Patterns

Celticheart Investor

A beginner's guide to trading and investing

Understanding how individual candlesticks are formed is  one thing but how do we go about understanding their significance in the greater scheme of things?

Well the secret is quite simple really, like a lot of oriental based knowledge, it is all about recognising repeating patterns and their associated actions. By that I mean that if certain patterns are usually (not always) followed by certain market reactions then we can use those "triggers" to our advantage.

Charting patterns can, as I have previously explained fall into one of three categories, Bullish (buyers dominant), Bearish (sellers dominant) or Neutral (neither buyers nor sellers dominant). The problem is the strength of those signals vary in certainty from a weak signal (there might be a directional change) to a strong signal (there will almost certainly be a directional change). 
I say almost certainly because in the world of investing, especially in small caps there is no such thing as certainty, no matter who tells you there is.

Forgive me if I re-visit elements that I have already talked about but seeing them in isolation is not the same as seeing them in the context of a chart. 
So let's look at some examples of charts showing these repeating patterns:

This is an example of a candlestick chart for the Footsie 100, as you can see 
the change in direction is preceded by a spinning top or a hammer but the important thing to notice is the next bar which gives a confirmation of that change in direction. Interestingly enough the colour of the bar is less important than the formation of that candlestick.

This is a great example of how charting patterns repeat themselves, note the similarity in the MACD, the relative positions of the EMA20 dn EMA 50 and also 
the closing together of the Bollinger bands just prior to an uptrend.

Looking at individual reversal signals though is less effective than some of the patterns we have looked at previously. Learn to identify at least some these combinations for more accurate interpretation of the charts. This is just a sampling there are many more patterns to become aware of as you progress.
 

  


Apart from what we have already looked at here another pattern which we should look at, and are often regarded as being the most positive of reversal signals, so much so that you don't even have to wait for a confirmation signal
(if you are brave enough), they are called kickers and appear in both Bullish 
and Bearish variants.

In the bullish version, after three successive days of seller dominance the trend reverses on the fourth day with such a positive shift that it often forcing short sellers to close their positions with spectacular effect, the reverse happens in the bearish version of this strong signal.

One pattern that is well worth looking at is the "Bearish Tri Star Pattern", which is a very rare but significant top reversal pattern. It is formed by three Dojis. with the centre Doji being above the other two (called a Doji star).

For this signal to be valid the market has to be in an uptrend, the Dojis have to appear on three consecutive days. The second day Doji has to have a gap above the first and third Dojis.

The explanation for why this is so significant is that the fiest Doji indicates that the uptrend has stalled, the second shows that the market has lost direction and the third confirms indecision leading to a reversal.

To be sure that this is in act a reversal you should look for the fourth day as a confirmation signal, a black or red candlestick, a gap down or a lower close.


Next time: Confirmation

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.