Understanding Candlesticks Part-3

If you haven't read Part 2, read that here.

Bearish Patterns

In part 3 we discuss about bearish candlestick patterns on how to identify them and their interpretation.

Bearish Hanging Man

This pattern occurs at the top of a trend or during an uptrend. It is a single candlestick pattern which has a long lower shadow and a small body at or very close to the top of its daily trading range. The name Hanging Man comes from the fact that the candlestick looks somewhat like a hanging man.

Identification Criteria

• The market is characterized by an existing uptrend.

• A small real body at the upper end of the trading range is observed. The color of the body is not important. The length of the lower shadow is at least twice as long as the body.

• There is (almost) no upper shadow.

Candlestick Pattern Interpretation

The Hanging Man is a bearish reversal pattern. It signals a top for the market or a resistance level. Since the pattern is observed after an advance, it signals that selling pressure is starting to increase. The long lower shadow indicates that the bear’s pushed prices lower during the session. Even though the bulls regained control and drove prices higher towards the close, the appearance of this selling pressure after a rally is a hint of a correction. If the body is red, it indicates that the close was not able to get back to the opening price level, which has potentially more bearish implications.

Sell/Stop Loss Levels

The confirmation level is defined as the midpoint of Hanging Man’s lower shadow. Prices should cross below this level for a sell signal to be generated. The stop loss level is defined as the high point of the candlestick pattern formation.

Bearish Belt Hold

Bearish Belt Hold is a single candlestick pattern, basically, a red Marubozu that occurs in an uptrend. It opens at the high of the day, and then prices begin to fall during the day against the overall trend of the market, eventually closing near the low.

Recognition Criteria

• The market is characterized by an existing uptrend.

• The market gaps up and opens at its high, only to closes near to the low of the day.

• A long red body that has no upper shadow.

Candlestick Pattern Interpretation

The market opens higher, with a gap in the direction of the prevailing uptrend. However, after the market opening, things change rapidly and the market moves in the opposite direction from there on. This brings about a sense of fear among the bulls, leading them to close their position which tends to accentuate the selloff.

Sell/Stop Loss Levels

The confirmation level is defined as the last close. Prices should cross below this level for a sell signal to be generated. The stop loss level is defined as the high point of the candlestick pattern formation.

Bearish Belt Hold

Bearish Belt Hold is a single candlestick pattern, basically, a red Marubozu that occurs in an uptrend. It opens at the high of the day, and then prices begin to fall during the day against the overall trend of the market, eventually closing near the low.

Recognition Criteria

• The market is characterized by an existing uptrend.

• The market gaps up and opens at its high, only to closes near to the low of the day.

• A long red body that has no upper shadow.

Candlestick Pattern Interpretation

The market opens higher, with a gap in the direction of the prevailing uptrend. However, after the market opening, things change rapidly and the market moves in the opposite direction from there on. This brings about a sense of fear among the bulls, leading them to close their position which tends to accentuate the selloff.

Sell/Stop Loss Levels

The confirmation level is defined as the last close. Prices should cross below this level for a sell signal to be generated. The stop loss level is defined as the high point of the candlestick pattern formation.

Bearish Harami

This pattern consists of a blue body followed by a small red body candlestick that is completely inside the range of the blue body.

Recognition Criteria

• The market is characterized by an existing uptrend.

• A blue body is observed on the first day.

• The red body that is formed on the second day that is completely engulfed inside the body of the first-day candlestick.

Candlestick Pattern Interpretation

The market is characterized by an uptrend and there is heavy buying interest indicated by a blue body, which further supports the bullishness. However, the next day prices open lower or at the close of the preceding day and trades in a small range throughout the day, closing even lower, but still within the prior day’s body. The bulls now begin to doubt the strength of the market, due to this suddenly deteriorating trend.

Sell/Stop Loss Levels

The confirmation level is defined as the last close or the midpoint of the first blue body, whichever is lower. Prices should cross below this level for a sell signal to be generated. The high point of the candlestick pattern formation is considered as the stop loss level.

Bearish Harami Cross

This is a major bearish reversal pattern; the pattern is characterized by a blue body followed by a Doji that is completely inside the range of the prior white body.

Recognition Criteria

• The market is characterized by a prevailing uptrend.

• A white body is observed on the first day.

• The Doji that is formed on the second day is completely engulfed by the body of the first day.

Candlestick Pattern Interpretation

A bullish trend prevails in the market, and the bulls are firmly in control. The first day’s candlestick is a blue body, which further supports the uptrend. But the next day, prices open lower than the close or at the close of the prior day and manage to close at the price it opened. This implies a complete lack of decision and brings about a sense of fear among the bulls.

Sell/Stop Loss Levels

The confirmation level is defined as the last close or the midpoint of the first blue body, whichever is lower. Prices should cross below this level for a sell signal to be generated. The high point of the candlestick pattern formation is considered as the stop loss level.

Bearish Shooting Star

This pattern consists of a blue body followed by an Inverted Hammer that is characterized by a long upper shadow and a small body. It is similar in shape to the Bullish Inverted Hammer pattern but unlike it, the Shooting Star appears in an uptrend and signals a bearish reversal.

Recognition Criteria

• The market is characterized by an existing uptrend.

• The first day of the pattern is a blue candlestick.

• On the second day, a small body is observed at the lower end of the trading range. Color of this body is not important.

• The upper shadow of the candlestick on the second day should be at least twice as long as the body.

• There is (almost) no lower shadow.

Candlestick Pattern Interpretation

The pattern occurs in a bullish uptrend and the blue candlestick that appears on the first day further supports the bullishness. On the second day, in which an Inverted Hammer is formed, the market opens at or near the day’s low. Then buying interest is witnessed leading to a rally. However, the bulls are not able to succeed in sustaining the rally during the rest of the day and prices ultimately close either at or near the low of the day. The price action generates a sense of discomfort among the bulls.

Sell/Stop Loss Levels

The confirmation level is defined as the low of the Inverted Hammer’s body. Prices should cross below this level for a sell signal to be generated. The high point of the candlestick pattern formation is considered as the stop loss level.

Bearish Dark Cloud Cover

This is a top reversal pattern with two candlesticks. A blue candlestick appears on the first day while an uptrend is in progress. The second day opens at a new high, with a gap up and closes more than halfway into the prior blue body, leading to the formation of a strong red candlestick.

Recognition Criteria

• The market is characterized by an existing uptrend.

• A blue candlestick is observed on the first day.

• A red candlestick opens on the second day with a gap up and closes more than halfway into the body of the first day.

• The second day fails to close below the body of the first day.

Candlestick Pattern Interpretation

The market is currently in an uptrend. The blue body on the first day reinforces this view. The next day the market opens higher via a gap after this bullish gap up the bears decide to take charge. The market witnessed a correction and prices start to go down resulting in a close way below the previous day’s close. At this stage, the bulls decide to close their position as a sense of fear sets in. Looking at the correction in price short-sellers consider to take fresh positions resulting in a reversal in trend.

Sell/Stop Loss Levels

The confirmation level is defined as the last close. Prices should cross below this level for a sell signal to be generated. The high point of the candlestick pattern formation is considered as the stop loss level.

Bearish Three Black Crows

Three black crows indicate a topping out the pattern in the market. It is characterized by three red candlesticks moving downwards. The opening of each day is slightly higher than the previous close and prices progressively close at lower levels.

Recognition Criteria

• The market is characterized by an existing uptrend.

• Three consecutive slightly long red candlesticks are observed.

• Each candlestick opens within the body of the previous day.

• Candlesticks progressively close at new lows, below the preceding day.

Candlestick Pattern Interpretation

The pattern appears in a prevailing uptrend where the market is testing new highs or is already at the top. Then we observe the first red candlestick which makes an attempt to move downwards. The downward correction persists for the next two days progressively making new lows at the close. This brings a sense of fear among the bulls who now consider closing their long positions leading causing prices to head lower.

Sell/Stop Loss Levels

The confirmation level is defined as the last close. Prices should cross below this level for a sell signal to be generated. The high point of the candlestick pattern formation is considered as the stop loss level.

Disclaimer: This post originally appeared on Stock Market Strategies written by Abhijeet Kumar and has been reproduced here (with certain minor edits) with his kind permission.