Understanding Candlestick Formation – Price Action!

Welcome  to  the  candlestick  formation  section. Please become familiar at trading the strategies on 4Hour Break-Out Strategy and MACD/STOCH Divergence System of my previous posts before attempting to use this section to increase your trading accuracy.

These formations are only a second confirmation for entry placing a higher chance of success on the trade. I find candlestick formations to  be  most  accurate  on  the  1  hour  charts  and  above,  I  would  not bother using any of these formations for the scalping system.

Candlestick formations are used to identify the underlying physiology of the market, usually with a reasonable accuracy.

Below is an example of a normal falling and raising candlestick:

When a candlestick tries to make a new high/low but fails to close at those levels it gives some clues as to who is in charge, the bulls or the  bears.  There  are  literally  hundreds  of  candle  stick  formations used by traders all over the world to profit from the markets. We are only  going  to  focus  4  formations  here  in  this  section, these  are  the formations I found to be most profitable and occur regularly.

Doji’s:
The  Doji  is  generally  a  small  candle  indicating  a  period  of indecision  with  not  much  movement,  the  open  and  close should be at the exact same price but it is acceptable within a pip or two.

This small candle if seen after a good move is a strong reversal signal,with confirmation it is very reliable entry point.You will often see the Doji when trading the divergence system,usually when the stochastic is topping/bottoming out, a great confirmation that you are on the right side of the market.

Engulfing: 
An  engulfing  candle  is  a  strong  change  in  momentum  in  the market  often  seen  off  of  breaks  of  support/resistance.  For  a buy  confirmation  the  first  candle  would  be  red  followed  by  a

green candle that completely engulfs the previous one. For a sell  confirmation  the  firs  candle  would  be  green  followed  by  a  red candle that completely engulfs it.You will often see engulfing candles with the 4H breakout strategy on the break of the support/resistance line, this indicates good volume and momentum in the market.

Inside Candle: 
The  inside  candle  formation  is  basically  the  complete opposite of the engulfing formation, the second candle is formed   completely   inside   the   body   of   the   previous candle.

This  formation  give   us   a  heads  up  that  the bears/bulls are loosing steam and the market may be thinking about a reversal.

This formation often happens just before a strong move or breakout, be sure to have your eye out for this formation when trading the divergence system.

Pin Bar Formation:
The pin formation is one of my favorites, it shows huge emotion of  the  market  indicating  a  sign  of  a  reversal,  in  this  case  the bulls  pushed  the  market  high  but  failed  to  hold  it  so  price returned back to around the open leaving a pin formation.

The pin always points away from where price may be heading, the opposite  is  true  for  a  bullish  pin  formation.  You  will  often  see these  formations  after  a  breakout  on  the  4H  breakout  system  when the retrace takes place.

These formations take some getting used to in the beginning but with a little practice will help you trading decisions immensely.

Examples:
Lets take a look at some of the previous examples in this book and see if we can spot some candlestick formations giving us a heads up of what is about to come.

The  chart  above  is  an  example  form  the  4H  breakout  system,  after the breakout occurred we were looking for a retrace. If you look at the retrace  you  will  see  a  pin  formation  giving  us  a  heads  up  that  price was being rejected and this was followed by a Doji.

Above  is  another  example  from  the  4Hour  breakout  strategy,as  this breakout  was  about  to  take  place  we  had  a  pin  formation  that  also totally engulfed the previous Doji candle. Looking now you can easily see  the  momentum  in  the  breakout.  Look  how  many  Doji  candles formed against the resistance line.

Above is an example form the divergence system, on both of these entries we had confirmation from candlestick formations.

The first trade was taken off of a Doji candle which is difficult to see in this picture due to the trend line covering it, but I assure you it is there.

The second trade was taken off of a bearish engulfing candle. Once you get to know these 4 formations you will see them everywhere its like reading a book!

This brings us to the end of Understanding Candlestick  Formation – Price Action, I hope you have enjoyed reading about this system, if you have any questions at all then don’t hesitate to use the comment box below!