Must-Know Candlestick Patterns Used in Price Action
NO.5
Here is a detailed explanation of how to use candlestick patterns such as Engulfing, Inside Bar, and Doji. These are some of the most common candlestick patterns in price action and serve as important trading signals.
Engulfing
Definition:
The Engulfing pattern occurs when a candlestick completely engulfs the previous one. This means that the body of the next candlestick fully surpasses the body of the previous candlestick. The Engulfing pattern often signals a strong trend reversal.
Types:
🔹 Bullish Engulfing:
- Appears in a downtrend and signals the start of a potential price increase.
- After a strong decline, a large candlestick with a positive body appears, completely engulfing the previous bearish candlestick.
🔹 Bearish Engulfing:
- Appears in an uptrend and signals the start of a potential price decline.
- After a strong upward move, a large candlestick with a negative body appears, completely engulfing the previous bullish candlestick.
Usage:
📌 Identifying Trend Reversals:
- A Bearish Engulfing following an uptrend and a Bullish Engulfing following a downtrend indicate possible trend reversals.
📌 Entry Timing:
- If the next candlestick breaks the high or low of the Engulfing pattern, it can be used as an entry signal.
📌 Risk Management:
- Since false signals can occur, it is essential to set a stop-loss to protect against potential price reversals.
Inside Bar
Definition:
An Inside Bar is a candlestick that is completely contained within the range of the previous candlestick. It is commonly seen in range-bound markets and is considered a signal of a potential large move in the near future. The Inside Bar represents a temporary consolidation phase and signals a possible breakout (upward or downward).
Usage:
📌 In Range Markets:
- The Inside Bar often appears when the price lacks direction in a range market. It indicates a quiet period before the next big movement. Monitoring the next candlestick’s direction can help traders enter at the breakout.
📌 Entry Timing:
- A trade can be entered when the price breaks the high or low of the Inside Bar, confirming the breakout direction.
📌 Observing Range Size:
- The smaller the Inside Bar, the higher the probability of a strong breakout. If the price quickly returns to the range, it can lead to a significant move.
Doji
Definition:
A Doji is a candlestick where the open and close prices are nearly the same, with the high and low forming wicks. It indicates market uncertainty, acting as a “waiting” signal before a decisive price movement. The Doji is often a sign of a potential reversal.
Types:
🔹 Standard Doji:
- The opening and closing prices are nearly identical, with long upper and lower wicks.
🔹 Long Lower Wick Doji (Bullish Reversal Doji):
- The price drops first and then rebounds upward, signaling a potential bullish reversal.
🔹 Long Upper Wick Doji (Bearish Reversal Doji):
- The price rises first and then falls, signaling a potential bearish reversal.
Usage:
📌 Trend Reversal Signal:
- A Doji appearing after a strong trend suggests market indecision and a possible trend reversal. If the next candlestick moves in the opposite direction, it confirms the reversal.
📌 In Range Markets:
- Doji patterns often appear in range markets and can indicate an upcoming breakout direction. It signals that the market is preparing for its next move.
📌 Entry Timing:
- If the next candlestick breaks above or below the Doji’s range, it can be used as an entry signal.
Summary
Each of these candlestick patterns provides valuable trading signals:
✅ Engulfing: Strong trend reversal signal, especially at turning points.
✅ Inside Bar: Indicates a potential breakout, effective in range-bound markets.
✅ Doji: Shows market indecision, signaling possible reversals or preparation for the next move.
These patterns are most effective when combined with other technical indicators and price action analysis to determine optimal entry and exit points for trades.
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