When it comes to price charts, candlestick charts are widely used among traders.
As opposed to fundamental analysis, which focuses on the financial health of assets, Candlestick trading is a type of technical analysis that employs candlestick patterns.
This guide will explain what candlestick patterns are and how to use them to help make your trading decisions.
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A candlestick chart illustrates an asset's historical price movement over time. Depending on the timeframe, each candlestick indicates a certain period. If you choose the monthly chart, each candlestick represents one month's price movement. Japanese rice traders invented candlestick charts to track rice prices.
A candlestick has two main parts:
The colour of a candlestick indicates the price movement's direction. Typically, a green or black body often indicates a price rise, whereas a red or white body indicates a price decrease.
Unlike a simple line chart, the candlestick chart, as explained above, gives a lot of information about the price history. Candlesticks form chronologically one after the other and can help you see the overall trend. In addition, you can spot support and resistance areas even if you don't have any technical indicators. Aside from that, candlesticks create patterns that can be used as buy or sell signals.
As mentioned above, we divide candlestick patterns based on their potential reaction: bullish or bearish.
Here are the most commonly known and used candlestick patterns:
Bullish candlestick patterns indicate that a market could be about to rally. They are divided into two types:
Here are six bullish candlestick patterns that are easy to spot and take action on:
A hammer candlestick is characterised by a small body, a long lower wick, and little or no higher wick. It's seen as a sign of an oncoming bullish reversal, which indicates that if you observe one during a downtrend, the market may reverse.
A hammer means sellers drove the price to new lows during the session but could not maintain it there. Instead, buyers resisted, and the market closed around its opening price, or higher. If a hammer is bear, it means the market closed somewhat lower than it opened. It closes above its initial price if bull, indicating that the signal is stronger.
Look at the length of the body in relation to the wick to discover a hammer. The wick should be twice or three times the length of the body.
An inverted hammer has a small body, a long upper wick, and little or no bottom wick.
As the name implies, the price action within is the reversal of what happens in the hammer. Bulls grabbed control early in the day, driving the market higher following a downtrend. However, the reversal failed to take hold, and bears ensured its price remained approximately where it began.
However, the sellers were unable to maintain the downturn, indicating that momentum may be shifting.
A bullish engulfing pattern is a combination of two candles.
The first is a bear candle and appears as part of a downward trend. The bear candle is followed by a bull candle that completely engulfs it, indicating that the market started lower but eventually rose over the previous candle's high.
Despite a shaky start to the session (the market begins below the previous close), the second candle in a bullish engulfing shows significant upward momentum. As the market concludes at or near the period's top and barely declines below the low open, there should be minimal apparent upper or lower wick.
A piercing line, like a bullish engulfing, is created by two candlesticks and indicates a potential bullish market reversal. In this case, a bear candle is followed by a bull candle.
In a piercing line, however, the bear candlestick has a longer body and is not consumed by the bull candle. Instead, the market often has a gap between the bear's close and the bull's open but rises above the previous session's midpoint.
We're still seeing market reversals. However, the bears had complete control of the market until about halfway through the second session, when the bulls began a rally.
The rising three method candlestick pattern is a little more complicated, consisting of five candlesticks that may appear to be a reversal at first glance.
Three smaller bear sticks are followed by a tall bull candlestick in the rising three techniques. In this case, those three bear candles must all fall inside the first candle's open and close range. The market then rises above the close of the first candlestick with a final bull candlestick.
While sellers have taken control of three consecutive sessions, momentum has been modest, failing to erase the gains gained in the opening quarter. When buyers return to the market, they easily outnumber sellers, restarting the previous bull run.
Following a severe decline, the three white soldiers pattern occurs.
It is made up of three bull candlesticks that come after a long bear period. The first candle should close in the previous bear candle's range. The second bull candlestick should close above the bear candle's open. The third is another bull candle closing above the previous candle, indicating that an uptrend has begun.
As buying momentum grows, each of the soldiers' should have a longer body than the last.
Bearish candlestick patterns indicate a potential downtrend.
Like their bullish counterparts, they are classified into two types: reversal patterns and continuation patterns. This time, though, a reversal indicates the conclusion of a rally and the start of a downtrend. Continuation patterns, on the other hand, indicate that a current bear trend is not yet done.
A hanging man resembles a hammer, except it emerges at the conclusion of an uptrend. It’s, like the hammer, indicates an oncoming reversal, but this time a bull trend may be set to turn into a bear trend.
During the session, sellers drove the asset's price down until being beaten back by buyers. However, those buyers were unable to continue the surge, signalling that momentum may be shifting.
This is known as a shooting star, another indicator of a potential bearish reversal. The price movement is similar to an inverse hammer, with sellers beating back an early continuation of the advance. Because this is happening at the peak of an upswing, a reversal is possible.
A bearish engulfing is formed by a bull candle followed by a bear candle, with the body of the second fully dwarfing the first.
In this case, the second session saw a rapid shift in the tide, with the market beginning higher but swiftly plummeting as bears took control. As more sellers enter the market, supply rises while demand declines, signalling the start of a likely new slump.
Look for a second candle with little or no wick on either end, like a bullish engulfing.
Two similar candlesticks (except the first is bull and the second is bear) arise at the top of an uptrend in the tweezer tops pattern. Both should have short bodies with extended upper wicks.
Tweezer tops describe that buyers tried to push the market to fresh highs twice but failed. The market then slid back to the first period's open the second time. This symmetry indicates that momentum is turning and that a potential bear run is expected.
Only the first and third candles are different this time. The centre candlestick remains a spinning top or Doji of any colour. However, the first candle looks bullish, and the last one is bearish.
The market surge continues in the first session before stalling in the second. By the third, a retracement has begun as more traders close long positions and sellers establish short ones.
Five candlesticks comprise the dropping three methods:
Essentially, the sellers are taking a breather before driving the market lower once more. This gives buyers control of three sessions, but they are unable to generate enough momentum to breach the starting price of the first candle.
Candlesticks are a simple technique to understand price movement. Candlesticks can be used to determine when to buy/sell or when to take profits. No analysis is perfect all of the time. However, many traders are enthusiastic about using candlestick patterns.
Candlestick analysis may be beneficial if the criteria are followed and confirmation is obtained, generally in the next interval's candle. Candlestick analysis is used by traders worldwide to determine general market direction rather than where prices will be. That is why daily candles, rather than shorter-term candlesticks, function best.
When trading any candlestick pattern, it's usually a good idea to wait for confirmation before entering a trade. Because patterns are no guarantee of future behaviour, waiting for confirmation can help lessen the risk of missing out when a trend or continuation fails.
You should practise reading candlestick patterns and find other factors that align and strengthen the signals generated by candlestick patterns.
Yes. Some candlestick patterns are employed specifically to anticipate trend reversals. However, this does not imply that they are always right.
The candlestick chart is distinct from the bar chart, although they have certain similarities in that they display the same amount of price data. But many traders believe that candlestick charts are simpler to interpret.
There is no particular candlestick pattern that is more dependable than others, although some are used to forecast price action more regularly than others. The three white soldiers and three black crows are frequently regarded as the most trustworthy of the candlestick patterns.
Candlestick patterns do work, but not always. Some are more trustworthy than others, but regardless of any pattern you trade, you should always confirm the move and implement a stop loss. This lowers your risk if the pattern fails.
Different technical traders utilise different candlestick patterns, and new ones are discovered all the time. If you're just getting started, you might want to stick to a few conventional patterns and grow from there.
Candlestick patterns are utilised in day trading, in the same manner they are used elsewhere: see a pattern emerge on the market, confirm the following move, and open your trade. Day traders will typically utilise shorter-term charts to identify chances, but the idea remains the same.