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How does the Money Flow Index (MFI) indicator work?

If you are looking to find the demand for a financial asset, you need to be able to track monetary flows in and out of the markets. The Money Flow Index (MFI) indicator is used to measure supply and demand, which is usually the simplest way to determine where a market may be going. Note that this indicator was initially designed to work with the stock markets, as forex markets are not centralised, and therefore some of the inputs will be different to the original scenarios many traders had been using in equities. The basic premise is that if demand for a particular currency is high but supply is limited, prices will rise as bidding increases. This is the same as any other bidding process: if there are more people wanting to own something, people will try to outbid each other. Of course, the opposite is true as well: when demand drops, sellers have to drop prices to attract buyers. The Money Flow Index indicator is a popular method of viewing how these forces interact with the markets. <h2>The calculation</h2> The indicator uses a couple of different mathematical equations in order to find where the market may be ready to go. The equation seeks to find the ‘Typical Price’ by determining in the mean of the high, the low, and the closing prices for the time period in question. In mathematical notation: TP = (H+L+C) / 3 I.e. the Typical Price equals the high, low, and close divided by three. The next part of the calculation takes in what is known as money flow. This takes the typical price and then multiplies it by volume. There’s no way to know in a non-centralised market exactly how much volume is being done, but by using the volume at your broker, you get a fair representation of what the larger market should be. The next equation: MF = TP x V Or, Money Flow equals Typical Price multiplied by Volume. The next part of the calculation looks at positive and negative flows over the quantity of periods that the indicator is set towards, known as money ratio. The indicator defines positive money flow as being any candle where the Typical Price is higher than the previous candle. Conversely, negative money flow is when any candle has TP lower than the previous candle. To get the positive money flow for the indicator, the calculation is to add up the total positive money flows over the time span in question. Ultimately, to get the negative money flow for the indicator, the calculation is of course to add up the total negative money flows over the same time span. The equation is: MR = positive money flow / negative money flow. Finally, everything is converted into an index using the following mathematical formula:   MFI = 100 - 100 / (1 + MR) In other words, the Monetary Flow Index is a ratio of positive money flow into an asset compared to the total money flow. The indicator of course shows this for you, and you don’t have to do the math behind it, as it is built into the <a data-di-id="di-id-8ed17442-be85d085" href="/metatrader-4/">MetaTrader 4 platform</a>.  The default measurement is 14, meaning that if you are looking at a daily chart, the Money Flow Index is giving you a reading of the last 14 days. If it is on the hourly chart, it is reading the last 14 hours, and so on. <h2>How to attach the Money Flow Index indicator</h2> To use the Money Flow Index indicator on the MetaTrader 4 or 5 platform, go to the 'Insert' menu then go to the 'Indicators' submenu, followed by the 'Volumes' submenu, and selecting 'Money Flow Index'.  The indicator will show up in its own window at the bottom of your platform. <img alt="" src="/TMXWebsite/media/TMXWebsite/money_flow_index_001.png" /> At this point, you can start to look for opportunities using the Money Flow Index. Using the indicator  The MFI indicator is used to indicate when a market is overbought or oversold. In the indicator, you will notice there are two levels marked by dashed lines of 20 and 80, with the absolute highs at the 100 level, and the absolute lows are 0. When the line is above 90, the market is possibly overbought. Conversely, the indicator moving below the 20 level suggests that the market is oversold. Let’s look at the chart below. The red arrow points out where the indicator has broken above the 80 level, suggesting an overbought condition. Shortly afterwards, the EUR/GBP pair dropped. After that, you can see there was a bounce where the blue arrow marks the Money Flow Index dropping below 20. While there is just a short term bounce, there is a bounce, nonetheless. This can often be filtered by something along the lines of a moving average, or even a trendline. <img alt="" src="/TMXWebsite/media/TMXWebsite/mfi_002.png" /> To summarise: <ul> <li>The 80 level is where a market enters an “overbought” condition</li> <li>The 20 level is where a market enters an “oversold” condition</li> <li>The indicator is built into the MetaTrader 4/5 platforms, as well as many others</li> <li>The default reading will be for the last 14 candles, but can be changed</li> <li>The Money Flow Index is often used with other indicators as well</li> </ul>   <h2>Adding an additional filter </h2> Many traders choose to compliment the MFI indicator with a moving average. This is because the moving average can keep you on the right side of a trend. If you are looking for an indication of an overbought or oversold condition within the Money Flow Index indicator, this can be validated by a move above or below a moving average. Let’s look at the below four-hour chart in the Canadian dollar/Japanese yen currency pair. <img alt="" src="/TMXWebsite/media/TMXWebsite/mfi_003.png" /> The blue arrow indicates where the Money Flow Index indicator reached the oversold condition. Shortly after that, the price crossed above the 20 exponential moving average, one that is commonly used. The way to think about this move is that the market had gotten oversold, and then by breaking above a common moving average, it shows that the momentum and trend is starting to change to the upside. At that point, most traders would enter a position. Later on, in the same chart, you can see that the Money Flow Index indicator had entered the overbought condition, and the price shortly thereafter fell below the 20 EMA. That tells you that the shift is starting to gain momentum, and the market starts to fall from there. Ultimately, this keeps you in the loop when it comes to a potential trend change, and then gives you confirmation in a one-two set up. In another example, we can apply the Bollinger Band indicator to the chart, looking for signs of oversold or overbought conditions from both indicators. <img alt="" src="/TMXWebsite/media/TMXWebsite/mfi_004.png" /> Looking at the chart, you can see where the blue arrows start that the market has broken below the oversold level, followed very quickly by the market breaking below the bottom of the Bollinger Band indicator. This shows that the market is oversold as far as the Money Flow Index indicator is concerned, but more importantly it is also oversold with both indicators. By breaking the bottom of the Bollinger Band indicator, it now is two standard deviations below its average price. With both of these indicators you have the ability to see a slowdown in volume going into the market, and at the same time you can see that the market is statistically farther away from normalcy than it should be. This almost always sets up for a ‘reversion to the mean’, demonstrated by the moving average in the middle of the Bollinger Band indicator. However, some people will also aim for the top of the indicator: it boils down to your own personal trading style.

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

How to Use the Stochastic Oscillator

One of the most basic and perhaps oldest indicators used by technical analysts is the stochastic oscillator. The stochastic oscillator is an indicator that measures momentum and the strength of a trend. Essentially, its job is to analyse price movement and show how strong the price move is.    The indicator measures the momentum of price, and also shows a slowing of momentum as the momentum of a financial instrument needs to slow down before changing direction. This addresses a weakness in retail trading, the fact that far too few traders pay attention to the importance of the rate of change.    The stochastic oscillator is one of the more common indicators, and it’s one that you will see in a lot of analysis. However, like any other indicator it is simply a tool that you will be using to navigate through the forex markets, and like any other tool it is needed to be used in the proper settings and situations.  <h2>How to add the stochastic oscillator to MetaTrader charts</h2> Adding the stochastic oscillator to the MetaTrader platform is very easy. By clicking on the Insert menu, you can pull down the list and click on Indicators, followed by Oscillators, and then Stochastic Oscillator. It's a common indicator, and as such it's built into the platform and there is no need to download from anywhere else. <img alt="" src="/TMXWebsite/media/TMXWebsite/Oscillator-picture-1.jpg" /> The settings dialog box will pop up, and there are multiple parameters that you can change. The %K period and the %D period settings are available. The %K should be thought of as the slow value of the stochastic indicator and the %D should be thought of as the fast value of the stochastic indicator. It uses a couple of moving averages to measure the overall momentum. <h2>Why does momentum matter?</h2> Think back to your mathematics studies. One of the biggest influences in calculus is the absolute rate of change. The idea is that if the market is in an uptrend, but if the momentum starts to slow down, it can suggest that the market is running out of steam and, therefore, could be ripe for a reversal. In this sense, it can suggest whether or not the market is going to continue, or if it might be over-extended in one direction or the other, and other words overbought or oversold. <h2>Using the indicator to make decisions</h2> The stochastic oscillator has a multitude of uses when it comes to trading forex. We have already mentioned the most obvious use for the stochastic oscillator: the idea of identifying overbought or oversold conditions. In this scenario, the stochastic oscillator is best used in a range bound market, as it can tell you when to buy and sell in a relatively well defined situation. When you look at the stochastic oscillator window at the bottom of the chart, you see the two moving averages going back and forth in an up and down pattern. You will notice that there are two lines in the indicator window including the 80 and the 20 level.   The area above the 80 level is considered to be overbought, while the area below the 20 level is considered to be oversold. Furthermore, you need to see the moving averages inside the stochastic oscillator to cross in the overbought or oversold areas in order to get a reversal signal. Anything between the two levels is essentially ignored in this scenario. <img alt="" src="/TMXWebsite/media/TMXWebsite/Oscillator-picture-2.jpg" />   Looking at the chart, you can see that the stochastic oscillator had several moves back and forth between the 80 and the 20 levels. However, there are only a couple of areas where the indicator either broke into the overbought area or the oversold area and had a cross. You need both of these things to happen in order for it to fire off a signal.   In the graphic below, you can see that the signals fired off are color-coded by the arrows, with the red showing an overbought condition and a potential selling opportunity, and the blue showing potential buying opportunities in an oversold condition.   It should be noted that using the stochastic oscillator in this way is much more reliable when in a sideways market, preferably between significant support and resistance. This makes the stochastic oscillator truly important, because statistically speaking markets are in some type of consolidation or sideways action more than 70% of the time. In other words, it’s much more common to be in this environment than it is to be out of it.  <h2>Measuring divergence</h2> Another way that people use the stochastic oscillator in forex trading is to measure for divergence. The idea is that as with any oscillator, you could see momentum going in a different direction than the overall price. As an example, the momentum could be rising while price is falling or vice versa. If you are in a scenario where price is rising but the momentum is slowing, that means that there is less aggression to the upside and therefore less demand, even as prices press higher. This can be a sign that potential trouble is on its way.    Take a look at the chart just below. You can see that there is a clear uptrend line on the four hour chart for the GBP/AUD pair. As the price was rising, though, notice that the stochastic oscillator made a lower high, which is the opposite of an uptrend. This suggests that the rate of change is slowing down, therefore one would have to be a bit suspicious about the efficacy of the move.    After all, if there is less momentum, it suggests that there are fewer fresh orders coming in to push the market to the upside. Ultimately, you can see that shortly after the diversions with the lower high in the stochastic oscillator, the market broke down below the trend line and then eventually fell from those levels. Divergence can be found in several indicators, essentially the oscillator family. Because of this, using your divergence spotting skills can work in multiple other oscillators as well, as they all essentially work the same in this scenario. <img alt="" src="/TMXWebsite/media/TMXWebsite/Oscillator-pic-3.jpg" />

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

A Guide to Trading the Head and Shoulders Pattern

The head and shoulders pattern, as well as the inverse head and shoulders formation, are two of the most popular trading formations. Although they are not so easy to identify, they are very reliable and effective patterns that offer extremely lucrative risk-reward opportunities.  In this blog post, we are looking at the structure of the head and shoulders and inverse head and shoulders patterns, how to correctly draw them on the chart  as well as their most effective use case. Moreover, we will be sharing tips on how to trade and make profit by trading the head and shoulders and inverse head and shoulders formations.  <h2>Spotting the head and shoulders pattern</h2> The head and shoulders pattern is arguably the most popular reversal pattern among traders. It's called head and shoulders formation because it resembles a baseline with three peaks, with the centre peak being the highest out of the three. As such, the three tops look like a ‘left shoulder’, ‘head’, and a ‘right shoulder’. Both the traditional formation - head and shoulders - and the inverse head and shoulders formations are reversal patterns. Both consist of three mandatory elements:   <ol> <li> Head - This is the highest (traditional formation) or the lowest (inverse version) peak of the formation. In both versions, the head should be at a higher/lower level compared to the two peaks on each of the sides.  </li> <li> Shoulders - Two tops sitting on both sides of the centre peak are called left and right shoulders. Ideally, they should be symmetrical i.e. at the same or near the same price level. As these are extremely difficult to identify, asymmetrical shoulders are also widely accepted, as long as the distance in two peaks is not huge.  </li> <li> Neckline - A trend line that connects bottoms of the two shoulders is called a neckline. It's arguably the most important feature of the pattern as its break activates the pattern.  </li> </ol>   The key difference between the traditional version and the inverse formation is that they occur at the opposite sides of the chart. A head and shoulders pattern is a bearish reversal pattern, which signals that the uptrend has peaked, and the reversal has started as the series of the higher highs (the first and second peak) is broken with the third peak, which is lower than the second. <img alt="" src="/TMXWebsite/media/TMXWebsite/traditional-head-and-shoulders-pattern.jpg" />   As you can see in the picture above, the traditional formation starts in an uptrend and ends in a downtrend. As such, head and shoulders signals a top (the second peak) of the current uptrend. A break of the neckline activates the pattern and makes the entire setup tradeable.  On the other hand, the inverse head and shoulders is a bullish reversal pattern that occurs at the end of a downtrend. The sellers have run out of gas as they were unable to continue the series of the lower lows. The third low (the right shoulder) is at a higher level than the previous peak.  <img alt="" src="/TMXWebsite/media/TMXWebsite/Inverse-head-and-shoulders-pattern.jpg" /> After the creation of a first peak (the left shoulder), the price action rebounds modestly before continuing lower to create a lower low (the head). The price then again rebounds to a level similar to where the first rebound was finished, creating a base for the neckline to be drawn.  What follows is another pullback to create a third low (the right shoulder), before the price action finally bursts higher, breaking the neckline resistance, and activating the inverse head and shoulders pattern.    <h2>Strengths and weaknesses</h2> Both versions of the pattern share the same strengths and weaknesses, as they only differ in the context of structure. Arguably, the greatest advantage of the head and shoulders pattern is that it defines clear areas to set risk levels and profit targets.  Due to its design, the pattern offers a clearly defined<a href="https://www.thinkmarkets.com/en/learn-to-trade/intermediate/stop-losses-and-take-profits/"> stop loss, take profit,</a> and entry levels. A trader should only follow the set of rules (described below) and make sure that they don’t “jump the gun” and enter a trade before the neckline is broken.  It's extremely important to stress that both the inverse and the traditional head and shoulders patterns only occur at the bottom of an uptrend or downtrend. This is a common mistake traders and analysts make. It doesn’t matter that you drew a perfect head and shoulders pattern, if there is no prior uptrend or downtrend as both versions are reversal patterns.    The key limitation of the head and shoulders pattern is that a strong trend sometimes causes the price action to continue in the same direction despite the third peak/low being a lower high or higher bottom. In this case, the head and shoulders, or inverse head and shoulders, are seen as continuation patterns as the prevailing trend has resumed after taking a short break. <h2 dir="ltr">Drawing the pattern</h2> Unlike some other chart patterns, trading the success of the head and shoulder formation rests very much on how well you draw the initial pattern. As outlined earlier, this pattern offers a set of predefined levels, as you are actually trading against the neckline. Thus, drawing the pattern and identifying three key elements is the crucial part of the entire trading process.  The daily chart of USD/CAD shows a head and shoulders pattern that helps reverse the direction of a trend. The price action pushes higher, creating three consecutive peaks with the right shoulder slightly lower than the left shoulder. Still, there are two clear peaks on each side of the centre peak, with a slightly ascending trend line connecting two shoulders.  <img alt="" src="/TMXWebsite/media/TMXWebsite/head-and-shoulders-pic-3.jpg" /> You can see that we started in an aggressive uptrend and finished the pattern in a downtrend, with the bears ultimately erasing more than half of the earlier gains. A similar situation occurs with the inverse head and shoulders pattern lower. This is a NZD/USD daily chart where the sellers are pressing the price lower, creating a series of lows. The head is represented by a series of similar lows, while the two shoulders are sitting on each side of the head. Although the head usually consists of a single peak/low, we can also have rounded lows or peaks, as long as there are shoulders visible on each side of the head. <img alt="" src="/TMXWebsite/media/TMXWebsite/head-and-shoulders-pic-4.jpg" /> You can see that the NZD/USD pair creates a new short term low (the lowest low of the head) before pushing higher to create a series of the higher lows before eventually surging higher above the neckline.    <h2>Trading the head and shoulders pattern</h2> We stated earlier that possibly the greatest advantage of this formation is that it offers precisely defined levels. The key is a neckline due to the three reasons:   <ol> <li>A break of the neckline activates the pattern. Before the neckline is broken, we consider the pattern to still be in the making. </li> <li>A neckline defines the stop loss i.e. after the breakout, any reverse move to the other side of the neckline activates the stop loss and automatically invalidates the pattern. </li> <li>A distance between the neckline and the head is measured to calculate the take profit. </li> </ol>   We will now use the same two examples to give you a step-by-step guide on how to trade the head and shoulders and inverse head and shoulders patterns. Once we have drawn the pattern and identified three key elements of the formation, we monitor the “draft” pattern closely and wait for the bears to potentially break the neckline and activate the formation. There are two options for the head and shoulders pattern as far as the entry is concerned.  <img alt="" src="/TMXWebsite/media/TMXWebsite/head-and-shoulders-pic-5.jpg" />   The first option offers you a chance to enter a short trade as soon as the neckline is broken and the daily candle closes below the broken neckline. This option means that you can’t miss a trade.  However, this one is also riskier as this move lower can easily prove to be a failed breakdown. In this case, your stop-loss would be activated almost instantly.  The second option is prefered by the majority of the trading community. It's based on an idea that you should make an entry after the price action closes below the neckline and the breakdown is confirmed. Accordingly, the buyers will then push the price action to retest the neckline, the so-called “throwback”, before resuming lower. Thus, you should place the entry when the throwback occurs. Of course, the price action can still return above the neckline, however, the chances are smaller than with the first option. The limitation of the second option is that the price action can simply resume lower without performing a throwback i.e. a retest of the neckline is not guaranteed (see example 2 lower). USD/CAD closed below the neckline on a daily basis, then the buyers pushed the price higher the next day, before ultimately sliding lower. From the risk-reward perspective, this is a perfect scenario as you are given the opportunity to enter a trade on the retest.  Wherever you decided to place the entry, the stop-loss should be located above the neckline. You are advised to always allow for a cushion between the stop-loss and a neckline. As you can see in our example, the buyers were able to trade briefly above the neckline before getting rejected.  The take profit is calculated by measuring the distance between the head and a neckline (the green line), and then copy-pasting the same trend line starting from the neckline and extending lower. This way, you define the exact point at which the head and shoulders pattern should be completed.    Finally, our entry is at $1.2820, stop loss around $1.2860, while a take profit order is set at $1.2550. Hence, we risked 40 pips to make 270 pips, which is a phenomenal risk-reward ratio and the best evidence as to why the head and shoulders is such an effective reversal pattern.    We now move to our second example by explaining how to trade the inverse head and shoulders. In essence, we follow the same set of rules. Once we have drawn all the key elements, we are waiting for the NZD bulls to push the price higher. <img alt="" src="/TMXWebsite/media/TMXWebsite/head-and-shoulders-pic-6.jpg" /> Earlier we discussed two options available to set your entry. This example belongs to the second option and it perfectly shows why this is a riskier option. As you can see, the bulls never returned to retest the broken neckline once the breakout occured. Hence, if you had opted to wait for a retest, you’d have missed the trade.  By choosing the first option, you’d enter a trade once the daily close above the neckline has been secured. The stop loss is again placed below the neckline, while the blue line measures the distance for a take profit order. A few weeks later, the inverse head and shoulders pattern is completed. In this case, we risked 70 pips to gain around 200 pips, which makes a nearly 1:3 risk-reward ratio, meaning this was a very good setup from the risk tolerance perspective.

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

Fibonacci ratios

The Fibonacci ratios commonly used are 100%, 61.8%, 50%, 38.2%, 23.6% - these are shown as horizontal lines on a chart and may identify areas of support and resistance. These levels are created by drawing a trend line between two extreme points and diving the vertical distance by the key Fibonacci ratios. These extreme levels are known as the recent swing high and swing low,  To identify the Fibonacci levels for an uptrend, click on the swing low and draw the trend line to the swing high. In a down trend you simply reverse the trend line. The following chart shows the Fibonacci levels on price which is in an uptrend. <img alt="Fibonacci Retracement" src="/TMXWebsite/media/TMXWebsite/Fibonacci-Retracement.png" style="vertical-align: middle;" /> As you can see on the chart, we have plotted the Fibonacci levels by clicking on the swing lows at 1.000 and swing highs at 1.14. The Fibonacci levels plotted show where price travels to and reverses, and are evident at the 61.8%, 38.2% and 23.6% levels. The 61.8% level is a common support level, as in the above example you can see the price has tested this level on many occasions. More recently, you can see where the price broke through the 38.2% level and retested this level. In this example there’s an expectation for the currency pair to test the 23.6% level at 1.11. The next chart shows the Fibonacci ratios plotted for the pricing action in a down trend.  As you can see, we’ve drawn a trend line from the swing high at 1.1037 to the swing low at 1.0994. Again, you can clearly see where the price reversed at key Fibonacci levels such as the 50% and 23.6% levels. <img alt="Fibonacci Retracement" src="/TMXWebsite/media/TMXWebsite/Fibonacci-Retracement-2.png" style="vertical-align: middle;" /> Fibonacci levels are by no means fool proof – they’re not areas where you would buy and sell from. You should look at them as areas of interest – an indication of where the price may go to in the future.   <h3>Combining Fibonacci ratios with support and resistance</h3> Fibonacci ratios can be subjective, but can also be used to identify key support and resistance levels. A potential way to use the Fibonacci levels is to spot potential support and resistance levels, and see if these levels line up with the Fibonacci levels. If you do spot these levels, the chances of the price bouncing off them are higher. <img alt="Fibonacci Retracement" src="/TMXWebsite/media/TMXWebsite/Fibonacci-Retracement-and-Support.png" style="vertical-align: middle;" /> As you can see from the chart, the key Fibonacci levels 61.8% and 38.2% have been areas of support and resistance previously, and by identifying this on the chart, these levels can potentially be areas where you could enter the market. With traders looking at the same support and resistance levels, there’s a good chance that there will be a number of orders around those levels.

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

How to trade bullish and bearish Engulfing candlestick patterns

Bullish and bearish Engulfing candlestick patterns, also called Outside bars, are powerful dual-candle formations. Found at the end of a downtrend or uptrend, these patterns often indicate a potential reversal. Engulfing patterns are also easy to spot, which adds to their popularity and makes trading with them very straightforward.  The difference between this pattern's bullish and bearing versions depends on the candle order within it.  <h2>Bullish Engulfing candlestick pattern</h2> A bullish Engulfing pattern occurs at the end of a downtrend and consists of two candles. The first candle is bearish (red) and has a relatively small body and short shadows, also known as wicks. The second candle, on the other hand, is bullish (green) and has longer wicks and a longer body that engulfs the body of the previous bearish candle.  <img alt="Bullish Engulfing candlestick pattern (Outside Bar)" src="/getmedia/4908dd05-65dd-4e63-8e2c-91688f3ef6cd/Bullish-Engulfing-candlestick-pattern-(Outside-Bar).png" /> The body of the first candle doesn't necessarily need to be exactly in the middle as long as it's completely overwhelmed by the body of the second candle. For a candlestick pattern to qualify as bullish Engulfing, the high price of the second candle should be higher than the high price of the first candle. The same scenario applies to the low prices – the second candle must have a lower low price than the first one.  If the closing price (top of the body) of the second candle is higher than the high price (top of the wick) of the first candle, the Engulfing pattern is considered a much stronger bullish reversal signal. The reason is that the second candle indicates that bulls gained control over the price.  <h2>Bearish Engulfing candlestick pattern</h2> A bearish Engulfing pattern works exactly the same way. The only difference is that it is a bearish reversal pattern that occurs at the top of an uptrend, with a bullish (green) candle on the left and a bearish (red) one on the right.  <img alt="Bearish Engulfing candlestick pattern" src="/getmedia/b35bbf54-f9e5-4090-a3ae-155c631dcdb8/Bearish-Engulfing-candlestick-pattern.png" /> <h2>How do Engulfing patterns work?</h2> As we mentioned above, both patterns take place at the end of a strong trend. The first candle in both formations (either bullish or bearish) signals the continuation of a trend. On the other hand, the second candle (bearish or bullish, respectively) is powerful enough to completely shut down the first one and initiate a new trend.  Engulfing candles in trading are very significant when conducting analysis, as traders usually aim to capitalise on new trends when markets change direction. Reversal patterns, such as bullish and bearish Engulfing patterns, signal an impending change in the price direction, as the so far dominant force has started losing momentum, which allows the other force to step in.  However, as with other candlestick patterns, Engulfing formations have their own limitations. While they are quite powerful at the end of a strong trend, they are almost non-tradeable when they appear in a sideways market.   <h2>Engulfing vs Harami candlestick patterns</h2> An Engulfing pattern has an opposite version – a Harami candlestick formation, also called an Inside Bar. Its structure is identical, but the candles within it swap places. The first candle is long, entirely overwhelming the second smaller candle. A Harami candle can also exist in two variations – bullish and bearish.  <img alt="Bullish and bearish Harami candlestick pattern (Inside bars)" src="/getmedia/418d3953-c8d9-46f8-b205-af678bcf1aeb/Bullish-and-bearish-Harami-candlestick-pattern-(Inside-bars).png" /> However, in general, this pattern doesn't provide a strong signal. Once it occurs, it may indicate an upcoming reversal, but the price often starts trading sideways instead or continues following the trend. That's why this pattern is not particularly popular among traders.  <h2>How to trade with Engulfing patterns</h2> A trading strategy with Engulfing patterns is pretty straightforward as they provide a powerful signal on their own.  <h2>Trading with a bearish Engulfing pattern</h2> On the image below, you can see a series of highs and lows that created an uptrend. Following a new short-term high price (the first candle in the bearish Engulfing pattern), the price suddenly drops lower to create a strong, powerful bearish candle.  <img alt="Trading with a bearish Engulfing pattern" src="/getmedia/e13e4fd6-918a-47a1-8d3f-669a1d94f57e/Trading-with-a-bearish-Engulfing-pattern.png" /> All elements are in place, and the bearish Engulfing pattern occurs. After that, the price still has both lows and highs but ultimately trades at lower levels.  In this particular example, you can see the power of a bearish Engulfing pattern. The trend reversed after the second candle generated a signal that the bears had taken control of the price, and the downtrend may be finished.  In such cases, traders tend to go short, using the second candle as an entry point and its high price as a stop loss. The take-profit level is derived using other technical indicators.   For a more complete trading strategy, you may also use additional technical analysis tools, such as support and resistance or technical indicators.  For example, if we zoom out of the previous price chart, we can see a potential placement of two support levels that may (and did, in this case) affect a newly formed trend.  <img alt="A bearish Engulfing candlestick pattern with support lines in a price chart" src="/getmedia/097e5469-ff87-4b8d-92c0-5528ed694c04/A-bearish-Engulfing-candlestick-pattern-with-support-lines-in-a-price-chart.png" /> On the other hand, if you have a long position open in an uptrend, a bullish Engulfing candle pattern may serve as a signal to exit the market before it reverses.  <h2>Trading with a bullish Engulfing pattern</h2> A strategy with a bullish Engulfing formation would work exactly the same, but you would go long following the same logic. With a short position in a downtrend, this pattern would also serve as an exit signal.  For example, the image below shows a bullish Engulfing pattern in action – the downward reversed right after the formation occurred.  <img alt="Trading with a bullish Engulfing pattern" src="/getmedia/13a3792d-d4e9-4eed-9fe4-0bbbd24b7401/Trading-with-a-bullish-Engulfing-pattern.png" /> Keep in mind that even the most accurate trading signals never guarantee that the market will move in the predicted direction. That's why experienced traders always have risk management tools, such as stop loss and take profit in place.    Create a demo account to solidify your knowledge in a risk-free market environment. Alternatively, move to our next article, where we explain how <a href="/trading-academy/forex/analysis/marubozu-candlestick-pattern">Marubozu candles</a> work.

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Forex Indicators and patterns

Hanging Man vs Shooting Star candlestick patterns

The hanging man and shooting star candles are often considered a part of the hammers group, along with the hammer and inverted hammer. All four patterns are indeed very alike in their structure and are single-candle reversal chart patterns.   As we mentioned in our previous article about <a href="/en/trading-academy/indicators-and-patterns/hammer-candlestick-pattern/">hammer candle stick patterns</a>, the main difference is that the hanging man and shooting star appear in uptrends, while both hammers occur in a downtrend. Hence, the hanging man and shooting star patterns are considered bearish – the opposite of bullish hammers.   <img alt="Hanging Man vs Shooting Star vs Hammer vs Inverted Hammer" src="/getmedia/7bdfd60c-d229-4aa6-ade5-26a2e31a7679/Hanging-Man-vs-Shooting-Star-vs-Hammer-vs-Inverted-Hammer.png" /> <h2 paraeid="{a93e94ed-6fea-4c9f-a350-f7bc6677a4d1}{52}" paraid="1878194966">Hanging man candlestick pattern</h2> A Hanging man formation is the uptrend version of a hammer candlestick. Their structures are virtually the same – little to no upper shadow (wick), a small body with the high, closing and opening price close to each other and a long wick extending to the bottom. The lower wick is usually at least twice as long as the body.  <img alt="Bearish and bullish Hanging Man pattern" src="/getmedia/8c89ad4d-4b7e-43a4-bc9e-c257d070c474/Bearish-and-bullish-Hanging-Man-pattern.png" /> A Hanging man candle can also be bullish (green) and bearish (red). Since this is a bearish reversal pattern, the red version of it is usually considered a stronger indication of the potential trend reversal.   <h2>Shooting star candlestick pattern</h2> A shooting star candle is the uptrend version of the inverted hammer candlestick. Its short body is created by the closing, opening and high prices located near each other and a twice as long wick protruding upward. A lower shadow is usually either very short or doesn’t occur at all.  <img alt="Bearish and bullish Shooting Star candlestick pattern" src="/getmedia/a10c2061-e0ae-4a23-a28f-01798e0bd049/Bearish-and-bullish-Shooting-Star-candlestick-pattern.png" /> Similar to the hanging man candle, a bearish shooting star formation is considered stronger due to the overall bearish nature of the pattern.  <h2>How do hanging man and shooting star candles work?</h2> Occurring in an uptrend, both hanging man and shooting star indicate that the trend is losing its momentum, and bears are trying to overpower the bulls.   The hanging man candle tells us that, although bulls still have some power that helped them to achieve a high close, bears were powerful enough to push the price much lower to create a long wick at the bottom.   The shooting star pattern is considered stronger than the hanging man candle because bears managed to push the closing price to the bottom despite the long wick at the top created by bulls. <h2>How to trade with a hanging man and shooting star</h2> When a hanging man and shooting star patterns occur, traders have two options. The first option is to go short right away, using the candle’s closing price as an entry point and its high price as a stop loss. The second option is to wait for two to three candles to close and confirm a trend.   There is no right or wrong decision, as it depends purely on the trader’s perception and risk appetite. However, it is important to keep in mind that neither hanging man nor shooting star candles serve as a direct trading signal. Just like any other chart pattern or technical indicator, they only suggest that a bullish trend is weakening, and price reversal may occur. It doesn’t necessarily mean that the price will reverse right after the hanging man or shooting star candle – it may take some back and forth between bulls and bears.   As you can see on the image below, a shooting star was formed at the end of the uptrend. However, the price didn’t reverse immediately. It took a hanging man and some side traction for bears to assume power and turn the trend downward. <img alt="Identifying Shooting Star and Hanging Man candlestick patterns in a price chart" src="/getmedia/c3064b11-26bb-441e-979f-6e7c8351b039/Identifying-Shooting-Star-and-Hanging-Man-candlestick-patterns-in-a-price-chart.png" /> It may also be helpful to confirm the trading signal you identified with other technical analysis tools, such as <a href="/en/trading-academy/technical-analysis/support-resistance/">trendlines</a> and <a href="/en/trading-academy/indicators-and-patterns/technical-indicators-beginners-guide/">technical indicators</a>.   Another important set of tools to use are risk management tools – stop loss and take profit. We suggest using them at all times to prevent larger than expected losses.   Create a free demo account to practise identifying Hanging Man and Shooting Star candlesticks and opening positions in a risk-free environment. To discover more helpful chart patterns, head to our next article, where we will explain how a <a href="/en/trading-academy/indicators-and-patterns/spinning-top-pattern/">spinning top candle</a> works.

6 Lectura mínimaPrincipiantes