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. Candlestick patterns are used to predict the future direction of price movement in the forex market and can be a great way to find entry and exit points when trading currency pairs.
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.
This jostling between buyers and sellers can result in a large number of differently sized candlesticks, but broadly speaking these can be classified as either wide range candles or narrow range candles. Wide range candles indicate high volatility, and narrow range candles indicate low volatility.
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.
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.
c. Hammer
The hammer pattern contains a small body with a small wick on one end and a larger wick on the other end.
d. Shooting star
The shooting star pattern is a single candlestick pattern just like the doji compromises of a longer upper wick with no or little lower wick.
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.
The Japanese have been using candlestick charts since the 17th century to analyze rice prices. Candlestick patterns were introduced into modern technical analysis by Steve Nison in his book Japanese Candlestick Charting Techniques.
Candlesticks contain the same data as a normal bar chart but highlight the relationship between opening and closing prices. The narrow stick represents the range of prices traded during the period (high to low) while the broad mid-section represents the opening and closing prices for the period.
- If the close is higher than the open – the candlestick mid-section is hollow or shaded blue/green.
- If the open is higher than the close – the candlestick mid-section is filled in or shaded red.
Candlestick charts trading strategy
Candlesticks are an easy way to understand the price action. You can use candlesticks to decide when to buy, or when to take your profits and sell. No analysis is accurate 100% of the time. But many traders are quite adamant about using them.
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 technical trading tools that have been used for centuries to predict price direction. Various candlestick patterns are used to determine price direction and momentum, including Three Line Strike, Two Black Gapping, Three Black Crows, Evening Star, Morning Star, Three White Soldiers and Abandoned Baby.
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.
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