Single Candle Patterns（2）

How are Doji candlestick patterns formed？

Dojis are formed when the price of a currency pair opens and closes at virtually the same level within the timeframe of the chart on which the Doji occurs. Even though prices may have moved between the open and the close of the candle; the fact that the open and the close take place at almost the same price is what indicates that the market has not been able to decide which way to take the pair (to the upside or the downside).

Keep in mind that the higher probability trades will be those that are taken in the direction of the longer-term trends. When a Doji occurs at the bottom of a retracement in an uptrend, or the top of a retracement in a downtrend, the higher probability way to trade the Doji is in the direction of the trend. In case of an uptrend, the stop would go below the lower wick of the Doji, and in a downtrend the stop would go above the upper wick.

Top 5 Types of Doji Candlestick Patterns

Standard Doji pattern

A Standard Doji is a single candlestick that does not signify much on its own. To understand what this candlestick means, traders observe the prior price action building up to the Doji.

Trades based on Doji candlestick patterns need to be taken into context. For example, a Standard Doji within an uptrend may prove to form part of a continuation of the existing uptrend. However, the chart below depicts a reversal of an uptrend which shows the importance of confirmation post the occurrence of the Doji.

Long-legged Doji

The Long-Legged Doji simply has a greater extension of the vertical lines above and below the horizontal line. This indicates that, during the timeframe of the candle price action dramatically moved up and down but closed at virtually the same level that it opened. This shows the indecision between the buyers and the sellers.

At the point where the Long-Legged Doji occurs (see chart below), it is evident that the price has retraced a bit after a fairly strong move to the downside. If the Doji represents the top of the retracement (which we do not know at the time of its forming) a trader could then interpret the indecision and potential change of direction. Subsequently looking to short the pair at the opening of the next candle after the Doji. The stop loss would be placed at the top of the upper wick on the Long-Legged Doji.

Dragonfly Doji

The Dragonfly Doji can appear at either the top of an uptrend or the bottom of a downtrend and signals the potential for a change in direction. There is no line above the horizontal bar which creates a ‘T’ shape and signifies that prices did not move above the opening price. A very extended lower wick on this Doji at the bottom of a bearish move is a very bullish signal.

Gravestone Doji

The Gravestone Doji is the opposite of the Dragonfly Doji. It appears when price action opens and closes at the lower end of the trading range. After the candle opened, buyers were able to push the price up but by the close they could not sustain the bullish momentum. At the top of a move to the upside, this is a bearish signal.

4 Price Doji:

The 4 Price Doji is simply a horizontal line with no vertical line above or below the horizontal. This Doji pattern signifies the ultimate in indecision since the high, low, open and close (all four prices represented) by the candle are the same. The 4 Price Doji is a unique pattern signifying once again indecision or an extremely quiet market.

What is the Spinning Top candlestick pattern？

A Spinning Top pattern involves a single candle indicating uncertainty in the market. The candlestick itself is defined by a short body surrounded by long wicks (approximately the same length) on either side. The Spinning Top can be either bullish or bearish at the candle close. This candlestick pattern is often located within an uptrend, downtrend and/or consolidation (sideways movement) signifying possible reversals.

How is the spinning candlestick formed？

The price movement within the Spinning Top candle represents buyers and sellers rescinding each other resulting in a similar open and close price level. The advantage of incorporating the Spinning Top candlestick pattern within a trading strategy is that it is easy to identify with minimal implied time investment.

The logic behind the indecision shown in the market during the formation of a Spinning Top is easy - while the candle was forming, traders moved prices both higher and lower throughout the chart period. This resulted in the closing price reverting back/very close to the opening price.

The Spinning Top pattern follows the same basic structure and logic as the Doji however, the Spinning Top displays a wider candle body which shows a more substantial movement in price during the candle period.

How to Trade the Spinning Top Candle

Trading with the Spinning Top candle involves understanding how it is formed and where it sits in relation to the overall market trend. The example below goes through identification, confirmation and execution of a practical forex trade using the Spinning Top.

In the EUR/NZD chart above, the Spinning Top candle (bearish) appears at the top of an uptrend – highlighted by the gold trend line. The indecision from buyers and sellers is apparent and leads to a reversal in trend direction.

Live traders should not look to enter a trade immediately after the Spinning Top has formed but rather delay the trade to wait for confirmation. Confirmation can come from technical indicators, fundamental factors, or oscillators as seen using a stochastic oscillator. The stochastic re-confirms a short entry as indicated by the blue circle.

The most common method used by technical traders to confirm a trend reversal is waiting for the formation of the succeeding candle. Using the example above, the succeeding candle should close lower than the wick of the Spinning Top. Without this confirmation, the signal of trend reversal may not be established, and uncertainty remains in the market.

Key takeaways for trading the Spinning Top candlestick pattern:

Locate a candle with a short body and long wicks on both sides

Identify market trends by using trend lines or technical indicators

Wait for confirmation prior to entering a trade

If confirmed, place trade in the desired direction

In conclusion, the Spinning Top candle depicts market indecision between buyers and sellers which could indicate price reversals. It is important to recognize the positioning of the Spinning Top within the market – within a trend or at key price levels of support and resistance. The Spinning Top candlestick pattern is most effective at these particular points.

What is an Engulfing Candlestick？

Engulfing candles tend to signal a reversal of the current trend in the market. This specific pattern involves two candles with the latter candle ‘engulfing’ the entire body of the candle before it. The engulfing candle can be bullish or bearish depending on where it forms in relation to the existing trend. The image below presents the bullish engulfing candle.

Types of Forex Engulfing Patterns

There are two engulfing candle patterns: bullish engulfing pattern and the bearish engulfing candle.

Bullish engulfing pattern

The bullish engulfing candle provides the strongest signal when appearing at the bottom of a downtrend and indicates a surge in buying pressure. The bullish engulfing pattern often triggers a reversal of an existing trend as more buyers enter the market and drive prices up further. The pattern involves two candles with the second candle completely engulfing the ‘body’ of the previous red candle.

Interpretation: Price action must show a clear downtrend when the bullish pattern appears. The large bullish candle shows that buyers are piling into the market aggressively and this provides the initial bias for further upward momentum. Traders will then look for confirmation that the trend is indeed turning around by having use of indicators, key levels of support and resistance, and subsequent price action after the engulfing pattern.

Bearish engulfing pattern

The bearish engulfing pattern is simply the opposite of the bullish pattern. It provides the strongest signal when appearing at the top of an uptrend and indicates a surge in selling pressure. The bearish engulfing candle often triggers a reversal of an existing trend as more sellers enter the market and drive prices down further. The pattern involves two candles with the second candle completely engulfing the ‘body’ of the previous green candle.

Interpretation: Price action must show a clear uptrend when the bearish pattern appears. The large bearish candle shows that sellers are piling into the market aggressively and this provides the initial bias for further downward momentum. Traders will then look for confirmation that the trend is indeed turning around by having use of indicators, levels of support and resistance, and subsequent price action that occurs after the engulfing pattern.

Why are Engulfing Candles Important for Traders？

Engulfing candles assist traders to spot reversals, indicate a strengthening trend, and assist traders with an exit signal:

Reversals: Spotting reversals are self-explanatory – it allow the trader to enter a trade at the best possible level and ride the trend to completion.

Trend continuation: Traders can look to the engulfing pattern to support the continuation of the existing trend, for example, spotting a bullish engulfing pattern during an uptrend provides more conviction that the trend will continue.

Exit strategy: The pattern can also be used as a signal to exit an existing trade if the trader holds a position in the existing trend which is coming to an end.

A limitation of the engulfing candle can arise when the pattern turns out to be more of a retracement than a definite change in direction, but traders can look for subsequent price action to reduce the likelihood of this undesirable outcome.

Engulfing Candle Trading Strategies

Using the Engulfing Candle Reversal Strategy

Traders can look to trade the bearish engulfing pattern by waiting for confirmation of the move by observing subsequent price action or to wait for a pullback before initiating a trade.

See below for guidance on how to trade the engulfing candlestick pattern observed on the GBP/USD four-hour chart.

Entry: Look for a successful close below the low of the bearish engulfing candle. Alternatively, traders can look for a momentary retracement (towards the dotted line) before entering a short trade.

Stop: Stops can be placed above the swing high where the bearish engulfing pattern occurs.

Target / take profit level: The target can be set at a previous level of support while ensuring a positive risk-to-reward ratio. The risk-to-reward ratio is depicted by green and red rectangles.

Using the Engulfing Candle When Trend Trading

Engulfing candles dont always have to appear at the end of a trend. When viewed within a strong trend, traders can glean information from the candle pattern pointing towards continued momentum in the direction of the existing trend.

For example, the chart below shows a strong uptrend in the S&P 500 with the appearance of multiple engulfing patterns (in the direction of the trend) adding more conviction to long trades. Traders can enter a long trade after observing a close above the bullish candle.

Furthermore, this example includes the presence of a bearish engulfing pattern (red rectangle) that appeared at the top of the trend, signaling a potential reversal. However, subsequent price action did not validate this move as successive candles failed to close below the low of the bearish engulfing candle and the market continued higher – thus underscoring the importance of validating the pattern.