How To Analyse Candlestick Chart Patterns
Candlestick chart patterns are a way to read the price of a market instrument.
They originated from Japan and are believed to have been invented by a rice trader called Munehisa Homma, though it is highly likely that they developed a lot after their initial use.
Candlestick charts are highly popular because they are easy to read and display a lot of information about what traders are doing.
With them, you can see the opening and closing price, as well as the highest and lowest points an instrument reached.
If it closes green (or white on some charts) it means the instrument has closed at a higher price, if it closes red (or black) it means the instrument has closed at a lower price.
The main difference between green and red candlesticks, aside from the colour, is that the opening and closing positions are at the opposite ends in what makes up the body.
The highest and lowest points are the line above and below the candlestick and it is called a wick (shadow).
Time frame also matters. You may use five-minute charts, one-minute charts, hourly, daily, monthly or yearly. This is particularly important depending on the trader you are.
By using candlestick charts and looking for candlestick patterns, we can reduce emotional trading and trade in the direction of the market, using it to our advantage.
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What are candlestick chart patterns?
A candlestick pattern is what we call a specific candlestick or group of candlesticks that in most cases signify a change in the market.
A good way to think of it is that every candlestick tells a story.
For example, let’s look at a bullish candlestick.
As we know, the closing price is the lowest part of the body and the opening price is the highest part of the body.
But when we take into consideration the above and below wick, there is a lot more going on than what first meets the eye.
The price likely went up after opening, but then met a strong rejection of higher prices from sellers.
It likely collapsed to the lowest point of the wick but then buyers managed to push the price back up a little bit more, finishing the candlestick at the closing price.
By looking at candlestick in this way, you are able to see not just that the price went down at this moment, but what buyers and sellers are doing and how strong they are.
In this case, sellers where stronger, but buyers where still active.
Looking at one candlestick though is not enough. You need information around you to explain what is happening in the market. With this the candlestick will tell a clearer story.
Look for support and resistance
You can use candlestick chart patterns to look for support and resistance levels as you would with any other charts.
Remember though, don’t just look at the opening and closing price, you should also look at the wick as this will highlight the highest and lowest points and give you a clearer idea of support and resistance levels.
Spot trend reversals
This is perhaps the most useful thing you can do with candlestick chart patterns. If you trade trends, then candlesticks are very helpful.
Candles with long wicks and small bodies may suggest that the current trend is about to come to an end and a new trend will begin.
That said, you should still wait for confirmation from the next candlestick to be sure if what the previous candlestick suggested will actually happen.
Never make a trade based on one candlestick, always look at it in the context of the market.
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Most used candlestick chart patterns
As we said, each candlestick tells a story, no two are exactly the same. Many may even look the same, but when you look at them in the context of the market they are different.
For example, the shooting star and inverted hammer (we’ll talk about these two in a minute) look the same in shape and inexperienced traders can easily confuse them.
What makes them different is where they are positioned and the state of the market at the time.
Let’s take a look at some of the most commonly traded candlestick patterns.
The hammer pattern signifies that a bearish trend may come to an end and a bullish trend could begin.
The opening and closing price are close and it looks like a hammer because of the long wick below it.
For it to be considered valid, the wick must be at least two times longer than the body. If it has a wick above, it must be very short.
An inverted hammer pattern is the exact opposite of the hammer pattern.
Essentially, it is an upside-down hammer that appears when an uptrend is on the brink of reversal into a downtrend.
The hanging man is quite similar to the hammer. What makes it different is that it appears in an uptrend and generally signifies that the uptrend is about to end.
The wick of the hanging man should also be two times longer than the body.
A Spinning Top pattern can signal that the direction of the currency pair is not yet clear. It is characterised by long upper and lower wicks and a short body.
Spinning Tops can indicate a trend reversal, though this should be confirmed by the following candle.
This pattern is rare and only appears in extremely volatile trading environments. It is very simple and appears when the price of an instrument has risen exponentially.
It may not always be wise to try to trade such candles after a large market movement, as it is very likely the instrument will correct itself.
This is a very simple candlestick pattern. It is a bullish candle with a large body and no wick.
It basically means that the opening price was the lowest price and the highest price was the closing price.
This candlestick pattern is the exact opposite of a White Marubozu. It is a bearish candle and means the opening price was the highest and the closing price was the lowest.
There are many different variations of doji candlestick patterns. They are all characterised by having very close or the same opening and closing price.
What differentiates them from one another is their wicks and how high or low they are.
A Shooting Star has a close opening and closing price and has a long upper wick and is only considered as such when it forms as the price is rising.
It has the same shape as an inverted hammer, but its location is different.
While an inverted hammer will appear at the bottom of a downtrend, a shooting star will appear at the top of an uptrend.
Its appearance may mean the price may begin to fall.
Similar to the inverted hammer, the dragonfly symbolises a rejection of lower prices.
It’s opening and closing prices are very close or the same and it has a long wick below it, with little or not wick above.
Similar to the shooting star, the gravestone candlestick pattern is where the doji is very low. It is characterised by a very long wick above it and little or no wick below.
It is the reverse of a dragonfly and symbolises a rejection of higher prices.
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Candlestick patterns of two or more candles
A number of candlestick patterns involve more than one candle.
Bullish Engulfing Pattern
An Engulfing Pattern is where there are two candlesticks and the second one swallows up the first.
A Bullish Engulfing Pattern is where the first candlestick was bearish, but the second is bullish. It can indicate that a bullish trend may emerge.
Bearish Engulfing Pattern
A bearish engulfing pattern is the exact opposite of a bullish engulfing pattern.
It is where a bullish candlestick is completely swallowed by a bearish candlestick and can signify that a bearish trend is on the brink of emerging.
The Bullish Harami is made up of two candlesticks. The first one is a large bearish candle and the second one is a smaller bullish candle.
The second candle must be completely contained within the first candle. It can signify that a downtrend is reversing into and uptrend.
Harami is Japanese for ‘pregnant’.
The Bearish Harami has a large bullish candle and a small doji completely contained within the former candle.
It can signify that an uptrend maybe coming to an end and downtrend may start.
Bullish Harami Cross
The Bullish Harami cross is made up of two candlesticks. The first one is a large bearish candle and the second one is a small doji. The doji must be completely contained within the first candle.
A Bullish Harami Cross appears at the bottom of a downtrend and it can suggest that an uptrend is on the verge.
Bearish Harami Cross
The Bearish Harami Cross is characterised by a large bullish candle and a small doji. Again, completely contained within the former candle.
It can signify that an uptrend will come to an end and downtrend will start.
This is where three or more red and green candlesticks are sandwiched together, opening and closing at more or less the same price.
There isn’t much you can do with this candlestick, though it may indicate that there is indecision in the market or that the market is ranging.
Three White Soldiers
The Three White Soldiers is considered a significant sign that a downtrend has ended.
It is composed of three bullish candles, typically with short or almost no upper shadow with the first of the candles usually the shortest.
Three Black Crows
The Three Black Crows are the exact opposite of the Three White Soldiers.
They appear after an uptrend and signify a bearish market is about to emerge. Again, the first candle is usually the shortest of the three.
A tweezer top is a very useful pattern as it can signify that higher prices are being rejected.
The pattern is made up of two candles, the first one bullish, the second one bearish. Both have long upper wicks.
It gets its name because it looks like a pair of upside-down tweezers.
A tweezer bottom is the exact opposite of a tweezer top. The pattern is made up of a bearish candle and a bullish candle. Both have long lower wicks.
It can signify that lower prices are being rejected.
It is similar to the engulfing pattern, but with a slight variation. It consists of three candles. The first is a large bearish candle, the second is a doji and the third is a bullish candle.
The middle doji is the morning star and the formation means that a bullish trend is about to emerge.
An evening star is the exact opposite of a morning star.
The first candle is bullish, the second is a doji and the third is a bearish candle. It signifies that a bearish trend could possibly form.
The Piercing Line
This candlestick pattern consists of two candles, the first is bearish and the second is bullish, and it looks similar to an engulfing pattern.
What happens in this pattern is there is typically a price gap between when the first candle closed and the second candle opened.
The second candle then climbs above the 50% mark of the previous candle. It is generally seen as a sign that a bullish trend could emerge.
Two black gapping
A simple pattern, this consists of two long bearish candles. It signifies a continuation of a downwards trend.
Bullish Three Line Strike
This candlestick pattern consists of three bullish candles progressively moving upwards and then followed by long bearish candle that typically closes lower than the first bullish candle.
Bearish Three Line Strike
Opposite of the Bullish Three Line Strike. Three bearish candles are followed by a large bullish candle.
Dark cloud cover
Bearish reversal candlestick consisting of three candles. The first is a bullish candle, the third is a bearish candle and the last is a smaller bearish candle.
It is only useful if it appears in an uptrend and signifies that a downtrend may emerge.
Bullish Abandoned Baby
This candlestick pattern is made of three candlesticks. One long bearish candlestick, a small doji and then a long bullish candlestick.
The two longer candlesticks are like the parents and the doji is the baby. Typically, there will be a gap between the parents and the baby.
When you see this pattern, it can be a sign that a downtrend is about to reverse into an uptrend. It’s worth noting that this pattern is fairly rare.
Bearish Abandoned Baby
The bearish abandoned baby is the exact opposite of a bullish abandoned baby and can signify a bullish trend could come to an end.
Other useful indicators
It is highly advised that you do not rely solely on the candlestick chart patterns. Don’t trade them individually, trade them in the context of the market.
You can do this by adopting a few indicators that can help you identify if there is a trend or not. Bear in mind that you shouldn’t use too many as this will only make things confusing.
You can check out some useful technical indicators here.
- Trade candlestick patterns in the context of the market. Do not trade them solely by themselves.
- Many candlestick patterns indicate a trend reversal. They are highly useful for those that trade trends.
- Some of the most common candlesticks also work in reverse. That said, with the opposite meaning.
- A variety of candlestick patterns may look the same. But where they are positioned in the market changes their meaning.
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