As mentioned earlier one of the key assumptions in technical analysis is that, we rely on the fact that the history tends to repeats itself. This probably is one of the most important assumptions in Technical Analysis.
It would make sense to explore this assumption in greater detail at this juncture as candlestick patterns are heavily dependent on it.
Assume today, the 7th of July 2014 there are few things happening in a particular stock. Let us call this factor:
Factor 1 – The stock has been falling for the last 4 consecutive trading sessionsFactor 2 –Today (7th July 2014) is the 5th session and the stock is falling on relatively lower volumesFactor 3 – The range in which the stock trades today is quite small compared to the last four days.
With these factors are playing in the background, let us assume that on the next day (8th July 2014) the fall in stock gets arrested and in fact the stock rallies towards a positive close. So, as an outcome of the 3 factors the stock went up on the 6th day.
Time passes and let’s says after a few months, the same set of factors is observed for 5 consecutive trading sessions. What would you expect for the 6th day?
According to the assumption – History tends to repeat itself. However, we need to make an addendum to this assumption. When a set of factors that have panned out in the past tends to repeat itself in the future, we expect the same outcome to occur, as was observed in the past, provided the factors are the same.
Therefore, based on this assumption even this time around we can expect the stock price to go up on the 6th trading session.
4.2 – Candlestick patterns and what to expect
The candlesticks are used to identify trading patterns. Patterns, in turn, help the technical analyst to set up a trade. The patterns are formed by grouping two or more candles in a certain sequence. However, sometimes powerful trading signals can be identified by just a single candlestick pattern.
Hence, candlesticks can be broken down into single candlestick pattern and multiple candlestick patterns.
Under the single candlestick pattern, we will be learning the following…
MarubozuBullish MarubozuBearish MarubozuDojiSpinning TopsPaper umbrellaHammerHanging manShooting star
Multiple candlestick patterns are a combination of multiple candles. Under the multiple candlestick patterns we will learn the following:
Engulfing patternBullish EngulfingBearish EngulfingHaramiBullish HaramiBearish HaramiPiercing PatternDark cloud coverMorning StarEvening Star
Of course you must be wondering what these names mean. As I had mentioned in the previous chapter, some of the patterns retain the original Japanese name.
Candlestick patterns help the trader develop a complete point of view. Each pattern comes with an in-built risk mechanism. Candlesticks give an insight into both entry and stop loss price.