

What does it mean?

Again, the focus on the candle bodies looks for a real reversal. In this case, the second candle body fully engulfs the first and represents a strong reversal signal.

How do we trade it?

  1. In a bull trend, buy above the bullish Engulfing pattern for bullish continuation.
  2. In a bear trend, sell below the bearish Engulfing pattern for bearish continuation.

5. Piercing Line / Dark Cloud Cover

What does it look like?

The Piercing Line and the Dark Cloud Cover refer to the bullish and bearish variants of the same two-bar pattern.

The first candlestick of the Piercing Line pattern is bearish. The second candlestick:

  • Opens below the low of the first candlestick; and
  • Closes above the mid-point of the first candlestick.

As for the Dark Cloud Cover pattern, the first candlestick is bullish. The second candlestick:

  • Opens above the high of the first candlestick; and
  • Closes below the mid-point of the first candlestick.

Due to the first criterion of both patterns, the second bar must open with a gap away from the close of the first bar. Hence, these candlestick patterns are unusual in intraday time-frames where gaps are uncommon.

What does it mean?

It means some traders are sorely disappointed.

In the Piercing Line pattern, the second bar opened with a gap down, giving an initial hope of a strong bearish follow-through. However, not only did the bearishness fail to materialise, it proceeded to erase more than half of the bearish gains from the first bar. This bullish shock offers a great long trade.

Likewise in the Dark Cloud Cover pattern, the first gap up prompted hope from the bulls before the lower close crushed it.

How do we trade it?

  1. Find major bullish reversals with the Piercing Line pattern (preferably after a break of a bear trend line)
  2. Find major bearish reversals with Dark Cloud Cover pattern (preferably after a break of a bull trend line)

6. Hammer / Hanging Man Candlesticks

What does it look like?

Let’s get this straight. Both the Hammer and the Hanging Man patterns look exactly the same.

  • Candle body near the top of the candlestick; and
  • A long lower shadow (around twice of the candle body).

(Color of the candle body does not matter.)

The difference is this. The Hammer pattern is found after a market decline and is a bullish signal. However, the Hanging Man appears (as an ill-omen) at the end of a bull run and is a bearish signal.

What does it mean?

The Hammer pattern traps traders who sold in the lower region of the candlestick, forcing them to cover their shorts. As a result, they produce buying pressure for this bullish pattern. Its bar pattern equivalent is the bullish Pin Bar.

The Hanging Man pattern is a seemingly bullish candlestick at the top of an upwards trend. Infected by its optimism, traders buy into the market confidently. Hence, when the market falls later, it jerks these buyers out of their long positions. This also explains why it is better to wait for bearish confirmation before going short based on the Hanging Man pattern.

How do we trade it?

  1. In a downtrend, buy above the Hammer pattern for a reversal play. (You can also trade the Hammer pattern like a bullish Pin Bar.)
  2. In a uptrend, sell below the Hanging Man pattern for a reversal play after bearish confirmation.

7. Inverted Hammer / Shooting Star Candlesticks

What does it look like?

Simply invert the Hammer pattern.

The Inverted Hammer is visually identical to the Shooting Star pattern.

The difference is in where you find them. An Inverted Hammer is found at the end of a downtrend while a Shooting Star is found at the end of a uptrend.

What does it mean?

The Inverted Hammer is a bullish pattern. In a down trend, the Inverted Hammer pattern emboldens the sellers. Hence, when the Inverted Hammer fails to push the market down, the bullish reaction is violent.

The bearish Shooting Star pattern implies a different logic. The Shooting Star traps buyers who bought in its higher range, forcing them to sell off their long positions and hence creating selling pressure. Its bar pattern equivalent is the bearish Pin Bar.

How do we trade it?

  1. In a downtrend, buy above the Inverted Hammer pattern for a reversal play after bullish confirmation.
  2. In a uptrend, sell below the Shooting Star pattern for a reversal play. (You can also trade it like a bearish Pin Bar.)

8. Morning Star / Evening Star

What does it look like?

Both star patterns are three-bar patterns.

In candle-speak, a star refers to a candlestick with a small body that does not overlap with the preceding candle body. Since the candle bodies do not overlap, forming a star will always involve a gap. Thus, it is uncommon to find Morning Stars and Evening Stars in intraday charts.

A Morning Star comprises (in sequence):

  1. A long bearish candlestick
  2. A star below it (either bullish or bearish)
  3. A bullish candlestick that closes within the body of the first candlestick

An Evening Star comprises (in sequence):

  1. A long bullish candlestick
  2. A star above it (either bullish or bearish)
  3. A bearish candlestick that closes within the body of the first candlestick

This pattern is similar to the three-bar reversal.

What does it mean?

The first candlestick in the Morning Star pattern shows the bears in control. The star hints at a transition to a bullish market. Finally, the strength of the last candlestick confirms the bullishness.

The Evening Star expresses the same logic. The first candlestick shows the bulls in control. Uncertainty sets in with the star candle. The last candlestick confirms the bearishness.

How do we trade it?

We apply both patterns to catch reversals as well as continuations.

  1. Buy above the last bar of the Morning Star formation
  2. Sell below the last bar of the Evening Star formation

9. Three White Soldiers / Three Black Crows

What does it look like?

Each of the three candlesticks in the Three White Soldiers should open within the previous candle body and close near its high.

Each of the three candlesticks in the Three Black Crows should open within the previous candle body and close near its low.

What does it mean?

In the Three White Soldiers pattern, each bar opens within the body of the previous candlestick and suggests a potential fall. However, each bar ends up with a strong and high close. After three instances, the bullishness is undeniable.

In the Three Black Crows pattern, each bar opens within the body of the previous candlestick, suggesting bullishness. However, as each bar closes lower, the bearishness is clear.

How do we trade it?

These patterns are effective for trading reversals.

  1. Buy above the Three White Soldiers after a substantial market decline
  2. Sell below the Three Black Crows after a substantial market rise

10. Hikkake

(Despite having a Japanese name, the Hikkake is not one of the classic candlestick patterns. However, it is an interesting pattern that illustrates the concept of trapped traders.)

What does it look like?

To find a Hikkake pattern, first look for an inside bar.

For a bullish Hikkake, the candlestick after the inside bar must have a lower low and a lower high to signify a bearish break-out of the inside bar. When this bearish break-out fails, we get a long Hikkake setup.

For a bearish Hikkake, the next candlestick must have a higher high and higher low. When this bullish break-out of the inside bar fails, the market forms a short Hikkake setup.

If you need help looking for the Hikkake pattern, check out our Price Action Pattern Indicator.

What does it mean?

The Hikkake pattern pinpoints the failure of inside bar traders.

Trading the break-out of inside bars is a popular strategy. When the break-out fails, we expect the price to blaze in the other direction.

How do we trade it?

  1. Buy if a downside break-out of an inside bar fails within three bars
  2. Sell if an upside break-out of an inside bar fails within three bars

What’s Next?

Learn More Candlestick Patterns

Of course, you should not limit yourself to the 10 candlestick patterns above.

However, you should familiarise yourself with one pattern before moving to the next. Trying to look out for dozens of patterns without knowing what they are trying to tell you lands you in a confusing mess.

Start with Steve Nison’s Japanese Candlestick Charting Techniques, which is the closest you can get to the source of candlestick patterns without picking up a Far Eastern language with three scripts.

Compare with Bar Patterns

Despite differences in nomenclature, bar patterns and candlestick patterns are not mutually exclusive. In fact, integrating both will greatly improve your price action analysis.

In particular, you would find that candlestick patterns brought along with it a deep focus on analysing the candle body. The comparison of the candle body (the range between the open and close), which is largely ignored by bar patterns, adds great value to price action analysis.

The pairings below will get you started on studying the similarities and differences between bar patterns and candlestick patterns.

  • Harami – Inside Bar
  • Engulfing – Outside Bar
  • Hammer/Shooting Star – Pin Bar
  • Piercing Line/Dark Cloud Cover – Two-Bar Reversal
  • Morning Star/Evening Star – Three-Bar Reversal
  • Three White Soldiers/Three Black Crows – Three-Bar Pullback

Study Candlestick Trading Strategies

Note that we based the trading methods above on our own experience. They might not correspond strictly to Steve Nison’s book.

While you can refer to books and other online resources on candlestick patterns for a start, the best conclusion is always based your own observation and testing. You need to keep good trading records for this purpose.

Get started with candlestick trading with the strategies below.

Are you spending too much time learning patterns? And too little time on learning how to trade? Learn to take profitable trades with my price action trading course.

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