Multiple Candlestick Patterns (Part 3)

 The Harami Pattern

Harami is a two candle pattern. The first candle is usually long and the second candle has a small body. The second candle is generally opposite in colour to the first candle. On the appearance of the harami pattern a trend reversal is possible.

There are two types of harami patterns – the bullish harami and the bearish harami.

 The Bullish Harami

As the name suggests, the bullish harami is a bullish pattern appearing at the bottom end of the chart. The bullish harami pattern evolves over a two day period, similar to the engulfing pattern.

In the chart below, the bullish harami pattern is encircled.   

The thought process behind a bullish harami pattern is as follows:

  1. The market is in a downtrend pushing the prices lower, therefore giving the bears absolute control over the markets
  2. On day 1 of the pattern (P1) a red candle with a new low is formed, reinforcing the bear’s position in the market
  3. On day 2 of the pattern (P2) the market opens at a price higher than the previous day’s close. On seeing a high opening price the bears panic ,as they would have otherwise expected a lower opening price
  4. The market gains strength on P2 and closes on a high note, forming a blue candle. However, P2's closing price is marginally lower than the prior day's (P1) opening price.
  5. The price action on P2 creates a small blue candle which appears contained (pregnant) within P1’s long red candle

The trade setup for the bullish harami is as follows:

  1. The idea is to go long on the bullish harami formation
  2. Risk takers can initiate a long trade around the close of the P2 candle
  3. Risk takers can validate the following conditions to confirm if P1, and P2 together form a bullish harami pattern:
  • The opening on P2 should be higher than the close of P1
  • The current market price at 3:20 PM on P2 should be less than P1’s opening price

If both these conditions are satisfied then one can conclude that both P1 and P2 together form a bullish harami pattern

  1. The risk averse can initiate a long trade at the close of the day after P2, only after confirming that the day is forming a blue candle
  2. The lowest low of the pattern will be the stoploss for the trade

 The bearish harami

The bearish harami pattern appears at the top end of an uptrend which gives the trader an opportunity to initiate a short trade.  

The thought process behind shorting a bearish harami is as follows:

  1. The market is in an uptrend, placing the bulls in absolute control
  2. On P1, the market trades higher, reaches a new high, and forms a day with blue candles.
  3. On P2 the market unexpectedly opens lower which sets in a bit of panic to bulls
  4. The market continues to trade lower to an extent where it manages to close negatively forming a red candle day
  5. The unanticipated decline in the market creates panic, causing bulls to dump their positions.
  6. The expectation is that this negative drift is likely to continue and therefore one should look at setting up a short trade.

The trade setup for the short trade based on bearish harami is as follows:

1. The risk taker will short the market near the close of P2 after ensuring P1 and P2 together forms a bearish harami. To validate this, two conditions must be satisfied:

  • The open price on P2 should be lower than the close price of P1
  • The close price on P2 should be greater than the open price of P1
  1. The risk averse will short the market the day after P2 after ensuring it forms a red candle day
  2. The highest high between P1 and P2 acts as the stoploss for the trade.