Candlestick Patterns - Steemit Crypto Academy Season 4 - Homework Post for Task 10

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Question 2

(a) In your own words, explain the candlestick patterns and their importance in carrying out effective technical analysis.

(b) In your own words, explain the psychology behind the formation of the following candlestick patterns.

  • Bullish engulfing Candlestick pattern
  • Doji Candlestick pattern
  • The Hammer candlestick pattern
  • The morning and evening Star candlestick pattern.
  • The Harami Candlestick pattern.

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Cover Page created by me , @msquaretk | Canva App


Hello everyone. This is season 4 in the Crypto academy. I'm glad I participated in the season 3 of the academy which was full of experience and knowledge of blockchain and crypto trading.

The first lecture I attended is the beginner lecture taught by Prof. @reminiscence01. He taught "Candlestick Patterns." And at the end of the lecture, Prof. gave three (3) questions in which each student is expected to choose one (1) out of the three questions.

So, I have decided to pick question two (2) and it 's written below.

a) In your own words, explain the candlestick patterns and their importance in carrying out effective technical analysis.
b) In your own words, explain the psychology behind the formation of the following candlestick patterns.

  • Bullish engulfing Candlestick pattern
  • Doji Candlestick pattern
  • The Hammer candlestick pattern
  • The morning and evening Star candlestick pattern.
  • The Harami Candlestick pattern.

So, follow me closely as we see this question together.



(a) In your own words, explain the candlestick patterns and their importance in carrying out effective technical analysis

In finance trading, there are two methods which traders use to analysis the direction of price. These methods are technical and fundamental analysis. Fundamental analysis deals with the use of economic , political and social events and other factors to determine the direction of price of an asset. Technical analysis is a method which involves the use of graph or chart to analyze the behavior of buyers and sellers in the past to determine what will happen to the price of an asset in the future. Now, on the graph, there is what is called candlestick, line chart, Heikin-Ashi etc, which traders read. In this part of the questions, I am going to be talking about the pattern of candlesticks that form on the chart.

Simply put, Candlesticks patterns are formation of candlestick on the chart. Because of the usefulness of these patterns, traders are so much interested in them, use them to make trading decision and the likes. Candlesticks pattern can now be reffered to one of the tools used in technical analysis by traders to predict the movement of price of an asset. There are many types of candlestick pattern on the chart. Traders have given different names to them. Examples of these Candlesticks patterns are Hammer, doji, morning star and evening star bullish harami etc.

As we have candlesticks pattern on the chart, we also have chart pattern. The difference between the two is that, candlestick pattern contains less candle formation than chart pattern.

When the price of an asset is going in a direction, the candlesticks will be shown on the chart heading to the direction. But it is pertinent to know that price doesn't go like freely just like that. Price encounters obstacles which may make it to pause and retrace before it continues in its main direction. In essence, the movement of price in its main direction is usually referred to as impulsive move and the reverse against this move is known as retracement or correction. So, it's these moves of price that causes candlestick to form in the direction of price on the chart and form what is called Chart patterns.

Let's see some of these chart patterns in the screenshot below. In the next questions, we will see more on candlestick patterns.


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Fig. 1: Illustration of Chart Pattern on the Chart – Rising Wedge | Mt4 Platform


This is an example of a pattern formed on the chart. The pattern in the screenshot above is called rising wedge. Some people called it contractile diagonal.
Let see one more in the screenshot below.


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Fig. 2: Illustration of Chart Pattern on the Chart – Falling Channel | Mt4 Platform


The screenshot above shows an example of another chart pattern. It is called channel. When it's in a downtrend, traders call it falling channel and in an uptrend, it is called rising channel.

Now, notice in the two examples that trend lines are used to connect lows and highs of the candles. That's is to tell you that, trend lines also play a vital role in pattern identification. Traders, use trend lines to mark pattern.


Importance of Candlestick patterns in Carrying Effective Technical Analysis.

Now, one of the most effective tools in carrying out technical analysis are candlestick patterns. Candlesticks patterns have been popular because of their usefulness.

Firstly, Candlestick patterns and chart show the state of trend of an asset. For example, the falling Channel in the figure 2 above shows that the trend of that asset, DOGEUSD was in a downtrend at that particular time. So, seeing that on the chart, traders would know that, they are to join the downtrend if they would make effective analysis.

Also, candlesticks patterns helps determine a shift in trend. There are some candlestick patterns which are reversal pattern. When the pattern starts forming on the chart, traders will position themselves to trade the reversal.
In fact, chart pattern also show this, too. For example, In figure one, the screenshot is showing that the candles on the chart were contracting. And we could see that after the formation of wave 5, there was a breakout. So, that means, the pattern is a reversal pattern.

Candlesticks pattern help traders know the entry and exit points. This is another importance of candlesticks pattern in technical analysis. Pattern traders determine their entry and exit points from the candlesticks pattern.
Just as candlestick pattern show this, chart pattern also show it. For example, the entry point of the rising wedge in figure 1 is when the break out occur, and exit points - stop loss may be at the point 5 and and take profit at point 2. See the screenshot below.


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Fig. 3: Illustration of Candlestick Pattern for Entry and Exit Points | Mt4 Platform


Another importance of candlestick patterns in technical analysis is that, it is not a tool that lags or lead. You know technical indicators are lagging or leading indicators. That's before they give signals, price may have moved far or price still coming at the back. Candlesticks patterns are not like that. In fact, the candles that form the pattern are representation of price, and therefore can't be lagging or leading.

As important as these patterns are, traders need to learn how to read them so as to increase the effectiveness of his analysis. If a trader doesn't know how to read it, he may not find them useful. But If they are properly learned and understood, they are quite important. They are Importance cannot be overemphasized.



(b) In your own words, explain the psychology behind the formation of the following candlestick patterns. •Bullish engulfing Candlestick pattern. •Doji Candlestick pattern. •The Hammer candlestick pattern. •The morning and evening Star candlestick pattern. •The Harami Candlestick pattern.

In this part of the question, I'm going to be explaining psychology behind the formation of some patterns. Let's get right into the question.

  • Bullish engulfing Candlestick pattern

Bullish engulfing candlestick pattern is a type of candlestick pattern that is formed on the chart which may reverse the price of the market when it formed at a support level.
The candle is comprised of two candles, one is bearish and the other which engulfs the previous is bullish candle. So, it is pertinent to know that the close of the bullish candle must be above the open of the previous candle. If that doesn't happen, it is not a bullish engulfing.


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Fig. 4: Bullish Engulfing Pattern |
IMAGE SOURCE


Bullish Engulfing Pattern is a bearish reversal pattern. This pattern forms in a downtrend and indicates that the sellers are exhausted and the buyers are taking over the market. It is usually forms when the asset has been oversold. When it forms in a key support level, it can significantly reverse the direction of price upward. The previous candle, bearish candle that forms before the bullish candle signifies reduction in momentum. This means the power of sellers has reduced, and then the bullish candle forms with a great momentum showing that the buyers have taken over.

Let's see this pattern on the chart in the screenshot below.


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Fig. 5: Bullish Engulfing Patterns on BTCUSD Chart | Mt4 Platform

As it is seen on the screenshot above, when the engulfing pattern formed, the price of the asset changed direction from bearish to bullish, and this signifies that buyers have now stepped into the market. This pattern when formed in higher time frames, it is actually reliable.

  • Doji Candlestick pattern

This is another type of candlestick pattern. This pattern indicates that the open price and close price is very close. That means, there's dragging of price between the sellers and buyers as there's no much difference between the closing and opening price.


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Fig. 6: Doji Candlestick Pattern |
IMAGE SOURCE

There are three types of Doji. They are: gravestone, long legged, dragonfly
Gravestone doji has a very long upper wick with the closing and opening price very close. It is a bearish reversal pattern.
Dragonfly doji is an opposite of gravestone doji. It has a very long lower wick. It is a bullish reversal pattern.
Long legged doji or simply doji is the common doji candle. It is like plus sign the market. This candle has lower and upper wick with the opening and closing prive very close to each other.

Doji candle signifies indecision indecision in the market. This means the sellers can't push the price of an asset down and the buyers can't push the price of an asset down. Hence the closing and opening price of the candle is almost or the same. It is also believed that when the candle forms, the current may be coming to an end and may be tending to shift toward another direction.


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Fig. 7: Doji Candlestick pattern on the Chart | Mt4 Platform

As it is seen from the screenshot above, the doji candle forms on the chart. This period, traders don't know where the price will go as the candles that form is indecision candle. It is recommended to wait and see another candle form before one should decide which direction to trade.


  • Hammer 🔨 Candlestick Pattern

Hammer candlestick pattern looks like hammer. This candlestick pattern has a very long lower will and small body as its head. The candlestick could be bull or bear candle. What is most important is that, it must have long lower wick and small body.


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Fig. 8: Hammer Candlestick Pattern
IMAGE SOURCE

The screenshot above shows that hammer candlestick pattern. This candlestick pattern is a bullish reversal pattern when it's formed at support levels. The long lower wick of the candle signifies that the sellers pushed the price downward and Immediately the buyers step in and drive with great momentum the price upward making the wick to form. The price now close of an asset now closed with a little difference with the opening price, making the body to be very small.


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Fig. 9: Hammer Candlestick Pattern on the chart of BTCUSD | Mt4 Platform

The screenshot above shows hammer candlestick on the chart. You can see that after the formation of this pattern, the price of the asset change direction. This is to tell you that this pattern is a reversal pattern, especially when it I formed at support levels.


  • Morning and Evening Star candlestick pattern

Morning and evening start are another important candlestick pattern. Let's look into them one after the other.

  • Morning Star

Morning star is a candlestick pattern that is made up of three candles.

  • The first candle is a bearish candle. This candle is often appear as candle with volume, which signifies that the sellers are still in control of price.
  • The second candle is a small candle. Sometimes it could be doji. When this candle forms, it often signifies exhaustion of sellers as sellers could not drive the price of an asset down with great momentum.
  • The last candle is a strong bullish candle which forms as a result of buyers being stepped to the market to drive the price up. This third candle must engulfing the previous small or doji candle.

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Fig. 10: Morning Star Pattern
IMAGE SOURCE


As it is seen from the screenshot above, there are three candles. What happens is that the sellers are in control of the market, before they encounter barriers which make the sellers to pack their loads and buyers step into the market with great momentum which makes a strong bullish candle to form and the trend shift.


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Fig. 11: Morning Star Pattern on the chart | Mt4 Platform


As it is seen in the screenshot above, as the pattern formed, the trend change and the price rally up.


  • Evening Star

This is a direct opposite of morning star. It also comprises of three candles.

  • The first candle is a strong bullish candle in the uptrend, which shows that buyers are still in control of price.
  • The second candle is a small or doji candle which shows that the buyers are exhausted, since they can't drive the price any longer.
  • The last candle is a strong bearish candle which engulfs the previous candle. This candle shows that the sellers have stepped in to the market.

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Fig. 12: Evening Star Pattern
IMAGE SOURCE


The screenshot above shows an evening start pattern. As it seen, it has three candles. This pattern is a strong bearish reversal pattern. It actually forms when the buyerss have dragged the price of the market upward and are exhausted, the buyers now step in to the market and reverse the trend.


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Fig. 13: Evening Star Pattern on the chart | Mt4 Platform


As soon as the evening star formed on the chart above, the trend changed and the price of the asset rally down. Thanks pattern is a very strong pattern especially, at a resistance level.


  • The Harami Candlestick pattern

This is another candlestick pattern which trader look for on the chart.This pattern is of two types. There is bullish Harami and bearish Harami
The bullish Harami Pattern comprises of two candles. The first candle is a strong bearish candle which shows that the sellers are in the market, followed by a small candle which shows indecision in the market. Bullish Harami is a reversal and continuation pattern.

The bearish Harami is a direct opposite of bullish Harami. It also has two candles. The first one is a strong bullish candle which shows that buyers are in the market followed by a small candle that I'm which the previous candle seems like housing it. This pattern is a strong reversal pattern when it is formed at a resistance level. It can also be a continuation pattern.


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Fig. 14: Harami Pattern (Bullish and Bearish)
IMAGE SOURCE


When these patterns are spotted on the chart, traders take advantage to trade them. Let's see these pattern on the chart.


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Fig. 15: Bullish Harami on the Chart | Mt4 Platform


As it is seen on the screenshot above, the bullish Harami formed at the bottom of the the trend and reversed the direction of the price.

Let's see the screenshot of bearish harami in the screenshot below.


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Fig. 16: Bearish Harami on the Chart | Mt4 Platform


You can also see that the bearish harami on the screenshot above reversed the direction of price.



Conclusion


Candlestick patterns are one of the tools that the traders use in technical analysis to predict the direction of price. Candlesticks patterns and chart patterns have been widely known because of their Importance.

Thanks to Professor @reminiscence01 for bringing this topic up. I have learnt one or two things from the course.


CC: @reminiscence01

Written by @msquaretk

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Hello @msquaretk,

Thank you for participating in the #10 Fixed course for Newcomers in the Steemit Crypto Academy.

Your grade on this assignment is as follows:

CriteriaGrade
Presentation/Use of Markdowns2/2
Compliance with topic2/2
Quality of Analysis1.5/2
Clarity of Language2/2
Originality2/2
Total9.5/10

Homework task: 9.5/10

Feedback and Suggestions :
  • You have successfully answered all parts of the question.
  • You should direct all your screenshots to the original destination by sourcing all of them.
  • Overall work is appreciated. Keep it up.

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