Candlestick Patterns Explained with Examples – Bullish Reversal Patterns

Candlestick patterns are most popular commonly used by the traders nowadays. These patterns are a form of technical analysis and charting used in the stock market, forex market, commodity market and all other markets. Candlesticks patterns can be used in all time frames. You can use these patterns for long-term, mid-term, short-term, and day trading and even for swing trading.  Candlestick patterns have been in use since the 17th century. Japanese traders used to follow candlesticks patterns in the rice markets. You should always remember that these patterns are only useful when you understand what is happening in each pattern. You must combine with other technical chart patterns to get the result.

What do Candlesticks Look Like?

Candlesticks charts are more visually attractive than the standard two-dimensional bar chart.  There are 4 elements necessary to construct standard bar chart, OPEN, HIGH, and LOW & CLOSING price for a given period of time. Whereas, in the Candlesticks charts the body of the candlestick is called the real body and represents the range between the open and closing prices.

The red body represents that the close in that time period was lower than the open, it’s normally considered as bearish and when the body is green, it represents the closing price was higher than the open is normally considered as bullish.  A thin vertical line can be seen above or below the real body known as upper or lower shadow which indicates the high or low price extremes for the period.

Bullish Reversal Patterns

 

 

 

• Dragonfly Doji:

The stocks prices open and close at or near its high. It consists of a comparatively long lower wick, no real body, and no upper wick. It is generally seen at the bottom of a move. This reversal signal is more bullish than a hammer.

Prices typically open at a high, sell off and then return back to opening price during the period of dragonfly doji. It does not occur frequently, but when you find the dragonfly doji near the bottom that means it’s giving a strong signal for buying that stock. But keep in mind before buying any stock after viewing dragonfly dozi you should always wait for the next day candle sign. If it’s positive then you can go for it.

• Hammer:

Hammer is a simple candlestick pattern made of a single candle line. They are bullish in nature. Hammer candlestick develops during the downtrend. The long lower shadow of the hammer shows a bullish signal irrespective of the colour of the candlestick's real body. The body of the candle may be either green (white) or red (black). This type of candlestick basically forms because of the overpowering of bulls over bears. After opening the market the sellers push the prices down by overselling of the stock. Bulls fought back and finished by winning back some ground. For buying confirmation you should check the next candlestick if it’s bullish or not. For buying, there must be a bullish candlestick after the hammer candlestick. It's finally confirmed that the bulls now have a strength and are taking control.

• Inverted Hammer:

Inverted Hammer also gives a trend-reversal signal. This type of candlestick pattern can be found after a downtrend. It has a small real body, either bullish or bearish, and has a large upper shadow with a small or no lower shadow. It appears in a market that opens at or near its low, forming a candle with a small real body. Throughout the day buyers rallied price fairly high but were incompetent to withstand the rally. Again, for buying there must be bullish candles stick after the inverted hammer candlestick.

• Bullish Engulfing:

The bullish engulfing candlestick pattern specifies a bullish move ahead. It usually forms at downtrend and directs that bulls are no trying to take control from bears. It is stronger if it gets formed at any prevalent strong support zones. It is mainly composed of two candles. It can be identified by a large green (white candle) engulfing the previous bearish red (black) at the downtrend. The green candlestick started to form when selling pressure force to open the stock price below the previous close. Later the buyer steps up and forces to close the stock price above the previous open for a potential reversal. Wait for the next day signal. If it’s bullish then go for buying the stock.

• Piercing Line:

It is a simple and very effective candlestick pattern to look for when trading short-term up and down swings within a price channel. This bullish reversal pattern appears at the end of a downtrend. The first candlestick must be a ref (dark) candlestick with a large real body and the second candlestick should be green (white) and should below the low of the preceding candlestick. The last candlestick must be closing above the middle of the real body of the first candlestick, with the deeper it pierces the first candlestick the more substantial the pattern becomes. Traders also need this to form in context with another bullish trade setup as trade confirmation.

• Morning Star:

Morning Star is a strong positive three-line reversal pattern which is bullish in nature and appears at the end of the downtrend. This star can be a lucky star for you.  The Morning Star is a sign of good fortune. The first candlestick should be bearish candlestick (red or black) and with a fairly large real body.  And the second candlestick must have a small body and it can be either bullish or bearish candlestick. Although a bullish candlestick with a small or no upper wick specifies more bullishness. The second candlestick is the star. The star indicates the sellers were not able to drive the price close much lower than the close of the previous period. It is then confirmed by the third candlestick that must be green or white colour.

• Bullish Harami Cross:

This bullish reversal candlestick pattern also appears in the downtrend. The previous candlestick must be red or black and the very next candlestick must be a doji. The high of the Doji must be lower than the open of the previous candle. The low of the Doji must be higher than the close of the previous candle. When a Bullish Harami Cross candlestick pattern is recognized after a bearish move, it can signal a reversal in the price action.

• Three White Soldiers:

In a downtrend, it signals the continuation of the bullish trend in the same direction.  If we compare with other bullish reversal patterns this signal is not strong enough. The two candlesticks next to the first candlestick close at higher prices than the previous ones. Three significant, consecutive and boosting white candlesticks encompasses this formation. The former candlestick paves the way for the new successive candlestick.

These are the main bullish reversal patterns. You can always use this signals for trading either for short term or long term. Always compare these patterns with RSI (Relative Strength Index) and use a stop loss to become a successful investor.

Please check my next blog regarding the bearish reversal patterns.

Technical Analysis of Stocks & Commodities

Technical analysis started out with pretty simple concepts. Formerly, it was about looking for directional trends in prices and divergences between related market indexes.  When the stock prices start moving in one direction either upper or lower, then they are more likely to follow that trend than to reverse. Technical analysis was just a way to visualize this perception.

When I started to trade in the market, I usually rely on the market moves driven by the news. But frankly speaking, I never made money after following this approach. But when I am started to learn and follow technical analysis I started to gain from the market.

I have discussed few basics below about Technical Analysis which would help you to understand and trade in the market:

Price Trends:

Price Trends indicates the current direction of share prices. Is the price of the stocks moving upper or lower? How long has it been doing so? If the stock prices continue to rise higher, it is considered to be in an uptrend and when the stock prices continue to fall it is considered as a downtrend. Uptrend indicates increasing demand for shares, as buyers are willing to pay higher prices as supply diminishes. On the other hand, Downtrend indicates increasing supply of shares when not much buyers are interested to buy the shares. You can generate trend line by connecting the various high and low points on a chart. Now from this generated trend line, you can pinpoint support/resistance and direction of stock prices. For better understanding, you can compare your current trend line with the historical trend line of the similar stocks.

Trendline

Volume:

Volume tells us how strong the prevailing trend might be. Decreasing volume can be a signal that the trend might be on the edge of a reversal.  The number of shares or contracts that traded over a given period is called Volume. Volume is important because it helps us to confirm the reversal trend.

For example:

Suppose stock X is in a downtrend at the moment. If tomorrow it increases 5% high then traders can think the stock’s downtrend is over and they could start accumulating stock X. But for the confirmation traders should always check the volume of the stock on that particular day. If the volume does not increase subsequently then it is not a trend reversal. This might be a fluke.

Volume

Moving Averages:

Moving Averages are the most commonly used technical indicators. This indicator helps you to distinguish between typical market fluctuations and actual rate reversals. Moving averages make you easier to spot trends, something that is mainly helpful in volatile markets. They also form the building blocks for numerous other technical indicators and overlays.

Simple Moving Average (SMA)

The Simple Moving Average (SMA) is the most popular type of moving average and it is generated by calculating the average price of a financial market over a chosen period of time. To compute the simple moving average you need to do a fairly basic calculation. Firstly, you need to add a stock's closing prices over a set number of days, and then divide the addition by the total number of days. For example, stock X’s closing prices for 14 days –250, 240, 245, 242, 247, 255, 251, 260, 254, 262, 270, 280, 269, 271 respectively.

So the moving average is = (250 + 240 + 245 + 242 + 247 + 255 + 251 + 260 + 254 + 262 + 270 + 280 + 269 + 271/14) = 256.86

It indicates if the stock X stays above 256.85 then it can be considered as positive sign in short term say for 14 says.

With every new day, the latest closing price replaces the oldest closing price in the calculation.

Simple Moving Average

•    Moving averages help in the smoothing out of price action.

•    Moving averages are used not only to recognize the direction of the stock’s price trend but also for trade entry.

Weighted and Exponential Moving Averages

Weighted and exponential moving averages give greater significance to a stock's most recent closing prices rather than Simple Moving Averages.  Calculation of weighted moving average is almost similar with simple moving average calculation.  Heavier weightings are allocated to the utmost recent closing prices in the data set to confirm the moving average replicates recent trends and fluctuations.

Simple Moving Average VS Exponential Moving Average

 

SMV VS EMA

 

Notice how the green line (the 30 EMA) seems to be closer price than the violet line (the 30 SMA). This means that it more exactly represents current price action. You can perhaps guess why this happens. It’s mainly because of the exponential moving average places more importance on what has been trending lately. When trading, it is more important to see what traders are doing present days rather what they were doing last week or last month.

In this blog, I have only discussed few basics things about Technical Analysis. Please follow my future blogs for knowing more about technical analysis and how you can make a profit using this knowledge. My blogs on Relative Stock Index, Candle Stock Analysis are coming soon.....

Fundamental Analysis of Stocks

Fundamental Analysis – A Powerful Tool for Making Profit

You cannot invest in stock market blindly. Before investing your hard earned money to the stock market you should study the fundamental strength of those companies.

What is fundamental analysis?

Fundamental Analysis is a method, with this method you can evaluate the value of the underlying company. Basically, we do a fundamental analysis to understand the economic conditions and the industry along with the company’s financial condition and management performance. You can understand this by reading the balance sheet, the profit and loss statement, financial ratios and other data that could be used to forecast the future of a company. Generally, we use the real data to analysis a stock’s value. This method uses revenues, earnings, future growth, return on equity, profit margins and other data to define a company's underlying value and prospective for future growth.  The thinking behind the fundamental analysis is that as the company grows so will the value of the shares increase.

Fundamental Analysis Tools

Earnings Per Share

Earnings are profits. The most investors want to know about the earnings of the company before investing money in the company. Increasing earnings normally leads to a higher stock price and, in some cases, a regular dividend. Companies generally report about their earnings on a quarterly basis to their shareholders. Increasing earnings leads to a higher stock price and decreasing earnings leads to price fall of the shares. It works as an alarm. Factors defining earnings of the company are such as sales, costs, assets and liabilities. A basic view of the earnings is EPS (earnings per share). This figure of the earnings signifies the amount of earnings for each outstanding share.

Price to Earnings Ratio (PE Ratio)

Ratio analysis tool is the most commonly used tool in fundamental analysis. It is an indicator of the underlying value of a company in relation to the current share price and the reported earnings per share. It is calculated by dividing the current market price of an ordinary share by earnings per share.

The formula for calculating PE ratio:

PE Ratio =   Market Price per Equity Share                         

                         Earnings per Share

Example: The market price of XYZ Company’s share is Rs.500. And the earning per share is Rs.50. Then the PE ratio of that company will be 10. It refers the earnings per share of the company is covered 10 times by the market price of its share. Alternatively, you can say Rs.1 of earnings has a market value of Rs.10.

Now let’s understand how we can use PE ratio to analysis a stock

Suppose the market price of XYZ Ltd is Rs.600 and the earning per share is Rs.10. And the PE ratio of similar companies in the same industry is 8. It means the market value of XYZ limited should be Rs.800 (i.e., Rs.8 x Rs. 100). The market value of XYZ Limited is, therefore, undervalued by Rs.200. If the P/E ratio of similar companies is Rs.4, the market value of a share of XYZ Limited should have been Rs.400 (Rs.4 × Rs.100), thus the share is overvalued by Rs.200.

Price to Sales Ratio (PS Ratio)

Price to Sales ratio is another most popular fundamental analyzing tool.  Values below 1.0 often signal an undervalued company. A high PS ratio implies a high future revenue growth curve. Many stocks with high PS ratio have at least a few of quarters of demonstrated high revenue growth.

 

The formula for calculating PS Ratio

P/S Ratio = Price Per Share / Annual Net Sales Per Share

Let's assume company XYZ Ltd. reports net sales of 5,000,000 and it currently has 50,000 shares outstanding. The stock is currently trading at Rs.200.

Sales per share = 5,000,000/50,000 = 100

Price-to-Sales Ratio = 200/100 = 2

Now compare with company MNO Ltd.

MNO Ltd. reports net sales of Rs.5,000,000 and it also has 500,000 shares outstanding. The stock is trading at Rs.100.

Sales per share = 5,000,000/50,0000 = 10

Price-to-Sales Ratio = 100/10 = 10

Investors in MNO Ltd are willing to pay Rs.10 for Rs.1 in sales, while investors in XYZ Ltd are willing to only pay Rs.2 for Rs.1 in sales. MNO stocks are much more appealing here.

P/S ratio is suitable to use when valuing most types of stock. But note that P/S should never be the individual metric used when valuing a company.

Dividend Payout Ratio:

It works as an indicator of how the company is performing financially. The main motto of the companies is to maximize the wealth of the shareholders. When a company makes a profit then it becomes the duty of that company to pay dividends to their shareholders. When the profit is shared with their shareholders it is called dividend. And the percentage of the profit the company pays to their shareholders know as “dividend payout ratio”. 

Dividend Payout Ratio Calculation

Dividend Payout Ratio = Total Annual Dividends Per Share / Diluted Earnings Per Share

Let’s assume that Company X distributed four regular quarterly dividend payments of Rs.0.25 each, for a total annual dividend payment of Rs.1.00 per share. Over the same period, XYZ reported net earnings of Rs.10 per share. Company X dividend payout ratio is:

Rs.1 / Rs.10 = 10%

That means company X distributed 10% to the shareholders out of 100% as dividend and retains rest 90% as operating needs.

Dividend payout ratios offer valuable insight into a company's dividend policy.

Book Value:

Book Value is a key factor for measuring stock’s valuation. Book value means the total value of the company asset minus company's outstanding liabilities. Investors often look for the company’s book value. Investors find an opportunity to buy the shares when the shares traded below the book value.

Return on Equity:

It refers to how a company uses its valuable assets to produce earnings. This helps to evaluate the stocks.

ROE = Net Income / Book Value

A healthy company produces an ROE in the 14 to 15 percent range. You should not rely on this alone. Because a company might raise funds through borrowing fund rather than issuing stocks to the public. You need to consider at the ROE over a period of the past five years rather than just one year.

Always consider above all main fundamental tools for making investments in shares and get a healthy return on your investment.

Tips & Ideas for Investing in Shares without Taking Too Much Risk

Investing in stocks without taking too much risk is an art. I am going to share my experience on this blog with you.

Market Timing:

Buying and selling stocks at the right time is essential to successful investing. You have to wait for your turn when the market is in a downtrend and look for the buying opportunities. Always remember, don’t buy everything at once because your buying stock may come down further. For example, if you are thinking of buying 100 stocks of Reliance Industries when the market is in a downtrend, try to buy 25 stocks first and then if the market takes a downturn further then you can buy another 25 and so on. Alternatively, you can also buy 50 stocks first then 50 stocks later if the market comes down. So, spreading out of your initial investment over several months is a very important factor to minimize the risk. The same thing is applicable to selling stocks also.

Try to check the fundamental strength and technical chart of your selected stocks before buying the stocks. Reading technical chart is very important for timing in the stock market. Check if the stock trend is rising or declining. Stocks are moving forwards slowly can go further but if the stocks moving up rapidly, there is a high chance that it will level off or drop soon.

Check the trading volume of the trades. Trading volume is also very important in taking a decision. If the stock has more buyers, that's a good indicator of the stock's health. A rising price with a decreasing volume could mean that the price will fall soon due to lack of interest.

Always avoid volatile stocks, if the price of the stock jumps too much high, and you have noticed a lot of spikes in the technical chart. That means investing in these stock is not safe. Stay away from these stocks if you want to earn a profit without taking too much risk.

Diversify Your Investment to Minimize Risk:

Risk management is very important to achieve your investment goal. The investment in the stock market can give you a good return but if you are willing to do it with good risk management then it is best for you to learn about the diversification.  For example, if you are thinking to invest Rs.1,00,000, so with this amount you can select top 5 sectors and select 1 popular stock from each sector which will give you a higher return. You can then buy 5 stocks Rs.20000 each. In this process, you can get different ranges of returns without taking much risk. It is not a great idea to invest a massive amount in only one portfolio as if it will go in a loss, you will lose it all. 

The Timeframe is Key:

A long-term investment gives you a better chance of surviving any market storm - that's why I always say you should only invest for five years or longer if you are not willing to take a risk. If you buy and you’re your stocks repeatedly, much of your profit will go to commissions for brokers, and your gains will hurt. So, instead of buying and selling stocks frequently you should hold your stocks for a longer period of time. There is also a great chance of getting dividend frequently if you hold your stocks and you can reinvest them to increase your earning potential. Even investing before a huge market fall can also bring greater returns, provided your timeframe is long enough. 

Be Cautious about Buying Private Stock:

In reality, some companies keep their stock in private hands instead of trading their stock publicly on the stock market. Generally, these stocks are owned by a group of shareholders who can only sell their stock with approval from other shareholders. The shareholders set the price at which the stock can change hands. These stocks are very risky because you may not be able to buy or sell stock when you want to. You may have to make a large investment unless you are an employee of that company. OR it may even be a scam.

Start with Small:

This may sound very simple to you but it is also a very important factor if you are a new investor. You should start investing with a small amount in order to boost your confidence in the stock market. If you choose to invest a large amount to start you may not get a good return from the market. In that case, you may end up losing your hard earned money and confidence in the stock market. You need to gather more experience and knowledge if you want to earn a great return from the market. So starting with a small investment is always a great idea if you are a new investor. You can then start investing more as long as your experience and knowledge rises.

Don’t Monitor Your Investment too Closely:

If you want to invest to money for a long term in the stock market, then you do not need to monitor your investment frequently. Frequently monitoring your investment may distract you and force you to sell your stocks. You may end up with losing money. So, it is very important for you if you are expecting for good return without taking the risk.

Remember: The Bull market doesn’t last forever, and the main purpose of your portfolio is to allow you to live a more pleasing life. Your willingness and desires to take risk may not be as high as you think.