What Are Candlestick Patterns & How To Trade With Them

Candlestick Patterns

Candlestick patterns are one of the most commonly used trading patterns. A Japanese man Homa, in the 1770s, discovered the candlestick patterns while studying the supply and demand of rice prices.

What are Candlestick patterns?

The candlestick patterns represent price moves by measuring the market sentiment. The pattern has multiple candles of different colors and sizes, with each candle or multiple candles signifying a certain pattern. Traditionally, a bullish candle is blue or white, and the bearish candle is red or black, depending on the chart setup.

Like bars, a single candle has a real body, containing a price high, low, open, and close. When the body is filled, close prices are lower than open, and the candle turns bullish. Contrarily, when the candle is empty, the candle turns bearish and indicates the previous prices were higher than the current prices. The structure of the candle also has a wick/shadow above or below it. These wicks/shadows represent the opening and closing prices.

A chart displaying candlesticks
A chart displaying candlesticks

 

There are plenty of candlestick patterns with different characteristics; some are continuation patterns and some are reversal patterns. Some of the popular Candlestick patterns include:

a. Engulfing pattern

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

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

b. Doji

The doji is a type of pattern that defines the opening and closing prices in the form of a cross. These crosses can come in different variations like the gravestone doji, long-legged doji, and the dragonfly doji.

Types of Dojis
Types of Dojis

c. Hammer

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

Hammer candlestick patterns
Hammer candlestick patterns

d. Shooting star

The shooting star is a single candlestick pattern just like the doji compromises of a longer upper wick with no or little lower wick.

Shooting star candlestick patterns
Shooting star candlestick patterns

How to use Candlestick patterns?

As there are plenty of candlestick patterns, traders should trade each pattern differently.

Some of the candlestick patterns are positive meaning, they are bullish, while some of them are bearish, and some contains both characteristics.

For example, the engulfing pattern can develop in an uptrend or downtrend, and tell traders about a reversal. The bullish engulfing emerges in a downtrend, while the bearish engulfing pattern emerges in an uptrend. A trader may choose to enter the trade after the formation of the engulfing patterns. However, when there is a single candlestick pattern, traders may want to be more careful, as they are prone to false signals like in the case of a doji pattern. The pattern surfaces in an uptrend or downtrend tell traders about market uncertainty.

Candlestick charts trading strategy

The candlestick patterns can surface in shorter and longer timeframes; therefore, every type of trader can benefit from them.

Candlestick charts buy strategy

  • Look for 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 patterns conclusion

Candlestick patterns are considered one of the most accurate predictors of the markets. Traders often combine these patterns with other forms of technical analysis to find accurate buy and sell signals. Candlestick patterns can be used on your forex trading platform charts to help filter potential trading signals as part of an overall trading strategy.

I would prefer to use the majority of candlestick patterns on the 1-hour charts and above. I tend to find that these charts contain less market noise than the lower time frames and thus give more reliable signals for my forex trading strategies. This also means that I spend less time staring at charts and can also set alert notifications to let me know when price has reached certain levels, candlestick pattern has been formed or a particular indicator value has been reached.

Candlestick patterns are just one method of market analysis amongst thousands. I would not build a trading system alone, but rather combine with other technical indicators such as moving averages, Parabolic SAR, Stochastic Oscillator, RSI, ADX and price action analysis.

Of course, every trading system will generate false signals which is why money management is so important. I would personally be implementing sensible money management and only take traders that give me a favorable risk to reward ratio, ideally of at least 1:3. This means that one losing trade does not wipe out consecutive winners.

The methods of implementing candlestick patterns into a trading strategy that are outlined within this article are just ideas. I would always ensure that I have good money management, trading discipline and a trading plan when using any forex strategy.

Furthermore, I would combine multiple technical analysis, fundamental analysis, price action analysis and sentiment analysis to filter all entries. You should trade forex in a way that suits your own individual style, needs and goals.

If you would like to practice trading with candlestick patterns, you can open an account with a forex broker and download a trading platform. If you are looking for a forex broker, you may wish to view my best forex brokers for some inspiration.

Happy trading!