Technical analysis is the study of actual movements in the price of a financial product. However, in my opinion, technical analysis is less about trading and more about the study of mass psychology. We study the way people react in certain situations in the market, which is quite prevalent when identifying and trading using chart patterns.
This is particularly pertinent in one of my favourite candlestick patterns: the marubozu. In the image below, you can see a variety of different candlesticks. Here, the extremities of the symbol represent the high and low price, and either end of the body of the candlestick represents the open and the close of each period’s price.
Extending from these candlestick patterns are theoretically an infinite number of possible different patterns. There is extensive material available on different types of patterns and their interpretations.
What is a marubozu pattern?
In simple terms, a marubozu can be described as a long candle relative to other candles. Its shadow length relative to the body is very small. A perfect marubozu has no shadows, although these are quite rare.
Two bearish marubozu patterns are shown on February 8 and 9 of the USD/JPY below, showing the pairing’s steep drop in value over that two-day period. Notice that one of these long candles has no upper shadow at all, while another has a very small upper shadow and a long lower shadow, providing a bearish indication:
A marubozu is also sometimes referred to as a dominant candlestick or a significant candle as it shows very strong control by either buyers or sellers. There is tremendous momentum in place when a major currency pair moves so far in a short period of time. Obviously, longer candles tend to yield stronger signals.
How can you use the marubozu pattern in your forex trading strategy?
Having extensively studied client trading information in the past, I can tell you that, often, the majority of traders trade in the opposite direction of a marubozu. Therefore, after a strong upward marubozu, many clients will sell in the expectation that the price has extended too far and is likely to fall. This is rarely the case due to the amount of momentum in place.
However, the price often doesn’t return to levels prior to the marubozu candle, and if it does, it can take some time. Do your own research and draw your own conclusions about the effectiveness of the marubozu candlestick and what you think is most likely to occur after one happens.
Below is another recent example of a marubozu in the AUD/GBP currency pair, where the pair’s value drops quickly on February 18 before quickly bouncing back to not only return to pre-marubozu levels but to surge ahead:
Despite this fast recovery, traders often trade based on the assumption that this marubozu action will continue in the direction indicated through the chart pattern. A fast recovery like this is rare—and the risk of such a sudden turnaround can be mitigated through the placement of a stop-loss against any trades motivated by a marubozu candle.
What the candlestick is representing in the price action is far more important than demanding perfect candlestick shapes.
In a marubozu candlestick, the fact that the opening and closing prices are so far away from each other means there has been clear dominance by one side of the market, either buyers or sellers. However, more importantly, if the marubozu range (low to high) is significantly greater than the average, it demonstrates what little opposition there was to the move.
You will see in another example below in the price of gold (XAU/JPY), where a significant marubozu candle on February 16 triggers a price decline that maintains its negative momentum for weeks after the candle’s development:
Another interesting thing about marubozu candlesticks is how far the price can continue to move in that same direction afterward. Many would believe that once price has moved so far in a particular direction, that price has exhausted and must return.
In this example above, notice how strongly the market fell in that one red marubozu candlestick; however, the market fell that more than that distance again in the few weeks afterward. The marubozu candlestick should have been a clear sign as to how much control the sellers had.
What are the pros and cons of using the marubozu candlestick pattern?
An important point to consider when looking for marubozu candlesticks is that, while you may never trade in the same direction as the candlestick itself, you should definitely trade against them. Given the trading activity driving this pattern, you are likely to be run over as the market continues to move in that direction. History has shown that rarely does price reverse immediately and consume the move from the candlestick.
In that sense, the marubozu pattern is great at demonstrating the market sentiments behind a currency pair. When these patterns develop, they can help traders evaluate how forex traders as a whole are viewing this pairing, which plays a central role in determining the price movement of this pairing in the near future.
Sentiment, though, is only one factor affecting forex prices. For that reason, the marubozu can be a frustrating source of false signals that end up costing forex traders, causing misdirection on potential price movement and setting up your trades to suffer steep losses. For that reason, marubozu patterns should be combined with indicators and patterns that evaluate trade opportunities based on other key metrics, such as trading volume and/or lines of resistance.
Stop-losses are also essential to protect yourself given the limited reliability of this pattern.
Build a trading strategy that works for you.
In the end, there is no right or wrong way to use the marubozu candlestick pattern. What is important is you find an approach that you are comfortable with and then stick to it.
There is a well-known saying in trading: “Trade what you see, not what you believe”. The chart will tell you everything you need to know, and marubozu candlesticks can provide great insight into the interaction between buyers and sellers.
Unfortunately in this environment, what we think and believe counts for nothing. Remain objective and let the chart tell you precisely what is happening.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.