Chapter 7: Multi Candlestick Pattern Analysis (Part 1)

Chapter 7 - Multi Candlestick Pattern (I)

In our last discussion, we understood the various single candlestick patterns which are most commonly and regularly used by traders worldwide. Here, in this chapter, we will be talking about various Multi candlesticks patterns.

These are patterns generated by a series of candles. The Prior candle patterns and the pattern after the multi candlestick pattern formation go a long way to completely understand the candlestick patterns. Single candlesticks patterns along with multiple candlestick study goes a long way in understanding and giving better trade signals in the market.

Here is a list of Multi candlesticks patterns we will be having a discussion on in chapters to follow: The Engulfing Patterns (Bullish Engulfing pattern and Bearish Engulfing patterns), The Piercing pattern, The Dark cloud cover, The Harami Pattern (Bullish Harami & Bearish Harami), The Candles Gaps, The Morning star, The Evening star.

The Engulfing Pattern

The Engulfing pattern is the most basic two candlestick pattern. The first candle is a relatively small one and the second candle is a bigger one as it completely engulfs the first candle. If this pattern happens at the bottom of a bearish trend, then it’s called bullish engulfing (as the market makes a move up from here on) and if this happens at the top of a bullish trend then it’s called bearish engulfing (as the market makes a move down from here on).

— Bullish Engulfing

Here are a few characteristics

  • The Bullish engulfing pattern shows Long (buy) trade
  • The Prior trend should be bearish (new lows being made on a regular basis).
  • The prior candle should be Red.
  • The engulfing candle should be bigger than the previous (candle) and covering the whole body of a red candle and should be green.

In the image above (TCS), we see a bearish trend prior to the engulfing green candle. The market has been making regular lows on a continuous basis and the trend is expected to follow on the next day also. And, in lines of expectation, the market opens below the previous days close, but with a sudden surge in buying and profit booking from shorts in the market, we see bears panicking. And, once the engulfing pattern (Green candle) takes over, we see a long bullish trend. One important point to observe here is that the engulfing candle attempts to continue the bearish pattern, but constant buying and rejection at lows brings in more buyers and ultimately the candle closes green.

When to Enter?

The trades to be taken here depend on one’s risk appetite. A risk-taker will execute the trade on the day the trend is made but the risk-averse will wait for confirmation and execute his trade the next day. The Stop loss for this trade has to be below the body of the engulfing candle. In the image above, the trader with both kinds of a risk appetite would have made a substantial profit.

— Bearish Engulfing

As the name suggests, the bearish engulfing pattern gives an opportunity for short trades. The prior pattern here has to be a bullish one and the engulfing candle starts off by giving an indication of the continuing bullish pattern but due to constant selling pressure, the buyers eventually give in and the candle closes red. The engulfing red candle has to be bigger than the prior green candle.

In the figure above (Venky’s), we see a bull trend prior to the engulfing Red candle. The market has been regularly making new highs and the trend is expected to follow on the next day also. And, in lines of expectation the market opens above the previous days close but with a sudden surge in Selling pressure and profit booking from longs in the market, we see bulls panicking. And, once the engulfing pattern (Red candle) takes over, we see a long and sustainable bearish trend in the market. 

How to Trade?

The buying pressure gets exhausted by constant selling. It is advisable to exit long trades when this pattern happens and enter fresh short trades. The risk-taking trader enters short trade on the same day, while the risk-averse trader waits for the pattern confirmation and enters into trade on the next day. The image above (Venky’s chart) is a classic example of Bearish Engulfment with the engulfing body bigger than the previous green candle and substantial bearish trend post that.

The Piercing Pattern

The Piercing pattern is very similar to a bullish engulfing pattern with a minor difference. In the case of the piercing pattern, the size of the green candle should be between 50-100 % of the red candle. Say, if the size of the red candle is 100 points, then the piercing candle length should be more than 50 points but less than 100 points. This candlestick pattern has similar characteristics to Bullish engulfing but the confidence level on trades via piercing pattern is a little lesser compared to bullish engulfing.

The Dark Cloud Cover

A mini version of the Bearish Engulfing pattern. A bearish pattern indicator and uptrend halter. Here, unlike the bearish engulfing pattern, the red candle size should be between 50-100 % of the previous green candle. Say, if the size of the green candle is 150 points, then the dark cloud candle should be anywhere between 75-150 points.