Trading Boot Camp: 3 Crucial Candle Patterns

Yesterday we jumped into candlestick charts. Today we’re building on this concept…

Our trades are most profitable when we can pinpoint when a stock will most likely experience a reversal of fortune. So it pays to know the early signs of a change in trend. And candlestick charts are some of the best market visuals you can use to get advance notice that a trend change is on the way.

So let’s start putting all your newfound basic candle knowledge together [Click here if you need a quick review of the basics]. It’s time you learned some unique candlesticks that can help pave the way to fast, double-digit gains.

1. Hammer

A hammer is an important (and popular) reversal candlestick formation. A hammer is formed when a stock takes a huge dive at the open, then recovers and plows higher towards the close. What results is a hammer-like shape with a long lower shadow on the candle. And guess what? That’s bullish…
Hammer3

A hammer means one thing: all the sellers have been flushed out and buyers push the stock higher into the close. And when a hammer occurs at an important support area after a big swoon, you should pay close attention. Looking for hammers is a great way to bottom-fish for a trade on the long side. This is what it looks like when a hammer helps trigger a big run:
hammer4

Beautiful, ain’t it? But what if a hammer shows itself during a strong uptrend? In this case, you’re looking at an entirely different outcome—and another name for this important reversal candle, as you’re about to find out…

2. Hanging man

Hanging man candles might look like hammers – but these actually have bearish implications.

When you see a hanging man in an uptrend, it’s an indication that the stock in question might be running out of steam.

hangingman

A hanging man candle might not look like a hanging man. But trust me, it is. Yes, a hanging man candle closes well off its lows. But the intraday selloff is a hint that buyers are becoming exhausted.

As you’ve probably already guessed after learning about hanging man and hammer candles, you can’t view these signals in a vacuum. A stock’s overall trend is vital to deciphering a candle’s meaning…

 3. Engulfing candles

Sounds awful, right? But it’s another key reversal clue. An engulfing candle can give you strong indication as to when bulls or bears are gaining control to change a trend’s direction…

As the name suggests, an engulfing candle’s real body completely engulfs the real body of the previous day’s candle.
engulfing

Think about what this means. If a stock in a downtrend opens below the previous day’s close, then powers higher all day to close above the previous day’s open, it’s clear that buyers are quickly gaining an upper hand over the sellers. This action can lead to a rapid change in trend—and a chance for you to book fast double-digit gains.

Of course, the same is true for a bearish engulfing candle. If a stock in a strong uptrend experiences a day where it opens higher, then closes below the previous day’s open price, it’s probably a good idea to take profits…

So there you have it—three crucial candle patterns. Hopefully, this quick look into candles has given you a glimpse into the struggle between buyers and sellers and how you can take advantage of sharp reversals in your trading.

We’re just scratching the surface of countless candle formations used by traders around the world. If you’re interested in diving deeper into the candlestick game, I highly recommend Japanese Candlestick Charting Techniques by Steve Nison.

Nison is the man responsible for bringing candlestick charts to the West—and his book is considered by most pros to be the bible of candlestick charting. If you want to improve your trading, it’s well worth your time.

Sincerely,

Greg Guenthner

for The Daily Reckoning

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