An Introduction to Candlestick Charts Part 2: Multiple Candlestick Patterns

The second article of our series on candlestick charts will look at more complicated patterns involving two or three candlesticks, such as the Engulfing pattern, Harami, Stars, and Tweezer tops/bottoms.

Read the first part of Interdax’s series on candlestick charts here.

Image by Csaba Nagy from Pixabay

Engulfing Pattern

The Engulfing Pattern is a major reversal signal with two candlesticks of opposite colours.

The three characteristics of an Engulfing Pattern are:

1. The market is in a clear trend, even if it is a short-term trend,
2. Two candlesticks make the engulfing pattern; the body of the second candlestick must engulf the body of the first candlestick, and
3. The second candlestick’s body must be the opposite colour of the preceding candlestick.

The only time an engulfing pattern is valid when the candlesticks are the same colour is when the first candlestick is a Doji. For instance, if there is a downward trend and a tiny green candlestick is followed by a large green candlestick, this variant of the Engulfing pattern could point to a bottom in the market and a potential reversal.

There are several factors to consider once you’ve spotted an engulfing pattern that increases the probability of a reversal:

• There is a strong likelihood of reversal the smaller the first candlestick’s body is and the longer the second candlestick’s body is,
• If the engulfing pattern appears after a very fast move in the market,
• If there is strong volume accompanying the trading session of the second candlestick in the engulfing pattern, and
• If the second candlestick of the engulfing pattern engulfs more than one candlestick’s body.

Engulfing Pattern Example

The weekly chart for BTC-USD below illustrates a bearish engulfing pattern.

We can see that during the summer of 2018, there was a short-term uptrend that began in August. However, the bearish engulfing pattern provided a signal to go short around $6,236. The Bearish Engulfing pattern also engulfs more than one green candle, suggesting that the likelihood of a downward move is high.

Bearish Engulfing Pattern example.

Following the Bearish Engulfing Pattern, we see that BTC-USD eventually broke below $6,000 and reached lows of around $3,100.

Two examples of a Bullish Engulfing Pattern are shown in by the daily chart below. Following two consecutive Bullish Engulfing Patterns, the price of bitcoin entered a strong uptrend, rising from $8,171 to close near $9,300 exactly one week later.

Bullish Engulfing Pattern example.

Harami

The Harami pattern is the inverse of an engulfing pattern and predicts a break of the current trend. ‘Harami’ translates from Japanese as pregnant in reference to the candlestick engulfing a smaller candle around its mid-point.

In the Engulfing Pattern, a candle with a long body engulfs the small candle preceding it. However, with a Harami pattern, a candlestick with a small body follows a candle with an unusually long body, with two examples displayed below. While an engulfing pattern requires the two candlesticks to be of opposite colours, this is not the case for Harami patterns.

The Harami candlestick is the equivalent of an ‘inside day’ where the highs and lows of a candlestick are within the range of the prior candle. The Harami pattern is not as strong as Engulfing Patterns at predicting reversals, but can be thought of as applying a brake to the market. The current trend will often come to an end but a new direction may not be established for a while.

A variant of the Harami is when the second candlestick is a Doji, and is known as the Harami Cross. Since this variant contains a Doji, it is viewed as more of a reversal indicator than a standard Harami. A likelihood of reversal is higher if the Harami Cross occurs at a significant support or resistance level.

Bearish Harami Cross. Source: https://commons.wikimedia.org/wiki/File:Candlestick_pattern_bearish_harami_cross.jpgBullish Harami Cross. Source: https://commons.wikimedia.org/wiki/File:Candlestick_pattern_bullish_harami_cross.jpg

Further confirmation can be gleaned from waiting to observe the price action after the Harami Cross, for instance, traders may wait for price to go lower once they have observed a bearish Harami Cross. Similarly, traders might also use other indicators, such as a momentum indicator to confirm that the market is oversold or overbought.

For instance, if the Relative Strength Index (RSI) is above 70 when a bearish Harami Cross appears, then it is likely that the market will reverse as conditions are overbought and the Harami Cross pattern suggests buyers are losing control. However, if the RSI is below 70 when a bearish Harami Cross appears, then the likelihood of a reversal may be lower and you might want to wait for the price to go below the Harami Cross to enter a short position.

Harami Example

The daily chart shown below illustrates a Bullish Harami pattern, which occurred at an important support level that was tested (and held) on August 15.

Bullish Harami example.

Following the Bullish Harami pattern, the downward momentum slowed and the market rose from $9,579 to near $11,000.

Dark Cloud Cover

The Dark Cloud Cover is a two-candlestick pattern found at market tops after an uptrend. The first candlestick is a large green one, followed by a large red candlestick that closes near the lows of the trading session and well within the body of the green candlestick.

Dark Cloud Cover. Source: https://commons.wikimedia.org/wiki/File:Candlestick_pattern_bearish_dark_cloud_cover.jpg

The reversal signal provided the Dark Cloud Cover is stronger the more that the red candlestick drives into the body of the green candlestick — with 50% of the green candlestick’s body the minimum requirement.

The Dark Cloud Cover is also a stronger reversal signal if the red candlestick open above a major resistance level then closes below it. Finally, strong volume on the opening of the second candlestick increases the chances of a reversal since high volume could indicate a blow-off top.

Dark Cloud Cover Example

The 2-hour chart for bitcoin shows a Dark Cloud Cover pattern. The red candlestick moves well below 50% of the green candlestick’s body, implying that there is a high likelihood that the signal will be accurate.

Dark Cloud Cover example.

After the Dark Cloud Cover pattern, the price of bitcoin fell from $8,769 once the pattern was formed to lows of $8,555 during the next day’s trading session. The high of Dark Cloud Cover pattern can be used as a stop loss level.

Piercing Pattern

The Piercing Pattern is the opposite of a Dark Cloud Cover and is used to identify bottom reversals. The first candlestick is one with a red body and is followed by a large green candlestick which opens lower than the low of the first candlestick. The long body of the green candlestick must close above the midpoint of the red candlestick to be a valid Piercing Pattern.

The reversal signal provided the Piercing Pattern is stronger the more that the green candlestick drives into the body of the red candlestick — with 50% of the red candlestick’s body the minimum requirement.

The Piercing Pattern is also a stronger reversal signal if the green candlestick opes below a major support level then closes above it. Finally, strong volume on the opening of the second candlestick increases the chances of a reversal.

While there is flexibility for the Dark Cloud cover on how much the red candlestick pushes into the body of the green candlestick, a piercing pattern must show a green candlestick pushing more than halfway in the body of a red candlestick. The reason is that there are three variations of the piercing pattern that are bearish where the green candlestick pushes less than 50% into the body of the red candlestick.

The on-neck pattern is the piercing pattern, but the green candlestick closes near the lows of the red candlestick.

The in-neck pattern is where the green candlestick closes just inside of the red candlestick’s body and the thrusting pattern is where the close is stronger than the in-neck pattern but below 50% of the red candlestick’s body.

These three patterns are bearish if found in a downtrend and differ to the piercing pattern since the green candlesticks pierce less than 50% into the body of the red candlestick preceding it.

Stars

A useful set of three candlestick patterns that identify reversals are ‘Stars’. First, we’ll look at the morning star.

Morning Star

The Morning Star is a bottom reversal pattern that is composed of a strong red candle, followed by a candle that gaps lower and has a small body, then a strong green candle that move well within the body of the first candle. An ideal Morning Star has a gap before and after the candlestick with the small body, which is known as the ‘star’.

The Morning Star pattern shows that bulls have seized control. The colour of the second candlestick is not important, but the size of its body has to be relatively small.

Evening Star

The Evening Star pattern is the opposite of the Morning Star and is a reversal signal at tops found after an uptrend. The first candle is a strong green one, followed by a star (a candle with a small body) and then the top is confirmed with a strong red candlestick that moves well within the body of the green candle.

The Morning Star or Evening Star is a stronger reversal signal if there is:

• a gap before and after the ‘star’,
• The deeper the third candlestick closes into the first candle’s body, and
• Little volume on the first candle but large volume for the third candle (indicating the old trend is fading and there is increasing interest in the new trend).

Tweezers

If two or more candlesticks have matching highs or lows, it is known as a Tweezer pattern.

There are two types of Tweezer pattern: 1) Tweezer Bottoms (where the highs of two candlesticks are equal — or almost equal) and 2) Tweezer Tops (where the lows of two candlesticks are equal — or almost equal).

Tweezer tops and bottoms can be composed any type of candlestick, whether that be a long candlestick or a Doji. The Tweezer candlestick pattern is more important if found after a long trend, i.e., Tweezer Top is found after a long uptrend, and if other candlestick patterns are found within the Tweezers.

For instance, a Tweezer Top may comprise a large bullish candlestick and a hanging man — the hanging man candlestick is also a reversal signal, meaning it is more likely a reversal will follow the Tweezer Top pattern.

Tweezers Example

An example of a Tweezer Top pattern is shown below. The pattern marked the exact top for the rally during August 2019 and the price fell back to the $10,000 range after the pattern was printed.

Once you’ve entered a short position after confirming a Tweezer Top, you can place your stop loss level at or near the highs of the pattern.

Tweezer Top example

An example of a Tweezer Bottom is shown below by the monthly chart. We can see that the pattern formed after a strong downtrend (which means we should place more emphasis on this pattern) and the lows for January and February 2019 are almost equal.

Following the Tweezer Bottom pattern, bitcoin reversed the downtrend and traded higher over the following months, rising from lows near $3,200 to exceed $13,000 by June 2019.

Three Winged Crow

The Three Winged Crow is made up of three declining red candlesticks that close at or near their lows. The open of each candle should be within the prior candlestick’s body and each candle should have small shadows (or none at all).

Three Winged Crow. Source: https://commons.wikimedia.org/wiki/File:Candlestick_pattern_bearish_three_black_crows.jpg

The Three Winged Crow pattern can be used with other technical indicators to identify a reversal of an uptrend.

The pattern is stronger is there is weak volume in the preceding candlesticks that are bullish and stronger volume associated with the Three Winged Crow pattern, as it shows that bulls tried to push the market higher but were overpowered and outnumbered by bears.

Three Winged Crow Example

The 4-hour chart below shows an example of three winged crow. Once the pattern is observed, we can enter a short position and use the highs of any of the three candles that make up the pattern as stop loss levels.

Three Winged Crow example.

We see that after the pattern was formed, the price consolidated around $7,600 and then preceded to move lower towards $6,700. Also, notice that volume picked up significantly in the last two candles of the pattern, suggesting that interest in a continued move downwards was increasing.

Three Advancing Soldiers

The Three Advancing Soldiers pattern is the opposite of the Three Winged Crow and is used to diagnose potential bottom reversals. This pattern is made up of three ascending green candlesticks that close at or near their high. The opening price of each candlestick should be within the prior candlestick’s body and each candle should have small shadows (or none at all).

Three Advancing Soldiers. Source: https://commons.wikimedia.org/wiki/File:Candlestick_pattern_bullish_three_white_soldiers.jpg

The Three Advancing Soldiers pattern can be used in conjunction with other technical indicators to identify a reversal of a downtrend.

The pattern is stronger is there is weak volume in the preceding candlesticks that are bearish and stronger volume associated with the Three Advancing Soldiers pattern, as it indicates that bears tried to push the market higher but were overpowered and outnumbered by bulls.

If the second or third candlestick of the three advancing soldiers has long upper shadows or the real body gets smaller for each candlestick, then it becomes an ‘advance block’ pattern.

The ‘advance block’ pattern indicates that buyers are running out of steam. If the last two candlesticks have long green bodies that make new highs but the last candlestick has a small body, then it is known as the ‘stalled’ pattern. The ‘advance block’ and ‘stalled’ patterns are not motivations to sell but to protect long positions by liquidating them.

Three Advancing Soldiers Example

The daily chart for BTC-USD shown below illustrates the Three Advancing Soldiers pattern. After moving above $5,000, sellers managed to push bitcoin lower from the $5,500 to $5,600 range.

Bitcoin tested the $5,000 handle numerous times before the Three Advancing Soldiers pattern was formed. On May 2’s close, the Three Advancing Soldiers pattern had formed and would have given an indication that the trend was reversing and $5,000 was the local bottom.

The Three Advancing Soldiers were also a clue that a strong uptrend was about to take place. After the pattern was confirmed, BTC-USD went onto reach highs near $8,400.

Three Advancing Soldiers example

Looking at the volume for the bearish candles immediately before the Three Advancing Soldiers pattern, we see that volume rose slightly as the pattern was formed. For more certainty, the pattern should be accompanied with higher volume than in preceding candles.

Summary

Two- and three-candlestick patterns can identify high probability moves in the market, and are much more reliable when combined with other indicators, such as support and resistance, volume and oscillators.

Also, it is important to remember to interpret each candlestick pattern in relation to its position on the chart and previous candlesticks. As a rule of thumb, ensure there are at least 50 candles on your chart to see the big picture and gradually work your way up as you become more proficient.

In the third part of the series on candlestick charts, we outline how a modification of the simple candlestick can give rise to a powerful chart that cuts out the noise and clearly identifies trends (known as Heikin Ashi).

If you have yet to absorb all the information from Interdax’s introduction to candlestick charts parts 1 and 2, you can use our guides along with other resources to identify and keep track of candlestick patterns for bitcoin.

For instance, you could use Investing.com’s Bitcoin Index candlestick patterns or custom indicators on TradingView, such as Rocks8andpaint’s ‘Candlestick Patterns’ to identify patterns and then refer to our guide to analyse these patterns.

Read part 3 of our series on candlestick charts here, which looks at Heikin Ashi charts. To read more about candlestick patterns, we recommend reading Steve Nison’s book Japanese Candlestick Charting Techniques.

Disclaimer: This blog post is for informational purposes only and should not be taken as financial advice.