Candlestick Patterns
What Is a Candlestick Pattern?
Candlestick charts are a great way to visualize price data in trading. Each 'candle' shows the opening, highest, lowest, and closing (OHLC) price for a particular time period. So, they give you more information than just connecting closing prices with a line. The shape and color of the candle can indicate who was in control during that time period - the buyers or the sellers.
This type of chart, which dates back to Japanese rice traders in the 18th century, can also form patterns that might help predict where the price is going next.
Usually, each candle represents a whole day's worth of trading. This includes all the news, data, and price movements that happened in that day. So, candlestick charts are often used by traders who hold positions for more than a day.
The key thing to remember is that each candle tells a story of the tug-of-war between buyers and sellers. A green or white candle means buyers had the upper hand, and a red or black one means sellers took control. It's this ongoing battle that makes candlestick charts a favorite tool among traders.
KEY TAKEAWAYS
Candlestick patterns are long-standing tools in trading, used to help forecast where prices might go next.
There are many different types of candlestick patterns, and they often have descriptive names. Many patterns have a mirror image – for example, an "abandoned baby top" pattern has its counterpart in an "abandoned baby bottom" pattern, and "tweezer bottoms" have their match in "tweezer tops."
Traders often combine candlestick patterns with other technical indicators to fine-tune their trading strategies, like deciding when to buy or sell.
Candlesticks are based on present and past price movements – they don't predict the future. They give insights about potential price changes, but they're not guarantees.
How to Read a Candlestick Pattern
A daily candlestick on a chart shows four main prices for a market: the opening, highest, lowest, and closing (OHLC) prices. The main part of the candlestick, called the body, is a rectangle. If the price went down, the body is colored dark (often red or black). If the price went up, the body is light (usually green or white). The thin lines sticking out from the body, called wicks or tails, show the highest and lowest prices of the day. Together, these parts of the candlestick can often suggest if a market's direction might change or if a significant price move could happen. However, you typically need to check the next day's candle to confirm these signals.
Types of Candlestick Patterns
The examples below show a few candlestick patterns that are really good at predicting where the price might go and when it could reverse. They work best when you consider the other price bars around them. Also, keep in mind two important time-related points:
They only work as per the time frame of the chart you're looking at, whether it's intraday (within the day), daily, weekly, or monthly.
They start to lose their effectiveness pretty quickly, usually about three to five bars after the pattern is done.
Take Special Note of Long Tails and Small Bodies
Candlesticks with tiny bodies, like a doji or a spinning top, suggest a standstill between buyers and sellers. This means the closing price is almost the same as the opening price. These small bodies show that the market is unsure about its current trend.
Often, these tiny-bodied candlesticks hint at a trend reversal as the current upward or downward movement may be losing momentum. It's important to keep a close eye on these signs of market indecision because eventually, either the buyers or the sellers will take control. During such periods, it's best to observe the price behavior closely and be ready to act once the market trend becomes clear.
Long wicks, especially when seen with small bodies, are another crucial candlestick feature to monitor. These long wicks show that buyers or sellers tried to drive the price their way but couldn't maintain it, causing the price to return close to the opening value. A good example is the doji candlestick, which depicts an unsuccessful attempt to move the price either up or down, ultimately resulting in no significant change. If this occurs after a price increase, it may suggest a likely downward move next.
Frequently Asked Questions
Summary
Candlestick analysis, a type of technical analysis, has been used for hundreds of years. It works effectively because many traders use and rely on it. While you can pair candlestick analysis with other technical tools, like momentum indicators, it can also be used on its own.
Looking at daily candlesticks is an efficient way to read a candlestick chart since they encapsulate a whole day's worth of market data and price movements. If you choose to use shorter-duration candlesticks, remember that their relevance lasts only for a few periods of your chosen timeframe. For instance, the pattern formed by a four-hour candle is typically significant for just a few four-hour spans.
Candlestick signals can be based on individual candles, like a doji, or multiple-candle patterns such as bullish/bearish engulfing lines or bullish hammers/bearish hanging man patterns. Candlesticks are excellent for predicting future price movements, but it's often crucial to wait for additional candles to confirm a pattern before making a trade decision. Specifically, candlestick patterns often highlight moments of market indecision, giving traders a heads-up about a potential shift in trend.
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