How to trade two day candlestick patterns?

Investors and traders use technical analysis to identify trends, breakouts, reversals etc. In a bear market prices keep falling; so an investor who wishes to take long positions will have to wait until the market reverses. The breakout trader may take long or short positons based on bullish or bearish breakouts.

In my previous article "Candlestick Patterns in Indian stock markets" we discussed about engulfing pattern. Candlestick Charting is a complex and interesting subject. Steve Nison has authored a couple of books viz. Candlestick Charting Techniques and Beyond Candlesticks. Both offer excellent insight into various aspects of candlestick charting. Candlesticker is another site which explains reversal and continuation patterns with plenty of illustrations.

Candlesticks offer effective trading signals which are not available with other methods of charting. Several reversal and continuation patterns have been recognized but few of them (like abandoned baby) are very rare. Certain candlestick patterns require 3, 4 or 5 trading sessions to form. Therefore, two day candlestick formations are more common.

Following are the common two day candlestick patterns:

Engulfing (bullish & bearish)
Harami (bullish & bearish)
Harami cross (bullish & bearish)
Piercing line (bullish)
Dark cloud cover (bearish)
Shooting star (bearish)

The available literature suggests that engulfing & harami cross patterns are more powerful than others (of course it depends on where the formation occurs; rarely, a harami pattern has been found to be effective compared to engulfing pattern on a similar chart.)

It is to be remembered that the overall technical picture needs to be studied thoroughly before attempting to experiment on candlestick patterns. This of course comes with practice and patience.

Bullish engulfing pattern is formed when real body of a green candle engulfs (wraps around) real body of a red candle. This is the basic definition; however there are several variations as shown below:

1. The entire black candle, including shadows (this is the computer age; so red candle) is engufed by real body of white candle (green candle).


2. The real body of red candle is engulfed by real body of green candle and shadows of red candle are engulfed by shadows of green candle.


3. Real body of red candle and its lower shadow are engulfed by real body of green candle but upper shadow of red candle is not engulfed by either real body or shadow of green candle.



4. Real body of red candle and its upper shadow are engulfed by real body of green candle but lower shadow of red candle is not engulfed by either real body or shadow of green candle.



5. Real body of red candle is engulfed by real body of green candle but neither upper shadow nor lower shadow of red candle is engulfed by real body or shadows of green candle.



Based on available literature, my own observation and trading experience, I've created a checklist for engulfing and harami patterns (bullish). It is recommended to have checklist for each candlestick pattern.

Bullish engulfing / harami candlestick pattern checklist

1. Is the stock on a down trend?
2. Is the downtrend fast, protracted?
3. Is the green day volume more than red day volume?
4. Is the green day volume more than 21 day moving average?
5. Is the entire red candle is engulfed?
6. Are the shadows of red candle engulfed by shadows of green candle?
7. Does the entire green candle lies within real body of red candle? (Harami)
8. Are the shadows of green candle within the shadows of red candle? (Harami)
9. Does the candlestick formation occur after a critical support is tested?
10. Is there positive divergence in case the stock makes a new low while candlestick pattern is formed?
11. Is the red candle a ‘long black’ candle? (Harami)
12. Is the green candle a ‘long white’ candle? (Engulfing)
13. Is the first candle doji? (Engulfing)
14. Is the second candle doji? (Harami)
15. Does the red candle have minimal upper shadow?
16. Does the green candle have minimal lower shadow?
17. Are the candlestick centerlines nearly equal?
18. Does the green candle engulf more than one real body?

The ideal answer for all 18 questions above is YES; but it may not be always possible to achieve it. Interested investors and traders may start paper trading with these ideas and try to arrive at a conclusion as to what works and what doesn't in real trading.

Nifty Review : Bulls are ready to take charge...

At the outset, I wish all the visitors to this blog a very happy and prosperous new year. Will 2009 be a good one for investors and traders? Let's find out in a moment.

Visitors come to this site from across the globe; 72% of them are from India, 12% from US, 10% from Middle East and remaining from countries like UK, Singapore, Australia etc. There were surprise visitors from Korea and Lebanon too.

Many people have asked me through email why this blog is not updated more frequently. Of late, I am little busy with other commitments. I feel like posting at least 2 articles a week (time permitting) and hopefully I will be able to do it soon.

As I have mentioned in FAQ this site essentially discusses the Indian stock market scenario from a technical perspective. The information contained herein should not be considered as investment or trading advice.

Recently I reviewed a manuscript from McGraw-Hill Education (India) and this is what they wrote to me:

"Dear Mr. Sundaramurthy,

Thanks a lot for your wonderfully prompt reply!

Your views on the relative importance and relevance of technical and fundamental analyses are particularly enlightening. Although you had explained the same in the review form, I needed a clearer opinion on the applicability of the synthesis approach which I received in the mail. We would duly communicate your suggestions and comments to the author, and accordingly take the publishing decision. Your expertise has been of great help to us. Should you consider writing on your domain, do consider our organization. We hope to draw on your knowledge in such assignments in future."

Many thanks to McGraw-Hill Education (India).

During October 2008 Nifty had lost 26.41% while in November 2008 it lost only 4.52% and in December 2008 it gained 7.41%. Usually the stock market participants (investors and traders) think that December is not a great month because FII's will go for a year end holiday. But Nifty has developed an interesting bullish "Pennant" formation. We discussed about such a formation (bearish though) in Will the bulls be able to win the battle? as well.

Flag and pennant formations are short term continuation patterns which precede the resumption of previous trend. In the above chart, "pole" formation i.e. a sharp upmove started from October 27, 2008 (watch the hammer at the bottom of the downtrend) and this move contained 3 long white candles. A symmetrical triangle was formed between November 11, 2008 and January 2, 2009. A break above the resistance line will mark the beginning of continuation of the uptrend. Technical indicators like MACD, Wilder's DMI and parabolic SAR favour an upmove only (though both 50 DMA and 100 DMA are well below the 200 DMA).

So, watch out for the bulls! they are ready to take charge once again.

Given below are technically bullish for the short term.

Bindal Agro (15.25):


This stock moved from a low of 8.65 on October 29, 2008 to a high of 13.15 on November 10, 2008. The downtrend that followed made a new low of 8.20 on December 2, 2008 but it showed positive divergence (i.e. a lower low was formed but MACD showed a higher low). The stock touched a high of 17 on December 17, 2008. A bullish "Three Outside Up" candlestick pattern was formed on December 30, 2008 indicating support at the previous high at 13.15. Though the volume on the third day of the pattern was below average, it is still a powerful pattern. The stock is likely to face resistance at 21.60 (which was the support it broke during the previous downtrend).

Crompton Greaves (149.35):


The stock too made a positive divergence during November 2008. The demand during the first wave was steady as indicated by rising prices and volumes. The decline had only one black day with more than twice volume at the peak of wave 1. However this can occur at times. On January 2, 2009 the stock has broken the resistance trendline with good volumes. Technical target works out to 201.90; the stock may face resistance at the previous high at 186.90.

Gujarat Alkali (80.30):



The stock made a low of 55.35 on October 27, 2008 and a small upmove was witnessed till November 5, 2008 when it touched a high of 76.90. On November 21, 2008 it broke the previous low by registering another low of 55.10. However a positive divergence was seen. Nearly after 2 months of consolidation, the stock has broken out on January 2, 2009 with good volumes. Technical target works out to 98.70.

IFCI (23.15):


During the decline from a high of 22.65 made on November 5, 2008 IFCI did not break the previous low of 15.35 registered on October 27, 2008. After 40 days of consolidation the stock did break the previous high; however it declined further back to 19.55. The upmove has started once again. The falling window (downward gap) at 26.20 is likely to be a strong resistance; once this is broken the next major resistance is at 44.30.

Sterlite Technologies (70.10):

Like IFCI this stock was in consolidation pattern from November 5, 2008 till December 15, 2008. On December 16, 2008 it broke the previous resistance at 69.80 with very good volumes. It was once again consolidating and sharp rise in volume was seen on January 2, 2009. Technical target for the stock works out to 90 and 121.