Theory for Reversal Candle Patterns Strategy

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painofhell

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1. ABSTRACT

Technical Analysis can be defined as the attempt to exploit movements in the prices of a financial asset. These movements in prices often recur or are to some extent predictable, thus allowing us to have an advantage in Forex trading.
One of the main pillars of Technical Analysis is that all information is contained in the price. The integration of new relevant information that comes to the market is mirrored in its price. Traders are helping to price prices properly as they are in possession of new data. In this way the quotation of an asset incorporates all the available information about it.


2. INTRODUCTION

For a correct Technical Analysis we need to analyze the candles and their main patterns.
To interpret the candles, we have to understand how the body of the figure of a candle is formed.
The body of a candle is formed by the difference between the opening price and the closing of an asset in the period that one wants to analyze.
A red candle (bear), means that the closing price was below the opening price. And a green candle (bull), means that the closing price was above the opening price. The extended lines below and above the body mean the maximum and minimum that the instrument (e.g. EUR/USD) reached in the period we are analyzing and are called shadows. What a candle represents, or the combination of more than one, is that it makes it possible to read through a joint analysis of several candles, allowing us to do a market analysis in order to make a forecast.


What can their formations tell us about market movements?

The relationship between the open and close is considered vital information and forms the essence of candlesticks. Hollow candlesticks, where the close is greater than the open, indicate buying pressure. Filled candlesticks, where the close is less than the open, indicate selling pressure.

3. REVERSAL CANDLE PATTERNS IN ACTION

The shape of the candles and the grouping between them allows us to identify many patterns, but for the exercise of this article we will only explore the patterns that will be used in the strategy to be developed in the future.
The strategy that will be presented in the next article will take advantage of the patterns presented bellow. As I mentioned, this first article intends to present the theoretical part of the future development of a strategy where we will use the patterns presented. Let's see then how we will proceed in practical terms to use these patterns to open trades at the right time.



3.1. BULLISH

3.1.1. BULLISH MORNING STAR

Recognition Criteria:

1. The market is characterized by a prevailing downtrend.
2. We see a bear candlestick on the first observation.
3. Then, we see a short candlestick on the second observation in the direction of the downtrend.
4. A bull candlestick emerge in the third observation.
5. The close of the bullish candle must be beyond a 60% u-turn.
6. When you see this: BUY in the direction of the trend at the opening of the next candle or when it meets the criteria of the Bullish Morning Star. The stop loss level is defined as the lower of the last two lows.


3.1.2. BULLISH ENGULFING CANDLE

Recognition Criteria

1. The market is characterized by a prevailing downtrend.
2. We see a bear candle body in the first observation.
3. The next bull candle body that is formed completely engulfs the bear candle body of the preceding bear candle.
4. After the Bullish Engulfing candle appears in the direction of the trend, BUY at the opening of the next candle with a protective stop loss order approximately 10 pips beyond the lows of the wicks.


3.1.3. BULLISH PIERCING LINE

Recognition Criteria

1. The market is characterized by a prevailing downtrend.
2. A bear candlestick appears on the first observation.
3. A bull candlestick opens on the second observation and closes more than halfway into the body of the first bear candle observed.
4. The second candle fails to close above the body of the first candle, but the close of the bullish candle must be beyond a 60% u-turn of the bearish candle.
5. When you see this: BUY in the direction of the trend at the opening of the next candle or when it meets the criteria of the Bullish Piercing Line. The stop loss level is defined as the last low.


3.2 BEARISH

3.2.1. BEARISH EVENING STAR

Recognition Criteria

1. The market is characterized by a prevailing uptrend.
2. We see a bull candlestick on the first observation.
3. Then, we see a short candlestick on the second observation in the direction of the uptrend.
4. A bear candlestick emerge in the third observation.
5. The close of the bearish candle must be beyond a 60% u-turn.
6. When you see this: SELL in the direction of the trend at the opening of the next candle or when it meets the criteria of the Bearish Evening Star. The stop loss level is defined as the higher of the last two highs.


3.2.2. BEARISH ENGULFING CANDLE

Recognition Criteria

1. The market is characterized by a prevailing uptrend.
2. We see a bull candle body in the first observation.
3. The next bear candle body that is formed completely engulfs the bull candle body of the preceding bull candle.
4. When you see this: After the Engulfing Bearish candle appears in the direction of the trend, SELL at the opening of the next candle with a protective stop loss order approximately 10 pips beyond the highs of the wicks.


3.2.3. BEARISH DARK CLOUD COVER

Recognition Criteria

1. The market is characterized by a prevailing uptrend.
2. A bull candlestick appears on the first observation.
3. A bear candlestick opens on the second observation and closes more than halfway into the body of the first bull candle observed.
4. The second candle fails to close below the body of the first candle, but the close of the bearish candle must be beyond a 60% u-turn of the bullish candle.
5. When you see this: SELL in the direction of the trend at the opening of the next candle or when it meets the criteria of the Bearish Dark Cloud Cover formation. The stop loss level is defined as the last high.


4. CONCLUSION

So, the most important is to identify the trend, be able to identify the reversal of the trend and follow again the main trend. After carrying out this small study on the reversal patterns that seem to me to be more accurate, I have now the mission of the next article to present an automated strategy that allows to use the concepts described here to take advantage of the market when they appear. Creating an automatic strategy that does this analysis allows us to verify if these patterns are really the most accurate or not, when applied to the forex market.
 
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Nihuginn

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This is the basis of market research, which helps to understand different types of strategies. At first glance it may seem difficult, but once you gather all the information about it, you will realize that everything is not so complicated and scary, the main thing is to take your time and study the issue from and to...
 

Gurrentoln

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It was actually very interesting materials. I liked that you spent time on many small details, it was very constructive. I don't even have anything to add)
 
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