Price Action Guide – Part 4: Six Powerful Candle Formations

month time period on chart for finding multibaggers
Note the Nifty monthly candlestick chart. It has formed a bearish engulfing candle, which suggests the market will move south in the medium term. Note that the fall is supported by rising volumes, a bearish sign. That said, DIIs can step in to support the market and reverse the trend.

Before reading this piece, I’d urge you to read the following posts:

Candlestick Formations
How To Set a Candlestick Time Period on Charts

A part of this article is based on a technical session conducted by Rajan Kamboj. The rest is based on what I know and practice.

1: DOJI IN A BEAR MARKET

To help you understand how you can spot trade-able stocks using this formation, I have chosen the HPCL Candlestick chart of 2001 and have set the Candle time period to 1 Day.

how to interpret the doji
In 2001, HPCL CMP ranged between 27 and 42. Late 2001, in the middle after getting hammered for a few months from 42 to 27 levels, a Doji (almost a Doji) with a longer bottom wick was formed. One month before this Doji, a red candle with a long bottom wick was formed. These Dojis indicated exhaustion of selling. The candle before that also indicated the same thing. In fact, we can say that at 27, the selling in HPCL was completely exhausted, and therefore HPCL was a buy. You can see from the subsequent price movements how HPCL shot up and returned handsome gains to traders.

The Doji-in-a-bear-phase can also be used by intraday traders by adjusting the candlestick time periods in their charts. 15-minute Candles for those who trade several times in a day or 1 hour Candles for those who trade no more than 1-2 times in a day.

HOW TO TRADE THE DOJI IN A BEAR MARKET
  1. Watch from the sidelines
  2. Invest 10%-20% of your allocation for that stock and watch subsequent candles
  3. Consider it as a reversal signal and stand by to act based on subsequent charts and price action

2: DOJI IN A BULL MARKET

Let’s check out Reliance Power’s 1-day chart to help understand the importance of a Doji in a bull market.

Doji and bearish engulfing explained
On 2-1-18, Reliance Power, which was in a bull market, hit a high of around 65. Thereafter it dithered a bit and slowed down to 55 levels. It jumped again, but on 5-1-18, it formed a Doji and closed at about 58-59 levels. This Doji in a robust bull market is a sign of bull tiredness/trend reversal. Though it jumped up to 61 levels, a subsequent bearish engulfing candle confirmed bearishness in the counter. The Bearish Engulfing candle formation is explained below.
HOW TO TRADE THE DOJI IN A BULL MARKET
  1. Book 40%-50% of your holding in that stock and watch subsequent candles
  2. Consider it as a reversal signal and stand by to act based on subsequent charts and price action

3: BEARISH ENGULFING CANDLE

In theory, a bearish engulfing candle’s price first tests the previous day’s high, and then sellers hammer it and drag it below the the previous day’s low.

On charts, a bearish engulfing candle completely covers the prior candle. Let’s check this chart out:

how to trade bearish engulfing candle
On 9-1-18, Reliance Power crossed the previous day’s high and tested 62.25, higher than the previous day’s high. It then met with a wave of selling and closed at 57 levels, lower than the previous day’s low. A red candle was formed which covered the previous day’s green candle.
HOW TO TRADE THE BEARISH ENGULFING CANDLESTICK
  1. If the general market trend is bullish, and you are making handsome profits, sell 40%-50% of your holding and watch subsequent candles. The candle can also be used to book losses or shorting, depending on your investment strategy.
  2. If the market trend is bearish, book profits and hold on to free shares so long the stock is high quality.  Can book losses too. Can try shorting as well.

4: BULLISH ENGULFING CANDLE

In theory, a bullish engulfing candle’s formed when the price of a stock moves above the high and low price of the previous day’s candle.

On charts, a bullish engulfing candle completely covers the prior candle. Let’s check this chart out:

understanding bullish engulfing candles
On 18-12-17, Reliance Power formed a bullish engulfing candle as you can see in the chart (second encircled candle). At that time, Rpower was hovering around 36 levels, and from here on, it started zooming, and did not stop till it touched 65, and then the trend reversed following a bearish engulfing candle (see explanation above).
HOW TO TRADE THE BULLISH ENGULFING CANDLESTICK
  1. This is a buy signal in any market so long the candle is supported by rising volumes. However, in a bear or choppy market, you should ideally validate it by checking MACD and RSI. 
  2. If the market trend is bearish, book profits and hold on to free shares so long the stock is high quality.  Can book losses too. Can try shorting as well.

5: GREEN MARBOZU

A green Marbozu is a full bodied green-colored candle (no wicks). It’s an extremely bullish signal in any market.

how to interpret marubozu candle
On 16-10-17, Aries Agro opened at 172 and closed at 206, forming a green marubozu. Typically, investors would not have bought it, feeling the stock had appreciated like crazy. However, had they checked the charts and seen the Marubozu, they would have bought. Aries Agro went on to hit 260+ levels where it encountered several powerful bearish candles, and slipped to 213.
HOW TO TRADE THE GREEN MARUBOZU
  1. This is a buy signal in any market so long the candle is supported by rising volumes.

6: RED MARUBOZU

A red Marubozu is a full bodied red-colored candle (no wicks). It’s an extremely bearish signal in any market. It’s very difficult to find a red marubozu in a bull market for a prominent stock. But I’ve something that’s close to one.

how to analyze bearish marubozu
On 22-5-17 Fortis hit 206 and crashed against a wave of selling. It closed at 195. Its candle was bearish engulfing, and looked like an almost-Marubozu. It was a powerful sell signal, but I can bet that many investors would have waited because they loved ts business model. Well, the story is there for all to see. Fortis crashed to 109 on 5-2-18.
HOW TO TRADE THE RED MARUBOZU
  1. This is a SELL signal in any market so long the candle is supported by above-average volumes.

Well, these chart formations should hep investors reach some conclusions about any stock. Remember that candle formations do not work for illiquid stocks. If you read and practice the 2 articles liked at the top + this article, you will be able to spot stocks that can appreciate or depreciate.

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sunil.tinani

6 Comments

  2. Sir once again thanks for your knowledge sharing.My query is regarding Bullish Marubozu.On 14/02/18 Nelco formed marubozu with huge volume but after that it’s in downtrend.plz explain this

    Reply

    • It did retrace yesterday. Markets are choppy/weak these days and the trend is uncertain. In such a trend, sell-side technicals work better. In any case, you are referring to a 1-day Marubozu, and therefore should wait it out for at least a couple of weeks. Apply a 10%-15% SL.

      Reply

  4. Sunil ji, i just started reading articles and explanation given in your articles. a great work and i appreciate the way you explain, it clearly gives ways to understand and make decisions on the facts.

    my little suggestion, please ask someone to proofreading before posting it. there are some confusions e.g in 1: DOJI IN A BEAR MARKET :- you wrote you have used 1 day candles whereas it was 1M !!

    2: DOJI IN A BULL MARKET :- you wrote Reliance industries but chart is for Reliance power !!

    not complain but just an suggestion so that beginner like me should note get confusions.

    regards
    🙂

    Reply

    • Rectified (1)

      (2) is okay because in Investing.com, the name of the stock that was analyzed first remains fixed at the top.

      Reply

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