Candlestick patterns are the technical analysis tool that displays price data on multiple timeframes. Developed in Japan in the 18th century, candlesticks patterns have become a go-to source for many traders today.
Steve Nison first introduced the candlestick patterns to the Western world in the book Candlestick Charting Techniques, published in 1991.
There are two types of Candlestick patterns, bearish and bullish.
In this guide, we are going to discuss the top three bearish candlestick patterns and how you can trade them.
The bearish engulfing pattern emerges at the end of an uptrend. The structure of the pattern has peculiar characteristics and is easily identifiable. The first candle of the pattern is a small bullish candle followed by a larger bearish candle that engulfs the smaller candle.
One thing you need to understand is that the pattern has greater reliability when the opening price and closing price of the second candle are above the first candle. A larger second candle suggests a more powerful bearish pattern than the bigger first candle.
Before jumping to conclusions, you have to wait for the second candle to close and then take your positions on the next candle.
If you spot an engulfing pattern, it is best to exit your long positions or enter your short positions. If you are entering short positions, place a stop-loss close to the recent resistance area and profit-targets at the recent support area.
A smarter way to trade the pattern is to consider the overall picture before entering your short positions. For instance, going short may not always work out in your favor if the uptrend is too strong. In this scenario, even if the engulfing pattern occurs, the bulls may push the price higher.
Therefore, you need to trade the engulfing pattern when the overall trend is down, and there has been a recent price pullback to the upside. This outlines there will be a long-term downtrend and is helpful for your short positions.
As mentioned earlier, there has to be strong downward momentum if you want to enter your short positions. Besides this, engulfing patterns can pop up during the choppy or ranging market, but they are not that effective as the overall trend is ranging or choppy. Therefore, it is best to avoid these fake entries.
Engulfing patterns are helpful in suggesting a price reversal. However, you need to trade the pattern carefully, as the pattern can appear in ranging and choppy markets. You need to look for the overall trend before taking your short positions.
The term “hanging man” has an interesting analogy. A small body on top of a large lower shadow symbolizes the hanging man pattern.
Many people get confused with the hanging man color; however, the candle’s color isn’t the primary concern. What really matters is the body of the pattern. The hanging man has a small body with a lower shadow. The shadow of the candle should be twice the size of the body.
The hanging man and the hammer pattern are nearly identical. The only difference is the trend in which the patterns surface.
If the pattern appears in an uptrend indicating a reversal, then it is a hanging man pattern. If the pattern pops up in a downtrend suggesting a bullish reversal, then it is a hammer pattern.
To trade the hanging man pattern, you need to consider a few rules; one, the volume should be higher, and second, the long lower shadow is followed by a downward momentum. Only if the pattern follows these rules you can take your trading positions.
Upon identifying a pattern, you can initiate a short position on the next candle of the hanging man pattern, or you can exit your long positions.
If you are an aggressive trader, you can take short positions on the hanging man candle instead of the next candle. You can place a stop-loss near the recent high of the hanging man pattern and set your take-profits on the recent low.
If you want to avoid false entries, look for specific characteristics rather than blindly following the pattern. This is because the hanging man is not a very strong predictor of a trend reversal, unlike the engulfing pattern.
Therefore, only enter the trade when there is a high volume, longer lower shadows, and downward momentum following the hanging man.
The hanging man pattern frequently appears on the chart. They are only a mild predictor of a trend reversal. So, you need larger volumes, longer shadows, and the downward momentum, and use a stop-loss above the hanging man pattern. Subsequently, you can exit your long positions when these conditions are satisfied.
An evening star forex pattern is used by traders when the uptrend is about to reverse. The pattern comprises three candles; a large bullish candle, a neutral middle candle, and a large bearish candle.
The evening star pattern surfaces regularly on the charts and is a strong predictor of a price reversal. Each of the three candles of the pattern has specific requirements:
The evening star’s reverse is the morning star pattern, which appears in a downtrend and mentions a bullish reversal.
A keynote to include here is, in the forex market, the gap between the three candles isn’t as large as compared to stock or commodity markets.
After recognizing the pattern, you can enter at the next candle. If you are a conservative trader, you can wait for the pattern to fully appear and then take your positions if the price moves downwards. However, there is a drawback of this approach as you enter the positions at a much lower level, and you can’t make much profit from your positions.
You can select your profit targets at the recent support area. You can place stop-losses on the recent high from the evening star pattern.
The evening star pattern is a dependable bearish pattern, yet it can be difficult to trade the pattern when the market is choppy or ranging. Therefore, you need to utilize price oscillators like moving averages or trendlines after the occurrence of the evening star pattern.
The evening star pattern is a strong predictor of a bearish trend. You can combine the pattern with price oscillators and trendlines for more effectiveness. If you have open long positions, you need to leave them after the occurrence of the pattern.
All of the above-mentioned bearish patterns are a reliable identifier of price fluctuations. You need to consider the peculiarities that each trading pattern has; only then you can take your short positions. To get more accuracy, you can combine technical indicators like the RSI, Stochastics, or MACD.
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