In this next article brought to you by The Traders Club on using candlestick analysis to predict changes in the forex market, Â I will review some of the fundamental candlestick patterns used in forex trading.
In order to be successful in the financial markets you need to be able to predict when the current market trend is going to change. Â The use of candlesticks can give you forewarning of a change in market direction but is dependent on the correct interpretation of the candlestick patterns. Â There are two types of candles, bullish candlestick patterns that signify an upwards moving market and bearish candlestick patterns that signify and downwards moving market; i.e. with a bullish candle, the closing price is higher than the opening price and visa versa for a bearish candle.
In any trading situation, the key to being successful is being able to recognise possible trend reversals. As you become more familiar with the different candle lines and patterns, you will notice how correct interpretation of the candlestick chart offers the trader an early heads up on a possible trend reversal; in fact, the large majority of signals given by candlestick patterns are reversal signals. As the common goal of any trader is to buy low and sell high (or in the case of short selling, to sell high and buy low), being able to accurately predict when to buy or sell is tantamount to success.
There are a number of different types of candlestick patterns, too many to discuss in this article but I will review some of my personal favourites for trading off.
Hammer/Hanging man

The hammer or hanging man candle is a type of spike candlestick pattern. When found at the top of a trend it is called a hanging man, whilst if found at the bottom of a trend it is called a hammer.  In order for this to be considered a valid reversal signal, it needs to occur at the end of a trend.  When you come across a hanging man at the end of a trend, it is a great entry signal as the absence of a long wick allows you to enter the trade with a much smaller stop loss.
Shooting star/inverted hammer
When found at the top of a trend, this candlestick pattern is called a shooting star, at the bottom of a trend it is called an inverted hammer. As before, the appearance of this candle should only be considered a valid reversal signal if it occurs at the end of a trend or at a resistance level. Like the hanging man above, a valid shooting star allows one to enter a position with a very small stop loss. Spike high and spike low candlesticks like these are reversal signals at both the top or bottom of a trend. Surprisingly, the direction of the spike is not important as a reversal signal, but for better risk/reward, I prefer the spike to be in the direction of the reversal so to minimise my stop loss.
Engulfing candles
An engulfing candle is another great reversal candle. The engulfing candlestick completely covers or engulfs the preceding candlestick, but differs in the direction. Typically, the engulfing candle will cover the entire body of the preceding candle, but in some cases the wick of the candle maybe included when determining the signal.  Note, that the engulfing candlestick does not have to engulf the entire price range of its neighbour, but does need to cover its body.  Engulfing candlesticks are considered to be strong indicators of trend reversal.
Dark cloud cover and Piercing patterns
The dark cloud cover candlestick pattern (top image) is a bearish reversal pattern and is found at the top of a trend. It is similar to a bearish engulfing pattern except that its body does not completely engulf the previous candle. In order to be considered a dark cloud cover it needs to have retraced at least half way down the body of the previous candle.
Piercing patterns are the opposite of dark cloud covers and are found at the end of a downwards trend. They are bullish reversal candles, and like the dark cloud cover, for it to be considered valid, it needs to have retraced at least halfway up the preceding candles body. Piercing patterns and dark cloud covers are more difficult to spot but are reliable indicators of trend reversal.
These are a few of my favourite candlestick formations that I use in forex trading. To summarise, the spike candlesticks (shooting star, hammer, hanging man, and inverted hammer) are small bodied candles with long wicks, and when found at the end of a trend provide a good reversal signal. When the spike is in the direction of the reversal a low risk trade can be taken as the stop loss will be very small.
Engulfing candlesticks are strong reversal signals and their body completely engulfs the body of the preceding candle but in the opposite direction.
Dark cloud covers and piercing patterns are found at the end of a trend (dark cloud cover at the top, piercing pattern at the bottom), are in the opposite direction to the previous candle, and their body has retraced at least half the previous candles body.
