What Are Candlestick Charts & How To Trade Them

Candlestick charts are a graphical representation of price patterns. A Japanese man Homa discovered candlesticks in the 1700s while studying the supply and demand of rice prices. Today they are commonly used for trading forex online. A candlestick is composed of three parts; the upper shadow, lower shadow and body. The body is colored green or red. Each candlestick represents a segmented period of time. The candlestick data summarizes the executed trades during that specific period of time.

What are Candlestick charts?

Candlestick charts measure traders’ emotions and present price moves. They contain various candles of different colors. A candle has a bar-like structure, and each candle on the charts varies in size.

If the closing price is above the opening price, a bullish candlestick forms. And if the closing price is below the opening price, a bearish candlestick forms. Looking at a single candlestick, a trader can gain valuable information about the battle between buyers and sellers during a trading period.

Generally, a bullish candle is blue or white, and the bearish candle is red or black. Traders can select colors according to their preferences on a trading platform.

Just like a bar chart, a candle has a real body, containing a price high, low, open, and close. When the body is filled, this means close prices were lower than open. In this situation, the candle will turn bullish.

Contrarily, when the candle is empty, it indicates closing prices were higher than open, and the candle will turn bearish.

The body of the candle also has a wick/shadow above or below it. These wicks/shadows display opening and closing prices. The wicks are easy to identify, as they are much thinner than the real body.

Candlestick chart

Candlestick chart
Candlestick chart

There are many Candlestick patterns, showing trend continuation or a reversal. These patterns are formed when the price makes a certain move. Traders then use these patterns for their analysis.

All candlesticks are not reliable, but there are a couple of patterns that are reliable enough to become part of a trading strategy. However, which candlesticks that can be used varies a lot depending on factors like what market you trade, the timeframe, and other conditions that are pertinent to your trading strategy.

Some of popular Candlestick patterns are:

1. Engulfing candlestick pattern

The engulfing pattern consists of a long candle with three smaller candles. The longer candle engulfs the smaller candles, hence the name.

Bearish and Bullish Engulfing candlestick pattern
Bearish and Bullish Engulfing candlestick pattern

2. Hanging Man candlestick pattern

The hanging man is a single candlestick pattern with a small body. It has no or little upper shadow and the lower shadow is twice the body’s size.

Hanging man candlestick pattern
Hanging man candlestick pattern

3. Hammer candlestick pattern

The hammer also contains a small body with a small wick on one end and a larger wick on the other end.

Hammer candlestick pattern
Hammer candlestick pattern

4. Shooting star candlestick pattern

The shooting star is another single Candlestick pattern that consists of a longer upper wick with no or little lower wick.

Shooting star candlestick pattern
Shooting star candlestick pattern

How to use Candlestick charts?

As there are various types of candlestick patterns, each pattern should be used differently. Some of them are bullish, some are bearish, and some contain both bearish and bullish characteristics.

For example, the engulfing pattern can develop in an uptrend and downtrend. These patterns represent a trend reversal. The bullish engulfing appears in a downtrend, and the bearish engulfing emerges in an uptrend. A trader may choose to enter the trade after the formation of the engulfing patterns.

This is just a simple example of how to trade the Candlestick patterns. However, when there is a single candlestick pattern, traders should be careful, as it can produce false signals like in the case of a shooting star. The pattern surfaces in an uptrend and shows a sign of reversal. The candlestick can be bullish or bearish, but the problem occurs when even though the shooting star forms, the price continues to go downwards. In a situation like these, a trader could combine the Candlestick patterns with momentum oscillators or technical indicators to confirm the trend’s direction and of course, use sensible money management according to their own trading style.

Candlestick charts trading strategy

On the Candlestick chart, patterns can detect a trend for shorter and longer timeframes. It’s up to traders to decide the timeframe when trading the Candlestick patterns.

Candlestick charts buy strategy

  • Locate a reversal or a continuation pattern in an uptrend or downtrend.
  • Wait for the price bar to go bullish before entering.
  • Enter the trade right after the formation of the pattern.
  • Set a stop-loss near the recent low from the entry point.
  • Exit the trade on high.

Candlestick charts sell strategy

  • Locate a reversal or a continuation pattern in an uptrend or downtrend.
  • Wait for the price bar to go bearish before entering.
  • Enter the trade right after the formation of the pattern.
  • Set a stop-loss near the recent high from the entry point.
  • Exit the trade on low.

Candlestick charts conclusion

Candlestick charts show market volatility and trends and can be an important tool for investors and traders wanting a thorough analysis before investment. Technical analysis using candlesticks play a key part in any trader’s plan, determining times to enter and exit trades.

Since their discovery, Candlestick charts have helped traders analyse the forex market sentiment. Traders can use Candlestick patterns along with other technical indicators to try and improve their forex trading strategies.

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