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Cornell Series in Environmental Education. It may seem unusual that the same candlestick line can be both bull- ish and bearish. Yet, for those familiar with Western island tops and island bottoms you will recognize that the identical idea applies here. The island formation is either bullish or bearish depending on where it is in a trend.
An island after a prolonged is bearish, while the same island pattern after a downtrend is bullish. The hammer and hanging man can be recognized by three criteria: 1.
The real body is at the upper end of the trading range. The color of the real body is not important. A long lower shadow should be twice the height of the real body 3. It should have no, or a very short, upper shadow. The longer the lower shadow, the shorter the upper shadow and the smaller the real body the more meaningful the bullish hammer or bear- ish hanging man.
Although the real body of the hammer or hanging man can be white or black, it is slightly more bullish if the real body of the hammer is white, and slightly more bearish if the real body of the hanging man is black. If a hammer has a white real body it means the market sold off sharply during the session and then bounced back to close at, or near, the session's high.
This could have bullish ramifica- tions. If a hanging man has a black real body, it shows that the close could not get back to the opening price level. This could have potentially bearish implications.
The logic for this has to do with how the hanging-man line is generated. Usually in this kind of scenario the market is full of bullish energy. Then the hanging man appears. On the hanging-man day, the market opens at or near the highs, then sharply sells off, and then rallies to close at or near the highs.
This might not be the type of price action that would let you think the hanging man could be a top reversal. But this type of price action now shows once the market starts to sell off, it has become vulnerable to a fast break. If the market opens lower the next day, those who bought on the open or close of the hanging-man day are now left "hanging" with a losing position.
Thus, the general principle for the hanging man; the greater the down gap between the real body of the hanging-man day and the open- ing the next day the more likely the hanging man will be a top. Another bearish verification could be a black real body session with a lower close than the hanging-man sessions close. Hanging Hanging Man. A variation of a hanging man emerged in mid-March. Its lower shadow was long, but not twice the height of the real body.
Yet the other criteria a real body at the upper end of the daily range and almost no upper shadow were met. It was also confirmed by a lower close the next day.
This line, although not an ideal hanging man, did signal the end of the upturn which started a month earlier. Candlestick charting techniques, like other charting or pattern recognition techniques, have guidelines.
But, they are not rigid rules. As discussed above, there are certain aspects that increase the impor- tance of hanging-man and hammer lines. But, as shown in the hanging man of mid-March, a long lower shadow may not have to be twice the height of the real body in order to give a reversal signal.
The longer the lower shadow, the more perfect the pattern. The interesting feature of this chart is the buy signal given early in New lows appeared at hammers 3 and 4 as prices moved under the July lows at hammer 2. Yet, there was no continuation to the downside.
The bears had their chance to run with the ball. They fumbled. Copper-Weekly Hammers hammers 3 and 4 show the bulls regained control. Hammer 3 was not an ideal hammer since the lower shadow was not twice the height of the real body.
This line did reflect, however, the failure of the bears to maintain new lows. The following week's hammer reinforced the conclu- sion that a bottom reversal was likely to occur. In Exhibit 4. Hammer 2 signaled the end of the prior downtrend as the trend shifted from down to neutral.
Hammer 4 did not work. This hammer line brings out an important point about hammers or any of the other patterns I discuss. They should be viewed in the context of the prior price action. In this context, look at hammer 4. The day before this hammer, the market formed an extremely bearish candlestick line. It was a long, black day with a shaven head and a shaven bottom that is, it opened on its high and closed on its low.
This manifested strong downside momentum. Hammer 4 also punctured the old support level of January Considering the afore- mentioned bearish factors, it would be prudent to wait for confirmation that the bulls were in charge again before acting on hammer 4. For example, a white candlestick which closed higher than the close of ham- mer 4 might have been viewed as a confirmation. Drawing the intra-day chart using candlesticks shows the high, low, open, and close of the session see Exhibit 4.
Hammer 2. Hammer 4. The high and low for that hour would be used for the upper and lower shadows. By looking closely at this chart, one can see that a hammer formed during the first hour on April Like hammer 4 in Exhibit 4. This helped to con- firm a bottom. The second hourly line on April 12, although in the shape of a ham- mer, was not a true hammer. A hammer is a bottom reversal pattern. One of the criterion for a hammer is that there should be a downtrend even a minor one in order for the hammer to reverse that trend.
This line is not a hanging man either since a hanging man should appear after an In this case, if this line arose near the highs of the prior black candlestick session, it would have been considered a hanging man. The long lower shadow, many times the height of the real body a small real body, and no upper shadow made this a classic hammer.
New highs were made for the move via an opening gap on the hanging-man day. Silver-May Source: Copyright Trend Service" Daily Hanging Man market then gaps lower leaving all those new longs, who bought on the hanging man's open or close, left "hanging" with a losing position.
The importance of bearish confirmation after the hanging-man line is reflected in this chart. One method of bearish confirmation would be for the next day's open to be under the hanging man's real body. Note that after the appearance of the first hanging man, the market opened higher. However, after the second hanging man, when the market opened under the hanging man's real body, the market backed off.
Lines 1, 2, and 3 were a series of hanging-man lines. Lack of bear- ish confirmation after lines 1 and 2 meant the was still in force. The black candlestick which followed pro- vided the bearish confirmation of this hanging man line. Although the market opened about unchanged after hanging man 3, by the time of its close, just about anyone who bought on the opening or closing of hang- ing man 3 was "hanging" in a losing trade.
In this case, the on the long black candlestick session was so severe that anyone who bought on the hanging-man day-not just those who bought on the open and close-were left stranded in a losing position.
Observe where this rally stopped. It stopped at the hanging man made in the third week of This chart illustrates the point that a reversal pattern does not mean that prices will reverse, as we discussed in Chapter 3.
A reversal indicator implies that the prior trend should end. That is exactly what happened here. After the appearance of the hanging-man reversal pattern, the prior ended with the new trend moving sideways.
Another hanging man appeared in July. This time prices quickly reversed from up to down. But, as we have discussed previously, this scenario should not always be expected with a top trend reversal. American Airlines, Daily Hanging Man a very small real body, no upper shadow, and a long lower shadow.
The next day's black real body confirmed this hanging man and indicated a time to vacate longs. Note the bullish hammer in early April. As pre- viously discussed, they can send important signals about the market's health. Most candlestick signals, however, are based on combinations of individual candlestick lines.
The engulfing pattern is the first of these multiple candlestick line patterns. The engulfing pattern is a major rever- sal signal with two opposite color real bodies composing this pattern. The market is in a trend, then a white bullish real body wraps around, or engulfs, the prior period's black real body.
This shows buying pressure has overwhelmed selling pressure. Here the market is trending higher. The white real body engulfed by a black body is the signal for a top reversal. This shows the bears have taken over from the bulls. There are three criteria for an engulfing pattern: 1. The market has to be in a clearly definable or downtrend, even if the trend is short term. Bearish Engulfing Pattern 2. Two candlesticks comprise the engulfing pattern.
The second real body must engulf the prior real body it need not engulf the shad- ows. The second real body of the engulfing pattern should be the opposite color of the first real body. The exception to this rule is if the first real body of the engulfing pattern is so small it is almost a doji or is a doji. Thus, after an extended downtrend, a tiny white real body engulfed by a very large white real body could be a bottom reversal.
In an a minute black real body enveloped by a very large black real body could be a bearish reversal pattern. The closest analogy to the Japanese candlestick engulfing pattern is the Western reversal day. A Western reversal day occurs when, during an or downtrend , a new high or low is made with prices closing under or above the prior day's close. You will discover that the engulf- ing pattern may give reversal signals not available with the Western reversal day. This may allow you to get a jump on those who use tradi- tional reversal days as a reversal signal.
This is probed in Exhibits 4. Some factors that would increase the likelihood that an engulfing pattern would be an important reversal indicator would be: 1. If the first day of the engulfing pattern has a very small real body and the second day has a very long real body. This would reflect a dissi- pation of the prior trend's force and then an increase in force behind the new move.
If the engulfing pattern appears after a protracted or very fast move. A protracted trend increases the chance that potential buyers are already long. In this instance, there may be less of a supply of new longs in order to keep the market moving up. A fast move makes the market overextended and vulnerable to profit taking. If there is heavy volume on the second real body of the engulfing pattern. This could be a blow off volume using candlestick charts is discussed in Chapter If the second day of the engulfing pattern engulfs more than one real body.
During the last two weeks of July, a bearish engulfing pattern emerged. September's bullish engulfing pattern was the bottom of the prior to the major rally. The third and fourth month of showed the two can- dlestick lines of the bullish engulfing pattern. It signaled an end to this downtrend. The rally that began with this bullish engulfing pattern con- cluded with the bearish engulfing pattern in mid The small bullish engulfing pattern in February and March of terminated the trend that started with the mid bearish engulfing pattern.
After this bullish engulfing pattern, the trend went from down to sideways for five months. The black candlestick of February came within 8 ticks of engulf- ing the January white candlestick. Bearish Engulfing Patterns.
It is safer to view this as a bearish engulfing pattern with all its inherently bearish implications than to ignore that possibility just because of 8 ticks. As with all charting techniques, there is always room for subjectivity. The bearish engulfing patterns in and in convey an advan- tage provided by the engulfing pattern-it may give a reversal signal not available using the criteria for a reversal day in Western technicals.
A rule for the Western top reversal day or, in this case, reversal month is that a new high has to be made for the move. New highs for the move were not made by the black real body periods in the bearish engulfing patterns. Thus, using the criteria for the Western reversal they would not be recognized as reversal patterns in the United States.
Yet, they were reversals with the candlestick techniques. Observe the price action on July 7 and 8. Here again, since there was no new high made, there was no sign of a top reversal by using the traditional Western reversal day as a gauge. Yet, with candlesticks, there is a bearish rever- sal signal, namely the bearish engulfing pattern, does show itself. Platinum-October, , Daily. Bearish Engulfing Pattern engulfing pattern. However, the bullish engulfing pattern is a bottom trend reversal indicator.
This means it must appear after a downtrend or sometimes at the bottom of a lateral band. In early June, when the bull- ish engulfing pattern appeared it did not warrant action since it did not appear in a downtrend. Pattern 1 dragged the market into a multi-month lateral band from its prior Engulfing pattern 2 only called a temporary respite to the rally.
Bearish engulfing patterns 3, 4, and 5 all gave reversal signals that were not available with Western technical techniques that is, since no new highs were made for the move they were not considered reversal weeks. Reversal Patterns , It is a two candlestick pattern that is a top reversal after a or, at times, at the top of a congestion band. The first day of this two candlestick pat- tern is a strong white real body.
Dark-cloud Cover prior session's high that is, above the top of the upper shadow. How- ever, by the end of the second day's session, the market closes near the low of the day and well within the prior day's white body. The greater the degree of penetration into the white real body the more likely a top will occur. If the black candlestick does not close below the halfway point of the white candle- stick it may be best to wait for more bearish confirmation following the dark cloud cover.
The rationale behind this bearish pattern is readily explained. The market is in an A strong white candlestick is followed by a gap higher on the next session's opening. Thus far, the bulls are in complete control. But then no continuation of the rally occurs!
In fact, the market closes at or near the lows of the day moving well within the prior day's real body. In such a scenario, the longs will have second thoughts about their position. Those who were waiting for selling short now have a benchmark to place a stop-at the new high of the second day of the dark-cloud cover pattern.
The following is a list of some factors that intensify the importance of dark-cloud covers: 1. The greater the degree of penetration of the black real body's close into the prior white real body, the greater the chance for a top. If the black real body covers the prior day's entire white body, a bearish engulfing pattern would occur. The dark-cloud cover's black real body only gets partially into the white body. Think of the dark-cloud cover as a partial solar eclipse blocking out part of the sun that is, covers only part of the prior white body.
The bearish engulfing pat- tern can be viewed as a total solar eclipse blocking out the entire sun that is, covers the entire white body. A bearish engulfing pattern, consequently, is a more meaningful top reversal. If a long, white real body closes above the highs of the dark-cloud cover, or the bearish engulfing pattern, it could presage another rally. Reversal Patterns 2. During a prolonged if there is a strong white day which opens on its low that is, a shaven bottom and closes on its high that is, a shaven head and the next day reveals a long black real body day, opening on its high and closing on its low, then a shaven head and shaven bottom black day have occurred.
If the second body that is, the black body of the dark-cloud cover opens above a major resistance level and then fails, it would prove the bulls were unable to take control of the market. If, on the opening of the second day there is very heavy volume, a buying blow off could have occurred. For example, heavy volume at a new opening high could mean that many new buyers have decided to jump aboard ship. Then the market sells offs. It probably won't be too long before this multitude of new longs and old longs who have ridden the realize that the ship they jumped onto is the Titanic.
For futures traders, very high opening interest can be another warning. The two candlesticks in June constitute a dark-cloud cover. A long, white real body is followed by a long, black real body.
Dark-cloud The municipal bond market backed off after this top reversal appeared. The final coup de grace came a few weeks later when the bearish engulfing pattern materialized.
We see how the dark-cloud cover's black real body covered only part of the prior white real body. The black real body of the bearish engulfing pattern enveloped the entire previous white real body. Other bearish signals confirmed each of these patterns. Let us look at them on an indi- vidual basis. Dark-cloud cover 1. This is a variation on the ideal dark-cloud cover pattern. In this dark-cloud cover, the second day's black real body opened at the prior day's high instead of above it.
It was still only a warning sign but it was viewed as a negative factor. This dark-cloud cover also signified a failed attempt by the bulls to take out resistance at the mid-February highs. Dark-cloud cover 2. A technical axiom is that a prior support level, once broken, can convert to new resistance. The failed rally attempt during the dark-cloud cover pattern during the first two days of April proved this resistance.
Chapter 11 examines this concept of the interchange- ability of support and resistance. Dark-cloud cover 3. This shows that there was also a failure at a resis- tance zone made during the late April highs. These are instances where the bearish dark-cloud cover coincided with resistance levels. This concept, where more than one technical indi- cator corroborates another, is important. It is the main focus of the sec- ond half of this book where the combination of candlestick techniques with other technical tools is discussed.
A week-long correction ensued. Two more dark-cloud covers formed in April. Dark-cloud cover 2 hinted that the prior sharp two-day rally was probably over. Dark-cloud cover 3, in mid-April, was especially bearish. Why did this dark-cloud cover turn out to be so negative? The reason has to do with the psychology of this pattern. Cover 1. Myers, Daily source: L. What would happen, though, if, on the second day of the dark-cloud cover, the open pene- trates the highs not from days, or even weeks ago, but from months ago and then fails at these new highs?
This would produce very negative connotations. This is the scenario that unfolded in April. The highest levels in at least three months were touched on the black candlestick session of dark-cloud cover 3. This high failed to hold and prices closed well within the prior white real body. Yes, there is and it is called a piercing pattern. Just as a dark-cloud cover is a top reversal, its opposite, the piercing pattern, is a bottom reversal see Exhibit 4.
It is composed of two candlesticks in a falling market. The first candlestick is a black real body day the second is a long, white real body day. This white day opens sharply lower, under the low of the prior black day.
Piercing Pattern push higher, creating a relatively long, white real body that closes above the mid-point of the prior day's black real body. The bullish piercing pattern is akin to the bullish engulfing pattern. In the bullish engulfing pattern the white real body engulfs the previous black real body.
With the bullish piercing pattern, the white real body only pierces the prior black body. In the piercing pattern, the greater the degree of penetration into the black real body, the more likely it will be a bottom reversal. An ideal piercing pattern will have a white real body that pushes more than halfway into the prior session's black real body.
If the market closes under the lows of the bullish engulfing pattern or the piercing pattern by way of a long black candlestick, then another should resume. The psychology behind the piercing pattern is as follows: The market is in a downtrend. The bearish black real body reinforces this view.
The next day the market opens lower via a gap. The bears are watching the market with contentment. Then the market surges toward the close, managing not only to close unchanged from the prior day's close, but sharply above that level.
The bears will be second guessing their posi- tion. Those who are looking to buy would say new lows could not hold and perhaps it is time to step in from the long side. The piercing pattern signal increases in importance based on the same factors 1 through 4 as with the dark-cloud cover, but in reverse.
See previous section. In the section on the dark-cloud cover, I men- tioned that although some Japanese traders like to see the black real body close more that midway in the prior white candlestick, there is some flexibility to this rule.
With the piercing pattern, there is less flexi- bility. The piercing pattern's white candlestick should push more than halfway into the black candlestick's real body. The reason for less lati- tude with the bullish piercing pattern than with the bearish dark-cloud cover pattern is the fact that the Japanese have three other patterns called the on-neck, the in-neck, and the thrusting pattern see Exhibits 4.
The difference between them is in the degree of penetration by the white candlestick into the black candlestick's real body. The on-neck pattern's white candlestick usually a small one closes near the low of the previ- ous session.
The in-neck pattern's white candlestick closes slightly into the prior real body it should also be a small white candlestick. The thrusting pattern should be a longer white candlestick that is stronger than the in-neck pattern but still does not close above the middle of the prior black real body. With these patterns, as prices move under the white low, the trader knows that it's time to sell. Note that the thrusting pat- tern in Exhibit 4.
The thrusting pattern is also bullish if it occurs twice within several days of each other. It is not important to remember the individual patterns in Exhibits 4. Just remember the concept that the white candlestick should push more than halfway into the black candlestick's real body to send a bottom reversal signal. The next day the market opened lower. This opening turned out to be the low of the day and Boeing closed well within the prior day's black real body. The two candlesticks on April 27 and 28 created the bullish piercing pat- tern.
Note how the white real body followed a very weak long, black real body. The white day opened on a new low for the move. The strong close that day, which pushed well into the previous black real body, was a powerful indication that the bears lost control of the mar- ket.
The white day was a very strong session. Variation Pattern. Note how this bullish piercing pattern brought to an end the that com- menced with the bearish engulfing pattern of March 19 and On this Wheat chart there is also a variation of the piercing pattern during the week of March The reason it is a variation is because the white real body opened under the prior day's real body, but not under the prior day's low.
During the latter part of Febru- ary , a broker asked me what I thought of oats. I rarely monitor oats. Nonetheless, I retrieved the candlestick chart shown in Exhibit 4. I had noticed that during the week of February 20, an almost classic piercing pattern appeared. I also saw this piercing pattern coincided with a successful test of the early February lows.
This increased the chance that a double bot- tom had been built. Cash Yen, Monthly Piercing Pattern appearance of this piercing pattern. Although the market did not rally after this bottom reversal signal, the signal did forecast the end of the selling pressure that had pulled the market down from mid to mid- After the piercing pattern the market stabilized for a year, and then rallied.
A star is a small real body that gaps away from the large real body pre- ceding it see Exhibit 5. It is still a star as long as the star's real body does not overlap the prior real body. The color of the star is not impor- tant. Stars can occur at tops or at bottoms sometimes a star during a downtrend is labeled a rain drop. If the star is a doji instead of a small real body, it is called a doji star see Exhibit 5. The star, especially the doji star, is a warning that the prior trend may be ending.
The star's small real body represents a stalemate in the tug of war between the bulls and bears. In a strong the bulls are in charge. With the emergence of a star after a long white candlestick in an it is a signal of a shift from the buyers being in control to a deadlock between the buying and selling forces. This deadlock may have occurred either because of a diminution in the buying force or an increase in the selling force.
Either way, the star tells us the prior power has dissipated and the market is vulnerable to a setback. The same is true, but in reverse, for a star in a downtrend. That is, if a star follows a long black candlestick in a downtrend, it reflects a change in the market environment.
For example, during the downtrend the bears were in command but a change is seen in the advent of the star, which signals an environment in which the bulls and the bears are more in equilibrium. The downward energy has thus been cooled. This is not a favorable scenario for a continuation of the bear market. Doji Star in an and a Downtrend and Downtrend The star is part of four reversal patterns including: 1.
In any of these star patterns the real body of the star can be white or black. Its name is derived because, like the morning star the planet Mercury that fore- tells the sunrise, it presages higher prices. It is comprised of a tall, black real body followed by a small real body which gaps lower these two lines comprise a basic star pattern.
The third day is a white real body that moves well within the first period's black real body. This pattern is a signal that the bulls have seized control. I will break down this three- candlestick pattern into its components in order to understand the ratio- nale behind this last statement. At this time the bears are in command. Then a small real body appears. This means sellers are losing the capacity to drive the market lower.
The next day, the strong white real body proves that the bulls have taken over. An ideal morning star would have a gap before and after the middle line's real body that is, the star. This second gap is rare, but lack of it does not seem to vitiate the power of this formation. Exhibit 5.
The rally that began with this pattern ran out of steam with the dark-cloud cover on December 26 and The week after this star, the market had a strong white real body. This white real body completed the morn- ing star pattern.
The black candlestick after this white body formed a dark-cloud cover. The market then temporarily backed off. The morning star nonetheless became a major bottom. Note how the third small real body session that is, the third star was a hammer and a bullish engulfing line. It is aptly named because the evening star the planet Venus appears just before darkness sets in. Since the evening star is a top reversal it should be acted on if it arises after an Three lines compose the evening star see Exhibit 5.
The first two lines are a long, white real body followed by a star. The star is the first hint of a top. The third line corroborates a top and completes the three-line pattern of the evening star.
The third line is a black real body that moves sharply into the first periods white real body. I like to compare the evening star pattern to a traffic light. Western Island Top In principle, an evening star should have a gap between the first and second real bodies and then another gap between the second and third real bodies.
The main concern should be the extent of the intrusion of the third day's black real body into the first day's white real body. At first glance Exhibit 5.
Analyzing the evening star more closely shows it furnishes a reversal signal not available with an island top see Exhibit 5. For an island top, the low of session 2 has to be above the highs of sessions 1 and 3.
However, the evening star only requires the low of the real body 2 to be above the high of real body 1 to be a reversal signal. The evening star pattern shown in Exhibit 5. I wonder if the Japanese technicians who use candlesticks were looking at this!
The star portion of this evening star pattern would not have been an island top based on the aforementioned discussion. In this instance, candlesticks provided a top reversal indication not avail- able with the Western island top. Also note how the rally that ended with this evening star began with the morning star on September 4.
Although more important after an the evening star can be important at the top of a congestion band if it confirms another bearish signal. See Exhibit 5. That is what happened in the middle of April.
The star portion that is, the second day of the evening star coincided with a resistance area. Old support often converts to new resistance.
Try to remember this! It is a very useful trading rule.
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