Candle formations - professional use and useful tips
Trade based on various formations price action is undoubtedly one of the most popular concepts used by investors. However, regarding this topic, there are still many misunderstandings and errors that can cause misinterpretation and, consequently, incorrect trading decisions. In this article, we will discuss the most effective formations and present how professionals trade on their basis. It will be a slightly different view on this type of setups taking into account the problems that traders may come across in everyday trading.
The most important assumptions of candle formation
Really all candle formations, which we can observe in the price chart, are based on one basic relationship - context. The basic thing a trader should do is to analyze the formation in relation to the current market situation taking into account a given movement and not just one single candle. Playing a specific signal should take place only when it makes sense in the current context and fits into the whole of the given scenario.
The next factor is location on the chart. Only formations that have to be considered appear at key levels. For example, the embrace or pin bar is more important if it appears on the double bottom or top than in the middle of the chart, at a much less significant level.
Another thing to look for when analyzing formations is hers size. The shape and size of the candle can provide a lot of important information about strength, momentum, or e.g. a given trend. If the impetus increases and individual candles get bigger, the trend is gaining momentum. Small candles after downward or downward rallies can announce a reversal.
Another factor is wick. Very often, shadows indicate rejection or unsuccessful attempt to attack the upper or lower significant level. A long shadow on the top / hole is a clear signal and even in itself can be an interesting idea to enter the position. A large candle with a long body devoid of shadows is a sign of strength determined from the sides of the market.
Be sure to read: Wicks of candles - ways to play and use
The last thing to look at when using candle formations in commerce is body. This is nothing more than the distance between the opening and closing range. It should always be interpreted in relation to the entire size of the candle and its shadows. The small body and long shadows are a sign of indecision. The reverse situation, i.e. a large body and small shadows, is a sign of strength. There is a third option, a candle with a small body devoid of wicks - it can be a sign of a lack of interest by both buyers and sellers.
Candle formations - useful tips
1. Evening star
This is a formation that is most often used on daily charts, but can also be successfully used at lower intervals. It consists of three candles:
Rising trend
- long demand candle - small candle / may occur after a growth gap - large supply candle; may occur after a downside gap
Downward trend
- long supply candle - small candle / may occur after a downward gap - long demand candle; may occur after a growth gap
important: in the case of this type of formation, the occurrence of a gap, either upward or downward, is not a necessity. The most important is the arrangement of candles. A small candle, which occurs between large ones, very often has both lower and upper shadows, which proves the fight between supply and demand.
Pronunciation: this is a classic reversal formation. After a strong trend movement, a gap opens in its direction, but the price no longer has the strength to continue the move. The third candle is usually a strong phrase confirming a change in trend. In this type formation, the most important thing is to wait for the third candle, which confirms.
2. Doji
This type of formation is common and has different names. The interpretation depends on the market context. Doji usually has a small body and shadows on both sides. Perfect shape Candles are one where wicks are basically the same length. Most often it occurs after strong movements in trends, or at previous levels of support or resistance.
important: doji as a single candle is not a signal to enter the position and this type of setup should be avoided. Candles with a similar structure may appear on the chart during low-activity sessions, so you should always look for additional confirmations.
Pronunciation: simply put it signal of indecision on the roar. If the formation occurs after a strong move, it means that the market catches the proverbial breath and a force analysis follows. If the wicks are long it means a strong fight between buyers and sellers. Short signals indicate inactivity.
3. Embracing / outside bar
This formation can be a very strong setup provided it occurs in the right place and fits in well with the context. It can be a signal of both reversal and continuation. The shape is as follows: a small candle followed by a larger candle that covers it entirely.
important: formations in which shadows of candles are relatively small and the second candle is much larger than the first give the strongest signals. If the wick of the embracing candle further discards some significant level, it further increases the signal strength.
Pronunciation: when a large downward candle occurs after a long upward rally, this may indicate a change in sentiment. Often, an outside bar can also be found during reversing, which can be an interesting opportunity to add to your position, or look for an entrance.
Be sure to read: Bull's embrace - What is it and how to use it in trading
4. Pin bar / hammer
One may be tempted to say that this is one of the most popular price action formations. As a rule, the pin bar is easy to see on the chart, which means that signals are not always available generated prove themselves in real trade. The characteristics are extremely simple. The candle has a long wick on one side and a body on the opposite side. From the side of the body, the wick usually does not occur, and if so, very small.
important: pin bars can appear both after strong movements and during a trend. During trend movements, they are more signals of continuation.
Pronunciation: the shadow in this type of formation usually shows the impatience of amateurs. They enter the position too soon, trying to predict a specific price move. Professional players on the market know this very well, with their large volume orders they quickly return the price, which creates this wick.