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Part III. Simple but fundamental and important patterns

Fundamental and important patterns - Forex School

Commander in Pips:
 Today we will continue to talk about candles, and study some simple, but still important initial, patterns. Major parts of more complicated patterns are based on combinations of those that we will talk about today.

Combinations of patterns - Forex School
Pipruit: And what does “pattern” mean, and for what purposes does is have?​

Commander in Pips: Although each candle carries important information that tells us about price behavior in particular trading period, and this is very important and could help to make some trading decision itself, patterns are even more useful.

Pattern is a forgone combination of different candles that represents early signs of future price movement with solid probability and allows you to make a trade decision on the early phase of this price movement. In general these patterns could be “reversal”, “continuation” and “Cautionary”. Usually a pattern consists of 1-3 candles.

Pipruit: Hold on, hold on…wait a minute, Sir. You want to say, that if we see on the market some predetermined combination of candles, as you call them “patterns” – they can predict further price action? Even more, they can tell, what price action this will be – reversal or continuation?​

Commander in Pips: Absolutely. But be careful with the “predict” word. Remember, that trading is a business of probabilities, so there is never any absolute certainty. When I say “represents early signs of future price movement with solid probability” – it means precisely what I’ve said. In other words, the appearing of a pattern increases the probably of further moves in a direction according to this pattern. Say, we see some reversal pattern. It does not mean that market will reverse here with 100% probability. But it tells us, that the probability of reversal here, either temporary or long-term, is higher. That’s all. Any pattern could fail. That’s why, we repeat it again and again – you should not rely only on some single tool, whatever it could be – lines, patterns etc… you should use them in complex. How? You will learn a bit later.

Another way you should treat the patterns - is as a warning sign. For example you hold a “long position” and market is forming reversal pattern. This thing should worry you.

Pipruit: Ok, I think I’ve got it.​

Commander in Pips: Fine. So, let’s start with them:

The first pattern is Tweezers or Spinning Tops/Bottoms. This pattern classifies to “Cautionary” group, because it neither purely reversal, nor purely continuation. Definitely speaking, it could lead to both price actions. All that it indicates is indecision condition on the market. That’s why, when market will make a decision it could follow in any side, depending on what kind of decision it will be.

Tweezers candles have small body, usually in the middle of the candle with relatively long shadows. Like those as on the picture:

Tweezers candles - Forex School
Commander in Pips: Can you describe the price action during this pattern as we did in previous chapter, and how do you think, why it classifies as “Cautionary” and not as reversal or continuation?

Pipruit: I think I can, besides, we’ve already familiarized with alike price action in the previous chapter… Well, long shadows tell us, that during trading period as bulls as bears had periods of power and success when they staved the counterparty. Bulls has driven back bears right to the highs, but then bears found some hidden reserves and returned status quo. Or this was vice versa – bears dominated first and bulls second. It does not matter. At the same time small bodies and close right near the open price tell us that nobody could held the final domination - neither bears nor bulls. As a result, the market was not able to find further direction. That’s why, probably, this pattern clarifies as market’s indecision and is classified as a “Cautionary” pattern.​

Commander in Pips: Perfect, well done, Son!

Pipruit: Thanks, Commander, and does a color of candle carry big importance?​

Commander in Pips: And how do you think?

Pipruit: Hm, to my mind, if market wasn’t able to find a direction either it has closed a bit higher than open (white candle) or a bit lower (black) – then the color doesn’t greatly matter.​

Commander in Pips: Yep, So it is.

Pipruit: Ok, I understand that this pattern tells us that neither the bears nor the bulls prevail currently, it’s a draw. But how we should treat the appearing of this pattern?​

Commander in Pips: Although the theoretical explanation suggests that the appearance of a spinning top (i.e. after move up) tells that the power of bulls is becoming weaker and there are not so many buyers on the market as it were initially, so the reversal may occur. And a spinning bottom (i.e. during down trend) tells that the power of bears is gradually exhausting, so the reversal to upside is possible.

Notwithstanding, Tweezers are not a reversal pattern. Although their appearing on tops or bottoms is more often than in the middle of some move, we highly recommend treating them as indecision. Because tweezers itself does not show the future direction, and what decision the market will make, who knows… Just look at the chart #1 – you can see that tweezers appear in different places, as before continuation as before reversal.

#1 Swiss franc futures Daily chart
Swiss Franc Futures Daily Chart - Forex School
Treat them as a pause, after which can follow the continuation or reversal.

Pipruit: Well, Commander, don’t you think that after any candle could follow either continuation or reversal?​

Commander in Pips: If we are talking purely about candles – so it is. As we’ve said, there is no 100% assurance in any expectation. But still, patterns shift the probability in our favor, second, our task here is to study how to recognize patterns and what they mean, third, by your question you’ve just confirmed our notice – do not rely just on some single tool in trading.

Pipruit: All right, but can you give me just simple example, how it could be done – a combination of different tools, just to not rely on single one? Using only with stuff that I know already…​

Commander in Pips: Ok, here is your example. What tweezer has greater importance, those that have appeared in, say, free space of the market or those one that has appeared at a support/resistance area?

Pipruit: At support/resistance of course. And there is a greater probability that it will lead to reversal rather than to continuation…. Way cool!​

Commander in Pips: See – you’ve answered by yourself. And now imagine that you know not just spinners and lines but many more different tools that could be used for decision making. Each tool allows you to shift probability in your favor a bit. Using patterns in this context are much more safe and useful.

Pipruit: Finally, Commander I understand what you are talking about. But, in general, how we can understand purely by pattern where the market will go?​

Commander in Pips: In general, any pattern treated as triggered one, when market shows close above or below it. For example, let’s assume that we see spinning top, as on the chart #1. You can enter short, when market will close below the low of tweezer, i.e. below the lower shadow. This has happened with first nasty black candle to the down side. The same has happened, when tweezer appeared in the middle of down move. See, on the next day market has closed below tweezer’s low.

But now we are speaking in general – where is the trigger of any pattern. Still you can find some tweezers that failed. For instance – the last group of spinning bottoms on the chart #1. See, market has closed below it, but then reversed up.

Pipruit: Yes, Commander, I’ve asked in general only. I remember that we should not use any tool as a single one for trading.​

Commander in Pips: Good, let’s shift to the next pattern – Marubozu or Marubozo.

Pipruit: Maru.. what? Commander, I think, I’ve just broken my tongue. May be there is some ordinary names?​

Commander in Pips: Son, this is Japanese candlesticks. What names are you expected? Compose yourself!

Pipruit: Yes Sir!​

Commander in Pips: Ok, Marubozu is a kind of candle with no shadows. It means that market has shown direct move right from the high/low to “low/high. White Marubozu (i.e. up candle) has open price that is equal to the low and a close price that is equal to the high. Marubozu should have a long body. A small candle with the same qualities is not a Marubozu.

Black Marubozu, in opposite, has a long black body with opening price right at the high and closing price at the low. Look at this sweet pair at the picture – it becomes much simpler to understand:

Black and white Marubozu - Forex School
Black and white Marubozu – nothing to add here…

And here how it looks like in real life:

Marubozu candle in chart - Forex School
I think that you understand that this is very strong candles that show the domination of bulls (white Marubozu) or bears (black) during the whole trading period. Because, say, during a white Marubozu the market opens at the low price and closes right at the high – so, bulls push the market up without giving bears any chance during the whole period. The same is true for black candle – bears dominate right from the highs until the lows. Usually (but not always), after appearing of Marubozu we can count on some continuation of this move – at least in the beginning of a next trading period, because the market has some momentum. Also Marubozu very often becomes a part (one of the candles) of reversal patterns. You can see it later.

Doji

Commander in Pips: The next type of candle that we will start to study is the Doji…

Pipruit: Yeah, my uncle also has a 1980 Dodge…​

Commander in Pips: Not Dodge, but Doji. In general this is a type of candle that has the same open and close prices. Sometimes, these candles that have very tight (hardly seen) difference between close and open price also calls as Doji. But the location this open=close price in day range makes an important difference. Here are different types of Doji:

Doji candle - Forex School
Here you can see that the length of shadows could be different. Despite this moment – any candle will call as Doji that has equal open and close prices.

Pipruit: Well, it looks like Doji has the same quality as a Tweezers, at least Simple/Long-legged Doji and Four Price Doji. This means indecision, right?​

Commander in Pips: Absolutely. Simple Doji so as 4-price Doji shows that although bulls and bears have struggled each other, pushing and tossing – nobody was able to gain a control. As a result, market calmed down and closed at the same level as open. These two types of Doji are “Cautioning” patterns.

Pipruit: And what do they caution us about?​

Commander in Pips: Well, so as with Tweezers, the major importance carries the preceding price behavior. If such kind of Doji appears after strong bulls run (this could be for example number of white Marubozu or at least strong candles with small shadows) it could mean that the power of bulls becomes weaker, so that market falls into indecision. The same is true for appearing of such kind of Doji after a strong down move. But it does not mean definitely the reversal, although such kind of Doji could appear as on tops (like spinning tops) as on bottoms (spinning bottoms). So using them in context with other tools, as we’ve just discussed. In fact, you can take a look at Chart #1 again and just imagine Doji instead of Tweezers – this will make the same sense.

And here is a simplified example of an appearance of a Doji after strong moves – as bullish or bearish:

Bullish or bearish candles - Forex School
Appearance of a Doji after a Black Marubozu or any strong down move

If a Doji appears after series of strong black candles, it tells us that the number of Sellers became fewer, and cautions us. If more sellers will come – the move down will continue, if not – there may be a reversal or a retracement could happen. That’s why Doji is just a “Caution” pattern, not a reversal.

The 4-price Doji even more undecided, because it shows very small trading range. Bulls and bears not just were unable to estimate the winner - they also were too lazy while making their estimation.

Pipruit: And what about the Dragonfly and Gravestone?​

Commander in Pips: Although from time to time you can see them in the middle of some move, and in this case you can treat them as Simple Doji or Tweezers, more often they appear in reversal points. I think that you should guess why…

Pipruit: …Because the location of a close price and/or trading range. So, a Doji with close at the high (dragonfly), should appear before a market reversal to the upside and with a Gravestone – to the downside.​

Commander in Pips: That’s right. The reason is the same – the high close price tells us that the bulls were able to return to their positions at the end of the trading period and pushed the bears back, while Gravestone tells about the opposite situation – the bears have conquered the bulls.

That’s why these types of Doji can be part of reversal patterns, or even be reversal patterns by themselves.

Doji reversal patterns - Forex School
Appearing Doji after White Marubozu or any strong up move
If a Doji appears after series of strong white candles, it tells that the number of Buyers became fewer, and cautions us that buyers are gradually becoming exhausted. If more buyers will appear – the move up will continue, if not –reversal or retracement down could happen.

ADVANCED talks about small ranged candle or bar.

Commander in Pips: There is one type of candle or bar that potentially could provide you very important information. It not necessary has to be a Doji. It could be any candle but it should appear with some conditions:

1. This candle should appear at support or resistance area;

2. The trading range of this candle (i.e. difference between high and low prices) has to be no more than 30% of an average candle.

3. The tick volume during this period should be at least 50% greater than the average trading volume during the period

Here, you can see how it looks like on the chart:

#3
Small ranged candle - Forex School

Pipruit: Looks nice, but what is it?​

Commander in Pips: First of all take a look at the candle that is on line crossing. What can you tell me about it?

Pipruit: Well, this is a small candle that appears at support. After this candle we can see explosive move up.​

Commander in Pips: Very good, so we’ve accomplished the two initial conditions – “candle appears at support (or resistance)” and “this candle is small”. What is the last condition?

Pipruit: The tick trading volume during this period should be at least 50% greater than the average trading volume during the period. But what does it mean?​

Commander in Pips: Look at lowest histogram – such vertical bars, see? This is a trading volume that has happened during the each candle on the chart. Let’s say for simplicity now, that trading volume shows how much trades had happened during each particular period. The volume could be in money terms, number of contracts or other points – it doesn’t matter currently. More important, that we see that during this small candle trading volume was significant and almost 50 % higher than average.

Pipruit: Ok, I understand, and what do red vertical lines show?​

Commander in Pips: This is derivative indicator – in fact, this is just a volume divided on trading range of particular candle. This indicator just helps us to find these candles that we’re talking about. So, what do we have - small ranged candle at support with combination of huge trading volume. Sometimes this combination is called “Churning”, Joe DiNapoli and Larry Williams refer to this as “Squat”. Let’s take a look at market mechanics of this pattern.

#3
Market mechanics of Squat pattern - Forex School
First, we see, that initial move to our candle was down – so, bears controlled the market. Then, the market has reached a support area. Bears continue to sell with hope to break this level, while more and more buyers entered the market with hope that support will hold. The large trading volume suggests that the struggle between bulls and bears was very hard – much harder than usual. And now imagine that all these happen in a very tight range. So, the dual pressure as from bears as from bulls does not allow price to move much higher or lower. This is the same as fill the small room with big amount of sumo wrestlers and then drop a svelte girl in there. What do you think, how much chance does she have to save her hairstyle?

Pipruit: I guess not much… I understand why such a combination calls “Churning” because huge amount of money is changing the owners but market just stands in tight range.​

Commander in Pips: That’s right. And now pay attention to the last important condition – the market stands at support! It means that bears are very strong – and do no allow bulls to move higher, but bulls are even stronger – because they do not allow bears to break the level, although the bears control the market (initial move was down).

Pipruit: And what is the conclusion?​

Commander in Pips: Very simple. Appearing of such candle or bar (it doesn’t matter) gives you a confirmation or, at least, more confidence, that this support will hold. The same is true for resistance levels.

Pipruit: Well this is really advanced tool. Thank you.​

Commander in Pips: You’re welcome. In later chapters we will take a look at more complicated candlestick formations and how to interpret them. Our task here is to teach you to find these patterns in the real market by yourself, so that you will able to apply them in your trading plan.

Comments

Muriel V
8 years ago,
Registered user
Where to download derivative indicator MT4?

Thank you Sive for the sharing...
I have a volume indicator. I am looking for MT4 derivative indicator.
I did find a derivative oscillator. Is it the same?
Sive Morten
8 years ago,
Registered user
> Thank you Sive for the sharing...
I have a volume indicator. I am looking for MT4 derivative indicator.
I did find a derivative oscillator. Is it the same?

Hi Muriel,
You mean the same to Tick volume?
Unfortunately I'm not very familiar with derrivative oscillator. But on spot forex there are some problems to use any volume indicators. For more detais re-read comparison Spot Forex with Futures and stock markets.
mrVynes
7 years ago,
Registered user
Hi, regarding short range candle illustrated in chart#3:

At condition no 3, you say that tick volume during this period should be at least 50% greater than average trading volume during the period.

The first period I gather refers to the period of the candle, but what is the second period? Where do I see this average? Does it have something to do with the red bars? I don't understand the definition given for that derivative indicator.

Thanks!
Sive Morten
7 years ago,
Registered user
> Hi, regarding short range candle illustrated in chart#3:

At condition no 3, you say that tick volume during this period should be at least 50% greater than average trading volume during the period.
..

If you will take a look at volumes during the previous (almost a year) you'll see that average volume is about the half of current bar. THis is a bit advanced approach and you will not find it very often on the market.
Besides, on Forex it is almost impossible, since you can't see overall trading volume of spot forex market.
Hamza Samiullah
2 years ago,
Registered user
nice and informative..
cormact
2 years ago,
Registered user
Could a lot of this volume be bears stop losses being hit, and short covering at support?

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