Candlestick patterns for trading indices
Candlestick patterns are
essential tools in the world of trading indices. As visual representations of market fluctuations, they
can provide you with insightful information about potential price trends and reversals. These
candlestick patterns can help you predict whether market sentiment is shifting from bullish to bearish
or vice versa. In addition, they help in identifying key support and resistance levels, which can inform
trading strategies.
Below, we dive into commonly
used candlestick patterns such as the engulfing pattern, the doji, the hammer, and the shooting star.
Each pattern provides unique insights into market dynamics and can be a powerful tool for your indices
trading.
Engulfing candlestick pattern
The engulfing pattern is a
popular candlestick pattern used in technical analysis to predict potential reversals in price trends.
This pattern consists of two candles, and the pattern can either be a bullish candlestick pattern or a
bearish candlestick pattern.
Bullish engulfing pattern
A bullish engulfing pattern is
an indication of a reversal from a downtrend. The three main things you need to know about this pattern
are:
- The first candlestick of
this bullish pattern is a bearish candlestick (downward candle). This bearish candlestick indicates
that sellers are in control.
- The second candlestick of
this pattern is a bullish candlestick (upward candle) that completely engulfs or ‘swallows up’ the
previous bearish candle. This means it opens below the low of the first candle and closes above the
high of the first candle.
- This pattern suggests a
potential shift in market sentiment from bearish to bullish, as the buyers have now outnumbered the
sellers in the marketplace. It may signal the end of a downtrend and the start of an uptrend.
The pattern’s usefulness depends
on context. It’s better to use it if it reaches a certain support level, either static or dynamic .
Static support is a fixed price level that previously served as support, while dynamic support could be
a simple moving average.
Here’s an example of this
bullish pattern for the NASDAQ index (USTEC), which occurred in July 2023. The price hit a dynamic
support area (the combination of 20-day and 50-day moving averages), after which it reversed higher and
continued to rise, indicating a strong bullish market.
This is the bullish
engulfing pattern for NASDAQ that appeared in July 2023, as seen on Tradingview.com. Bullish
candlestick patterns for indices tend to lead to a price rebound if they appear near the strong
support levels.
The bullish engulfing pattern
for NASDAQ looks like this example: after the first bearish day, the market opened higher and closed
substantially higher than the previous day’s close. Following this strong bullish signal, or bullish
continuation pattern, you could open a position the day after the pattern’s completion.
A bullish engulfing
continuation pattern for NASDAQ in July 2023, as seen on Tradingview.com. This type of pattern is
one of many bullish candlestick patterns.
Bearish engulfing pattern
A bearish engulfing candlestick
pattern is an indication of a reversal from an uptrend. The three main things you need to know about
this pattern are:
- The first candlestick of
this pattern is a bullish (upward) candle, indicating that buyers are in control.
- The second candlestick of
this pattern is a bearish (downward) candle that completely engulfs or ‘swallows up’ the previous
bullish candlestick. This means it opens above the high of the first candle and closes below the low
of the first candle.
- This pattern suggests a
potential shift in market sentiment from bullish to bearish, as the sellers have outnumbered the
buyers in the market. It may signal the end of an uptrend and the start of a downtrend.
Here’s an example of a bearish
engulfing pattern for the Australian stock index AUS200, which occurred in July 2023. The price had
initially risen above the dynamic resistance area (between 20-day and 50-day moving averages), but then
dropped sharply from $7200 to $7000 due to a bearish pattern.
This is a bearish engulfing
pattern for AUS200, July 2023, as seen on Tradingview.com.
Doji candlestick patterns
A doji is a candlestick pattern
that suggests market uncertainty. It occurs when the opening prices and closing prices are very close or
even identical, resulting in a small or non-existent candlestick body with long upper and lower wicks.
Dojis can signal potential reversals or trend continuations, depending on their chart position.
For stock indices, it’s better
to use the doji pattern on timeframes smaller than a daily chart, although the daily chart can still
provide a number of useful candlestick patterns.
Let’s look at doji’s use on
4-hour charts.
For instance, a doji pattern was
seen on the Nikkei index (JP225) in May 2023. After the appearance of several doji patterns, the market
kept moving in the direction of the previous trend. So, in this case, the pattern indicates a
continuation of a trend.
Doji candlestick pattern
for JP225, May 2023, as seen on Tradingview.com.
Hammer candlestick pattern
The hammer pattern is a sign of
a bullish reversal. It’s characterized by a small body near the top of the candlestick and a long lower
wick. The hammer often appears after a downtrend and suggests that buyers are starting to gain control,
and possibly signaling an uptrend (bullish) reversal. The hammer pattern is often called a “pin bar”,
and is commonly used in trading stocks and indices to identify a bullish reversal pattern.
For instance, a hammer pattern
showed up in the Hang Seng index (HK50) after a dip in August 2023. After the price hit a new low at
around $19000, buyers took control and closed the day with a slight increase, forming the hammer
pattern.
On the contrary, an inverted
hammer is a bearish candlestick pattern, which appears on the top of the trend. The inverted hammer
indicates that sellers are about to take control and push the trend downwards.
Hammer candlestick pattern
showing a bullish reversal pattern for HK50, August 2023, as seen on Tradingview.com.
Shooting star pattern
The shooting star pattern is a
sign of a bearish trend reversal. It looks like an upside down hammer with a small body near the bottom
of the candlestick and a long upper wick. This pattern can indicate that sellers are taking control and
that an increasing selling pressure would shift the price downwards.
In September 2023, this pattern
was seen in the UK100 index (FTSE100). After the price reached a new peak, sellers outnumbered buyers
and closed the day in a red, forming a shooting star pattern. Following this, the price consistently
dropped several days in a row.
Shooting star candlestick
pattern for UK100 index in September 2023, as seen on Tradingview.com.
Dark cloud cover candlestick
pattern
Another candlestick pattern
quite common for trading individual stocks, but also applicable for indices, is the dark cloud cover
pattern. Essentially, it is a bearish reversal pattern. This pattern is a variation of a ‘bull trap’,
the control suddenly shifts from buyers to sellers, and buyers have to capitulate.
The dark cloud cover pattern
represents a bearish reversal in the price action. In this scenario, a downward candle (usually black or
red) opens above the last price before closing of the preceding upward candle (typically white or green)
and subsequently closes below the midpoint of the upward candle. Below is an example of what a bearish
reversal looks like.
Appearance of a dark cloud
cover pattern with a bearish reversal for the HK50 index, June 19 2023, as seen on Tradingview.com.
The pattern looks similar to the
engulfing pattern, but the red candlestick doesn’t close below the closing price of a previous
candlestick (as with the engulfing pattern) but just closes below the 50% level of a previous
candlestick. It becomes enough to create selling pressure and shift the price action lower.