Two Candlestick Patterns Predicting A Bottom
Candlesticks
were developed by rice traders in Japan many centuries ago to help
display price activity over a trading period. Candlesticks represent the
opening, high, low and closing
values for one period of trading; the period can be absolutely
anything, including one minute, one hour, one day or even one year. The
candles in the stock charts below are one-day candles.
The main body of the candlestick, as seen in the image below,
represents the range between the opening price and closing price. In the
case where the close is higher than the open, the candle is known as an
open candlestick;
it is often displayed in white or green (displayed blue in our charts
below). If the closing price is below the opening price, the candlestick
is known as a closed candlestick;
it is often displayed in black or red (displayed red in our charts
below.) The lines above and below the candlestick represent the high and
low prices of the trading period, and are often known as wicks, or shadows.
There are many patterns that candlestick pattern
traders can use to predict the movement of a stock. Because
candlesticks are so visually appealing, traders can recognize patterns
at glance that may signify a continuation or reversal. Let's take a look
at two reversal patterns that could be signaling a bottom in the stocks
they track.
Bullish Harami
As you can see in the example above, the bullish harami
is a candlestick chart pattern in which a large closed candlestick is
followed by a smaller open candlestick, the body of which is located
within the vertical range of the larger body. This pattern predicts the
reversal of a downward trend; the smaller the open candlestick, the more
likely the reversal. Here are two stocks that have just shown us this
chart pattern.
Midway Gold Corp. (NYSE:MDW) - This stock is a thinly traded stock that is currently at the bottom of its 52-week range. The Relative Strength Index
is currently indicating that the stock may be oversold and poised for a
reversal as it crosses back across the 30 line. This bullish harami
candlestick pattern may confirm that a reversal is about to occur.
Bullish traders should enter in long here, with a stop loss at $1.57,
the low of the previous candle
Oil-Dri Corp. of America (NYSE:ODC)
- Oil-Dri's stock is another that has just created a bullish harami
candlestick pattern. Like with MDW, the RSI has verified that this stock
is oversold. Although the RSI did not cross below the 30 level in this
case, it is bouncing off this level and appears to be looking for
support. Bullish traders going long here will want to place stop losses
at the low of the previous candle - $16.31.
Bullish Engulfing Pattern
In the chart pattern above, we see the bullish engulfing pattern
of a small closed candlestick is followed by a large open candlestick
that completely "engulfs" the previous closed candlestick. The shadows,
or tails, of the closed candlestick are short, which enables the body of
the large candlestick to cover the entire candlestick from the previous
period. This pattern suggests that the bulls have taken control of the
price, and a reversal is anticipated. Here are a couple stocks that have
just shown us a bullish engulfing pattern.
Lattice Semiconductor CP (Nasdaq:LSCC)
- This stock is trading near its 52-week lows, and seems to be finding
support at a pivot low. The price action of LSCC has created a bullish
engulfing pattern, which, along with the recent RSI cross above the 30
level, is a good sign of reversal. Traders wishing to go long here
should place a stop loss at the low of the engulfing candle - $2.66.
Netflix Inc. (Nasdaq:NFLX)
- Netflix is an example of a bullish engulfing pattern that does not
have verification of a reversal by the RSI. As you can see in the chart
below, there is a strong engulfment that has occurred, but RSI is
indicating indifference on whether the stock is oversold. Looking back
about six trading days, you can see that another engulfing pattern was
created, which ended up being a false signal. This stock is a perfect
example of why candlestick patterns should only be used along with other
technical indicators to predict future price action.
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Candlesticks are merely a visual representation
of supply and demand. As demand increases, the chance of the close being
near the high is much better. The opposite is true as supply begins to
outpace demand; the close will be closer to the low of the day as the
price falls to try and boost demand. Because supply and demand are the
main tenets of our financial markets, being able to visualize the
relationship at a moment's notice is a great advantage to the trader.
These patterns can be a useful tool for predicting future price movement
when combined with other technical indicators such as the Relative
Strength Index.
To learn more on candlesticks and their patterns, be sure to read The Art Of Candlestick Charting Part 1, Part 2, Part 3 and Part 4.
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