PIP ACADEMY
The Ultimate Path to Trading
Length : 7.00 Minutes
Double Candlestick Pattern
Candlestick charts are a technical tool that fits data for multiple time-frames into single price bars. In order to create a Candlestick chart, one must have a data set that contains close, open, high and low value for that specific time-frame.
Using Candlesticks and understanding their patterns is crucial and helpful in technical trading for tracking the movement of price in the forex market.
A bullish candlestick forms when closing price is greater than the opening price, which indicates the existence of buying pressure.
On the other hand, a bearish candlestick forms when closing price is lower than the opening price, which indicates the existence of selling pressure.
Bearish Japanese Candlestick
Bullish Japanese Candlestick
There are many candlestick patterns that can be useful in conjunction with other indicators to create an edge over the market to identify the movement in the market for trade opportunities or potentially filtering some of the bad trades.
Thus, we are going to cover some of the important candlestick patterns here and in the next following topics.
In this topic we are going to cover two candlestick price pattern, the famous inside/outside bars.
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Outside bar candlestick patterns
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Outside Bars are those in which the trading range totally encompasses that of the previous bar. They develop both in up and down trends, and represent a strong signal of exhaustion.
In order for them to work as a higher probability signal of trend reversals, it is suggested to utilise them, when they are formed at the sensitive psychological levels of support or resistance.
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There are several guidelines for deciding on the potential significance of an outside bar. They are as follows:
1) The bigger the outside bar (First candle) relative to the proceeding ones, the stronger the signal.
2) The sharper the rally (reaction) proceeding the outside bar, the more significance the bar. For instance, the stronger the existing trend has been, the greater the likelihood that an outside bar pattern will lead to a reversal. This is due to the fact that in the case of uptrend buyers have temporarily pushed prices up too far and need a rest. In the case of downtrends there is little supply because sellers have completed their liquidation.
3) The more candles encompassed by the previous candle, the better the signal.
4) The greater the volume accompanying the outside bar relative to previous bars, the stronger the signal.
In the AUD/NZD chart below, notice that there is a strong rally and then price pauses and forms an outside bar pattern as a sign of exhaustion. At the same time Relative strength Index (RSI) indicator signals an overbought condition. The alignment of the signals generated both by the candlestick pattern and the RSI indicator shows that there is a strong chance that the market has reached to the exhaustion point and might reverse in the near future. Thus, as you can see market right after the formation of the outside bar starts falling.
In the XAU/USD (Gold) chart below, it can be seen that after a sharp rally market reaches to a sensitive resistance level, where price forms an outside bar candlestick pattern. In addition, notice that the volume is building up while the market is approaching the reversal point.
This indicates that market is potentially exhausted at this point and it could bounce back in the near future. As it can be seen, market indeed started to fall right after the outside bar price pattern.
It is important to remember that we are dealing in probabilities, not certainties, in technical analysis. Therefore, the outside bar by itself would provide many false signals and it is suggested to be used in conjunction with other technical analysis tools and indicators, such as Support & Resistance, RSI and other strategies.
The theory behind inside bars is that since the inside candle has a lower high and a higher low and is traded within the previous candle, it could be an indication that the underlying currency pair is consolidating. The consolidation happens because the price is unable to break higher or lower than the high/low of the previous candle to continue the prevailing direction. In fact, once the inside bars are formed it could be interpreted that there is not sufficient buying or selling pressure to break the previous candle's high/low and there is a balance between buyers and sellers after a strong up or down trend.
However, one has to note that inside bars are not a strong indication of the reversal like outside bars. But, one could keep an eye for them when they are formed after an extended sharp uptrend/downtrend for a potential reversal in the near future. Especially, if they happen to form at the sensitive psychological levels in the market, for example important support/resistance levels.
Also the smaller is the inside candle relative to the previous candle the stronger the probability of the signal generated.
Inside bar patterns can be utilised for short term trading strategies, as they are a good indication of balance between buyers and sellers within a trending market, it could create an opportunity for a short term counter trend after formation of an inside bar.
In the GBP/USD chart above, notice that RSI is giving an overbought signal. Besides that, as you can see the price also has formed an inside bar pattern at a very important resistance level. Prior to that price has surged to 1.715 and started consolidating for a short period of time. Thus, this could be a great trade setup opportunity to sell. As you can see, the market has started falling rapidly right after the inside bar pattern.
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In general, candlestick patterns are effective tools and if utilised correctly in conjunction with other strategies, high quality trade setup can be generated. Bear in mind, that using two-candlestick pattern solely as a trading strategy would generate many false signals. Therefore, trend indicators and other price action strategies could help to filter the false signals generated.