Although investing in stocks can seem overwhelming, especially for beginner investors, dedicating the time to learning will help you understand the basic concepts.
Investing involves using data to decide whether to buy or sell particular stocks. Data is often presented in charts, where recognized shapes, or patterns, can form. A recognized shape a chart could form is called a pattern. Patterns are used to help investors predict changes in price, but it’s important to note that patterns aren’t useful on their own. In this article, we’ll review candlestick patterns.
What is a Candlestick Pattern?
A candlestick pattern is a type of financial chart that helps traders understand market trends and make trading decisions. These patterns are made up of individual candlesticks, each representing a specific time period (like a day or an hour) and showing four key pieces of information about an asset’s price:
Open: The price at which the asset started trading during the time period.
Close: The price at which the asset finished trading at the end of the time period.
High: The highest price the asset reached during the time period.
Low: The lowest price the asset fell to during the time period.
How to Read Candlestick Patterns
A candlestick has 3 components:
The body provides the open and close price ranges.
The wicks (also known as shadows) show the high and low for the day.
The color indicates which direction the market is headed: A green body or white body shows a price increase, and a red or black body indicates a price decrease.
Generally, there are 2 types of markets: a bull market and a bear market. A bull market is when stock market prices are expected to rise, and a bear market is when prices are expected to fall.
Correspondingly, candlestick patterns that suggest prices will rise are called bullish, and candlestick patterns that suggest prices will fall are called bearish. An advantage of candlestick charts is they efficiently give a lot of information, making it easy to recognize patterns.
Types of Candlesticks & Performance Indicators
As a rule, candlestick patterns show the battle between bullish markets and bearish markets over a time period. To understand the wide variety of candlestick patterns, you need to understand a few basic definitions.
Few Basic Definitions
Reverse candlestick patterns – represent an overall change in the direction of stock prices in either an uptrend or downtrend.
Continuation candlestick patterns – show that a current trend is expected to continue and is the opposite of a reverse pattern.
Bullish candlestick patterns – can be a good entry point for long trades and can be used to anticipate a change from a downtrend to an uptrend.
Bearish candlestick patterns – show an existing uptrend is about to reverse to a downtrend.
Although the stock market is known to be unpredictable, investors use a variety of tactics to identify changes in the market to help them decide how to proceed. Some patterns have become popular due to their simplicity.
As with any pattern, candlestick patterns can give you some information about the mood of the market and very limited information about the real-world situation affecting the stock price. They are only useful in combination with insights (e.g., if a company introduces a potentially successful product, then its stocks are likely to rise). However, no matter how well you prepare, it is still possible to lose some or all of your investment.
Single Candlestick Patterns
Compared to larger candlestick patterns, smaller candlestick patterns are more common and correlate even less with future market behavior.
Hammer candlestick
A hammer candlestick occurs during a downtrend and has similar opening, closing, and high prices but a much lower low price. It looks like a hammer with the long bottom wick being the handle and the body of the candle being the head of the hammer. Hammers are considered to be a bullish pattern.
Inverted hammer
An inverted hammer candlestick occurs during a downtrend and has similar opening, closing, and low prices but a much higher high price. Inverted hammers are considered to be bullish.
Hanging man
A hanging man candlestick pattern occurs during an uptrend and has similar opening, closing and high prices but a much lower low price. This pattern is considered to be a bearish pattern, which is appropriate, because of the morbid form it takes.
Shooting star
A shooting star candlestick occurs during an uptrend and has similar opening, closing and low prices, but a much higher high price. It’s thought to be a bearish pattern candlestick.
Dual Candlestick Patterns
Two black gapping
Two black gapping is a continuation pattern that suggests a bearish market trend will continue. It usually develops after an uptrend with a dip that falls lower and lower and is seen as a predictor that the decline will continue into a full-blown downtrend.
Piercing line
The piercing line pattern is a bullish pattern 2 candlestick reversal pattern positioned at the bottom of a market downtrend. It may precede a trend reversal from bearish to bullish. The first candle is red and closes properly above where the second candle opens. The second candle is green and closes above the halfway point between the open and close of the first candle. The larger the candles, the stronger the indication is. However, remember indication is never very strong or long term (it is a simple pattern, so it is common whatever the underlying market conditions).
Dark cloud cover
The dark cloud cover is the opposite of a piercing line. It follows an uptrend and has two candlesticks. The first is green and closes properly below the opening of the second candlestick. The second candlestick is red and closes below the middle of the body of the first candlestick. This pattern is thought to suggest the market is going to enter a downtrend.
Bullish and bearish engulfing candlestick patterns
These both are two candle patterns with the body of the second candle covering the body of the first candle. For a bullish engulfing candlestick pattern, the first candle is bearish, and the second candle is bullish. For a bearish engulfing candlestick pattern, the first candle is bullish, and the second candle is bearish.
A bullish engulfing pattern indicates a reversal when it appears in a downtrend, while the bearish engulfing pattern indicates a reversal when it appears in an uptrend.
Triple Candlestick Patterns
Evening star
Three candlesticks form an evening star candlestick pattern if:
The first candle is large and green.
The middle candle is short and lies above the first (not including the wicks).
The third candle is large and red.
The bottom of the third candle is within the lower half of the first candle.
This pattern is thought to suggest that the stock’s price will decrease in the following days.
Morning star
The morning star pattern is the opposite of the evening star pattern. Three candlesticks form a morning star candlestick pattern if:
The first candle is large and red.
The middle candle is short and lies below the first (not including the wicks).
The third candle is large and green.
The top of the third candle is within the upper half of the first candle.
When this pattern occurs after a bearish period, it is thought to suggest that the stocks price will increase in the following days.
Evening doji star
A doji is a candle that is very short, corresponding to a day when the opening and closing prices were very similar. An evening doji star pattern is an evening star pattern satisfying the extra condition that the middle candle is a doji. This extra condition is thought to make these patterns more significant.
Morning doji star
As you might expect, a morning doji star pattern is a morning star pattern satisfying the extra condition that the middle candle is a doji. This extra condition is thought to make it more significant.
Bearish abandoned baby
The bearish abandoned baby is another kind of evening star pattern. The extra condition this time is that the middle candle is above the last candle as well as the first. As with the evening star pattern, the abandoned baby is a reversal pattern which means that it is thought to herald a change in the direction the price of the stock is moving, in this case from up to down. It is rare and is thought to be a strong indicator.
Bullish abandoned baby
A bullish abandoned baby is another type of morning star pattern (you have probably spotted the pattern now). To count as a bullish abandoned baby, a morning star pattern must have a middle candle that is below the third candle as well as below the first. As with the bearish abandoned baby, the pattern is thought to be a strong indicator that the direction of the market is going to change, this time from bearish to bullish.
Three black crows
The three black crows pattern consists of 3 long red candlesticks (black is sometimes used instead of red, hence the name). Each candle should have a short bottom wick, and the second candle should close lower than the first candle. The third candle should close lower still.
If this pattern occurs during an uptrend, it is thought to suggest that the market has lost confidence in the stock, and its price will fall. Though, if the price has fallen significantly over the 3 days of the pattern, then it may have done all the falling it is going to do.
Three white soldiers
The three white soldiers pattern is the opposite of the three black crows. Where three black crows pattern after an uptrend suggests that prices may start to fall, three white soldiers after a downtrend suggests that prices may start to rise.
Three white soldiers’ pattern is formed by 3 green candles (white is sometimes used instead of green), each closing higher than the last and with short top wicks.
Three line strike
The three-line strike candlestick pattern is a 4-candle pattern. It has a bullish version and a bearish version (which is the same as the bullish version except everything is upside down).
A bullish three-line strike has 4 candles:
The first 3 candles have progressively lower closes.
The fourth candle opens lower than the low of the third and closes higher than any of the highs of the earlier three candles.
The fourth candle also has a short bottom wick.
After a period of price decline, the bullish three-line strike is thought to herald a period of price increase. Correspondingly when after a period of price increase, a bearish three-line strike is thought to herald a period of a price decline.
Similarly, a bearish three-line strike has 4 candles:
The first 3 candles have progressively higher closes.
The fourth candle opens higher than the high of the third candle and closes lower than any of the lows of the earlier 3 candles.
The fourth candle also has a short top wick.
Conclusion:
Candlestick patterns are powerful tools in the trader’s arsenal, offering valuable insights into market sentiment and potential future price movements.
By learning to read and interpret these patterns, you can enhance your trading strategies and make more informed decisions. Whether you’re trading stocks, forex, or other assets, understanding candlestick patterns can give you a significant edge.
Although there are a lot of candlestick patterns that you can look at, with consistent practice and dedication, you can master these patterns and apply them effectively to improve your trading outcomes. Start your journey today and unlock the potential of candlestick patterns to elevate your trading success.
Frequently Asked Questions (FAQs) about Candlestick patterns
What are candlestick patterns?
Candlestick patterns are graphical representations used in financial trading to predict future price movements based on past price behavior.
How do candlestick patterns work?
Candlestick patterns work by displaying the opening, closing, high, and low prices for a specific period. Traders interpret these patterns to make decisions about buying or selling assets.
What are the basic components of a candlestick?
A candlestick consists of a body and wicks (or shadows). The body shows the opening and closing prices, while the wicks represent the high and low prices within the time period.
What is a bullish candlestick pattern?
A bullish candlestick pattern indicates that the price of an asset is likely to increase. Examples include the Hammer, Bullish Engulfing, and Morning Star patterns.
What is a bearish candlestick pattern?
A bearish candlestick pattern suggests that the price of an asset is expected to decrease. Examples include the Hanging Man, Bearish Engulfing, and Evening Star patterns.
How reliable are candlestick patterns in predicting market movements?
While candlestick patterns can provide valuable insights, they are not foolproof. Traders often use them in conjunction with other technical analysis tools and indicators.
Can beginners use candlestick patterns effectively?
Yes, beginners can use candlestick patterns effectively with proper education and practice. It’s essential to understand the basics and gradually learn more complex patterns.
