Single Candlestick Patterns (Part 1)
A single candlestick design is made up of just one candle. The trade signal is produced based on one day's worth of trading activity. As long as the pattern has been accurately identified, trading based on a single candlestick pattern has the potential to be very successful.
When trading using candlestick patterns, one must pay close attention to the candle's length. The length denotes the day's range. Typically, the buying or selling activity is more intense the longer the candle is. It is clear that the trading activity was quiet if the candles are short.
A perspective on the long/short, bullish and bearish candles is provided by the following image.
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.
The Marubozu
The Marubozu pattern is the first single candlestick pattern we shall learn. In Japanese, Marubozu denotes baldness. There are two different forms of marubozu: bullish and bearish.
Before we continue, let's review the three most significant rules of candlesticks.
- Buy strength and sell weakness
- Be 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 Marubuzo 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 Marubuzo has just the real body as shown below.
The red candle represents the bearish marubuzo and the blue represents the bullish marubuzo.
Bullish Marubuzo
A bullish marubuzo doesn't have an upper or lower shadow. This means that the low is the same as the open and the high is the same as the close. So, a bullish marubuzo is formed when Open = Low and High = close.
A bullish marubuzo means that there is so much interest in buying the stock that people were willing to buy it at every price point during the day. In fact, they were willing to buy it so much that the stock ended the day near its high point.
In a nutshell, a trader should search for buying opportunities when a bullish marubuzo appears. The purchase price should be close to the marubuzo's closing price.
In the chart above, the encircled candle is a bullish marubuzo. Notice the bullish marubuzo candle does not have a visible upper and a lower shadow.
Clearly, candlestick patterns do not provide a target. However, we shall discuss the topic of setting targets later in this lesson.
When do we actually acquire the stock after deciding to do so? The answer depends on your risk tolerance. Assume there are two sorts of traders with distinct risk profiles: risk takers and risk averse individuals.
The risk-taker would purchase the stock on the same day the marubozu is forming. Yet, the trader must verify the occurrence of a marubozu. This is fairly easy. At 4:20 pm, Bangladeshi markets close. So, at 4:10 p.m., one must determine if the current market price (CMP) is about equal to the day's high price and the day's opening price is approximately equal to the day's low price. If this requirement is met, you will know that the day is building a marubozu andyou can buy the stock near its closing price.
By buying on a bullish/blue candle day, the risk-taker is adhering to rule 1, i.e., buy on strength and sell on weakness.
The risk-averse trader would purchase the stock the following day, i.e. the day after the formation of the pattern. This category of traders need guarantee that the day is bullish prior to making a purchase. However, the drawback of buying the following day is that the buy price is far higher than the indicated buy price, resulting in a stop-loss that is quite deep. So, the risk-averse trader only buys after confirming twice that bullishness is genuine, even though he incurs some loss.
Here is a hypothetical stock where both the risk taker, and the risk averse trader would have been profitable.
Bearish Marubuzo
Bearish Marubuzo indicates extreme bearishness. Here the open is equal to the high and close the is equal to low. Open = High, and Close = Low.
Bearish Marubuzo signifies an excessive bearish stock. Here, the open equals the high and the close equals the low. Open = high, and Close = low.
A bearish marubuzo signifies that there is so much selling pressure in the stock that market participants sold at every price level throughout the day and the stock closed around its daily low. It does not matter what the prior trend has been, the action on the marubuzo day suggests that the sentiment has changed and the stock is now bearish.
The expectation is that this sudden change in sentiment will be carried forward over the next few trading sessions and hence one should look at shorting opportunities. The sell price should be around the closing price of the marubuzo.
In the chart above, the encircled candle indicates the presence of a bearish marubuzo. Notice the candle does not have an upper and a lower shadow. Let’s assume that the OHLC data for the candle is as follows:
Open = 355.4, High = 356.0, Low = 341, Close = 341.7
Here, a minor variation between the OHLC figures leading to small upper and lower shadows is ok as long as it is within a reasonable limit.
The trade on the bearish marubuzo would be to short the stock at roughly 341.7 with a stoploss at the high point of the candle. The stop-loss price in this instance is 356.0.
Do remember this, once a trade is initiated you should keep on to it until either the target is hit or the stoploss is exceeded. If you attempt to do something else before any one of these event triggers, then most likely your deal could go bust.
A trade might be initiated based on a person's risk tolerance. The risk-taker may open a short position on the same day around the market's close. Clearly, he must verify that the candle is making a bearish marubuzo. To accomplish this at 4:10 p.m., the trader must determine if the open is roughly equivalent to the high and the current market price is equal to the low. If the condition is met, it is a bearish marubuzo, and so a short trade can be opened.
