8.2 Important Candlestick Types – Part 2

Important Candlestick Types Part 2 - Text Version

In the previous lessons, we started talking about the five most important types of candlesticks that every trader needs to be able to recognize. We covered the first three, now we are going to talk about the remaining two: the engulfing bar and the doji.

The Engulfing Bar

Number Four. The engulfing bar. This is a candle whose real body engulfs, i.e. completely swallows up and reverses, the real body of the candle just before it. This means that a bullish engulfing bar may only form after a bearish bar, that is, a candle that closes lower than it opens, and that a bearish engulfing bar may only form after a bullish bar, that is, a candle that closes higher than it opens. A bullish engulfing bar’s close must be not only higher than its own open, but also higher than the previous candle's open. Conversely, a bearish engulfing bar’s close must be not only lower than its own open, but also lower than the previous candle's open. As their names suggest, bullish engulfing bars indicate a bullish move, and bearish engulfing bars indicate a bearish move.

The Doji

Number Five. The doji. This is a candle whose real body is either non-existent or very small. Its open and close are very close together, possibly even at exactly the same price. A “pure” doji is one where the upper and lower wicks are more or less the same size. When one of the wicks is much longer than the other one, this candle becomes more of a pin bar. Where one wick is longer than the other one, the candles are sometimes called a “dragonfly” or “gravestone” doji. Traditionally, a doji signifies indecision, as it shows that the price went up and down, but ultimately nowhere. This can signify a quiet, directionless market, or alternatively, that a move up or down may have run out of steam and be getting ready to reverse. Consecutive dojis at the end of a trend can signify a trend reversal, providing a potential low-risk, high reward entry point.

That concludes our explanation of five important types of candle that every trader should be able to recognize. It’s important to remember that some candles can be more than one type of candle at the same time. For example, an inside or outside bar can also be an engulfing bar. For another example, a doji may also be an inside bar. When you have had a lot of practice reading Japanese candlestick charts, you will be able to get some information from every candle. For new traders, it is a good idea to start with mastering these five candlestick types. We’ll conclude this lesson by talking about how location and time frame need to be taken into account when interpreting Japanese candlesticks.

Candlestick Location and Timeframe

It is very important to understand that the location of a candlestick is almost always more significant than the actual candlestick itself. For example, a very bullish outside engulfing candlestick that is just below a strong S/R level might be suggesting that a break out is about to happen. However, if that candle is positioned just above and touching a strong support level, the probability of a continuing bullish move upwards is probably higher, and so usually would present a more attractive reward to risk ratio. If the price runs up to a strong S/R level and prints two consecutive dojis during active market hours, there is a good chance that the trend will start to reverse. But if instead the dojis are printing in the middle of an area where the price has recently spent a lot of time, it probably just signifies a very quiet market that is not worth trading.

The timeframe of the candle is also an important factor. Generally, the higher the timeframe the candle is, the more significant it is. We will talk about this and other price action concepts in more detail in the next lessons.