Single Candlestick patterns (Part 1)

As the name suggests, a single candlestick pattern is formed by just one candle. So as you can imagine, the trading signal is generated based on 1 day’s trading action.


5.1 – Overview

As the name suggests, a single candlestick pattern is formed by just one candle. So as you can imagine, the trading signal is generated based on 1 day’s trading action. The trades based on a single candlestick pattern can be extremely profitable provided the pattern has been identified and executed correctly.

One needs to pay some attention to the length of the candle while trading based on candlestick patterns. The length signifies the range for the day. In general, the longer the candle, the more intense is the buying or selling activity. If the candles are short, it can be concluded that the trading action was subdued.

The following picture gives a perspective on the long/short – bullish, and bearish candle.

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The trades have to be qualified based on the length of the candle as well. One should avoid trading based on subdued short candles. We will understand this perspective as and when we learn about specific patterns.

5.2 – The Marubozu

The Marubozu is the first single candlestick pattern that we will understand. The word Marubozu means “Bald” in Japanese. We will understand the context of the terminology soon. There are two types of marubozu – the bullish marubozu and the bearish marubozu.

Before we proceed, let us lay down the three important rules pertaining to candlesticks. We looked at it in the previous chapter; I’ve reproduced the same for quick reference:

Buy strength and sell weaknessBe flexible with patterns (verify and quantify)Look for prior trend

Marubozu is probably the only candlestick pattern which violates rule number 3 i.e look for prior trend. A Marubozu can appear anywhere in the chart irrespective of the prior trend, the trading implication remains the same.

The text book defines Marubozu as a candlestick with no upper and lower shadow (therefore appearing bald). A Marubozu has just the real body as shown below. However there are exceptions to this. We will look into these exceptions shortly.

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The red candle represents the bearish marubozu and the blue represents the bullish marubozu.

📷5.3 – Bullish Marubozu

The absence of the upper and lower shadow in a bullish marubozu implies that the low is equal to the open and the high is equal to the close. Hence whenever the, Open = Low and High = close, a bullish marubozu is formed.

A bullish marubozu indicates that there is so much buying interest in the stock that the market participants were willing to buy the stock at every price point during the day, so much so that the stock closed near its high point for the day. It does not matter what the prior trend has been, the action on the marubozu day suggests that the sentiment has changed and the stock in now bullish.

The expectation is that with this sudden change in sentiment there is a surge of bullishness and this bullish sentiment will continue over the next few trading sessions. Hence a trader should look at buying opportunities with the occurrence of a bullish marubozu. The buy price should be around the closing price of the marubozu.

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In the chart above (ACC Limited), the encircled candle is a bullish marubozu. Notice the bullish marubozu candle does not have a visible upper and a lower shadow. The OHLC data for the candle is: Open = 971.8, High = 1030.2, Low = 970.1, Close = 1028.4

Please notice, as per the text book definition of a marubozu Open = Low, and High = Close. However in reality there is a minor variation to this definition. The variation in price is not much when measured in percentage terms, for example the variation between high and close is 1.8 which as a percentage of high is just 0.17%. This is where the 2nd rule applies – Be flexible, Quantify and Verify.

With this occurrence of a marubozu the expectation has turned bullish and hence one would be a buyer of the stock. The trade setup for this would be as follows:

Buy Price = Around 1028.4 and Stoploss = 970.0

As it is evident, candlestick patterns do not give us a target. However, we will address the issue of setting targets at a later stage in this module.

Having decided to buy the stock, when do we actually buy the stock? The answer to this depends on your risk appetite. Let us assume there are two types of trader with different risk profiles – the risk taker and the risk averse.

The risk taker would buy the stock on the same day as the marubozu is being formed. However the trader needs to validate the occurrence of a marubozu. Validating is quite simple. Indian markets close at 3:30 PM. So, around 3:20 PM one needs to check if the current market price (CMP) is approximately equal to the high price for the day, and the opening price of the day is approximately equal to the low price the day. If this condition is satisfied, then you know the day is forming a marubozu and therefore you can buy the stock around the closing price. It is also very important to note that the risk taker is buying on a bullish/blue candle day, thereby following rule 1 i.e buy on strength and sell on weakness.

The risk averse trader would buy the stock on the next day i.e the day after the pattern has been formed. However before buying the trader needs to ensure that the day is a bullish day to comply with the rule number 1. This means the risk averse buyer can buy the stock only around the close of the day. The disadvantage of buying the next day is that the buy price is way above the suggested buy price, and therefore the stoploss is quite deep. However as a trade off the risk averse trader is buying only after doubly confirming that the bullishness is indeed established.

As per the ACC’s chart above, both the risk taker and the risk averse would have been profitable in their trades.

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