Candlestick charts are the most basic data in technical analysis which any trader should always be able to comprehend. Understanding what a candlestick is and what it implies is a lethal arsenal for any trader. A candlestick is made up of data containing multiple time frames and by merely interpreting a candle formation, a trader can make good assumptions as to what happens next in the market. Making assumptions using a single candlestick can be a challenge, however, when combined with other candlesticks, it reinforces assumptions and decisions therefore decreasing risks. In this article, we’ll share with you an in-depth guide to how to trade using candlestick patterns. But before that, we’ll give detailed info about what a candlestick is, how it came to be, and how to read it.
(NOTE: Before we continue, we have to give a disclaimer that the trading products offered by the companies listed on this website carry a high level of risk and can result in the loss of all your funds. CFDs are complicated instruments that are never guaranteed to provide you supplemental earnings. In fact, Around 67% of all retail investors experienced a loss while trading CFDs. Make sure to keep this in mind before attempting to use the eToro platform yourself. All the information found on this website is not official trading advice and all practices shown are referenced for the use of the Demo account only.)
- 1 What is a Candlestick?
- 2 2 Candlestick Pattern Outcomes
- 3 Parts of a Candlestick
- 4 Top Reversal Candlestick Patterns
- 4.0.1 Hammer and Inverted Hammer Pattern
- 4.0.2 Bullish Engulfing Pattern
- 4.0.3 Piercing Pattern
- 4.0.4 Tweezer Bottom Pattern
- 4.0.5 Morning Star Pattern
- 4.0.6 Three White Soldiers Pattern
- 4.0.7 The Hanging Man Pattern
- 4.0.8 Shooting Star Pattern
- 4.0.9 Bearish Engulfing Pattern
- 4.0.10 Evening Star Pattern
- 4.0.11 Three Black Crows Pattern
- 4.0.12 Tweezer Top Pattern
- 5 Top Continuation Candlestick Patterns
- 6 Our final thoughts
What is a Candlestick?
Although this question may already be very ordinary and almost all traders know what a candlestick is by heart, it is always best practice to refresh our minds and skills regarding anything about trading. By doing so, we are given fresh ideas as well as strategies which we can use to further improve our trading performance.
It was known that using the candlestick for trading has been used in early centuries (as early as the 1700s to early 1800s) wherein it was used by Japanese rice merchants who trade their goods with other regions. After researches made by Steve Nison (a trading author who revealed the candlestick to the Western World), it was found that candlestick charting has already been used as early as the 1850s. And in 1991, a series of books published by Steve Nison about candlestick patterns had drawn the world’s attention to these patterns and charting techniques. Today, more and more candlestick charting techniques and patterns are being developed, and using candlesticks instead of the traditional lines or bars in a chart is much preferred by traders because of its reliability, readability, accuracy, and provides more detailed information toward price movement.
As we discuss candlestick patterns, we’ll be using actual examples from the eToro platform.
2 Candlestick Pattern Outcomes
According to many candlestick pattern users, there are basically two results that are to be expected when using such patterns or techniques – one is the reversal pattern and the other is the continuation pattern.
Basically, a reversal pattern is when a candlestick pattern signals a reversal of the trend in the market. This means, if the trend started with a bullish trend and the candlestick pattern has formed, the next price movement will go against the current trend or will become bearish. Reversal patterns are best-taken advantage of whenever a trader wants to establish entry or exit points in long trends. If prices will go up, it will always come down – knowing the reversal pattern will let know when will prices go the other way.
If a candlestick pattern signals a continuation pattern, it means that the trend will still continue in the future. For a bullish market, it means that the price will continue to rise thus making it a good decision to continue to invest in the stock. When dealing with a bearish market on the other hand, it would be best to sell positions if the candlestick pattern signals a trend continuation to a bearish trend.
Both of these patterns are equally important and helpful in lowering risks involved in trading and it optimizes profits. While these are equally essential for any trader, it is also necessary that a trader understands how to read and interpret these patterns to actually benefit from it.
For us to be fully aware of the candlestick, let us also determine its parts and its uses.
Parts of a Candlestick
Just like the regular candle, the candlestick used for trading is made up of a body and pair of wicks – one wick that extends on top and the other from its bottom. Oftentimes, the wicks may be longer or shorter than the other, and other times, the body is too long enough that the wicks can no longer be visible. Depending on what the parts look like, a trader is able to make assumptions on a particular trade.
Price High (H)
The wick that extends on top of the candle body is called the price high. This shows the highest price which the price movement reached at a particular time. This upper wick is also called by other traders as the upper tail or upper shadow of the candle.
Opening and Closing Price (O and C)
The open and closing price is what makes the actual body of the candle. If the price movement is going up, the opening price is located at the bottom and the closing price is located at the top. If the price movement is directed downward, the opening price is located at the top and the closing price is at the bottom.
Price Low (L)
The price low on the other hand is the counterpart of the price high. It shows the lowest price which the price movement has reached during a particular time. In addition, it is also called the lower tail or the lower shadow of the candle.
To indicate whether a price is going up or going down, platforms use two-color indicators. Back in the days, a bullish trend or upward price movement is indicated by a white candle, and a bearish or downward trend is indicated by black color. After a few years, traders preferred to use green for bullish trends and red for bearish trends. This color combination allowed better access and interpretation to the candlesticks knowing the general rule is easier to remember – and that is, red means “stop” and green means “go”.
Top Reversal Candlestick Patterns
There are basically more than dozens of candlestick patterns being used in the market today. And every year, there are new patterns being introduced to traders. However, for this particular guide, we’ll be sharing with you’re the most common or top candlestick patterns that can help any trader gain an edge in their trading.
Hammer and Inverted Hammer Pattern
The first and probably the most basic candlestick pattern that every trader should know is the hammer. A hammer is actually a single candle pattern that signals a bullish reversal – this means the next price is expected to go up or turn bullish after a bearish trend. As the name suggests, the candle forms like a standing hammer with its head and long handle.
It is made up of a little and sometimes no upper tail or shadow, a body that makes up a quarter of the candle, and a lower tail or shadow that is two or three times longer than the body.
This pattern suggests that the price started with the sellers wanting to push the price lower. However, at the end of the trade, considerable buying pressure made the price go higher. The pressure of the buyers was very strong that the closing price ended up near the opening price.
The Inverted hammer on the other hand is also the same as the result of the hammer pattern. It signals a trend reversal from a bearish trend to a bullish one. This pattern is displayed when the opening and closing price is near the price low or lower tail of the candle. It is also identified easily through its long upper wick compared to the lower wick.
Bullish Engulfing Pattern
Another bullish reversal candlestick pattern is the bullish engulfing pattern. This involves 2 candlesticks which shows a decline in the price. The first candle closes with a bearish price and the second candle overwhelming the body of the first candle and having a bullish price.
The bullish engulfing pattern shows that the price started bearish with sellers taking advantage. However huge buying pressure overwhelmed the performance of the sellers, making it possible to further overwhelm sellers in the future price movement.
Another 2-candle pattern that signals a trend reversal is the piercing pattern. This pattern develops after the price declines or after a strong price drop.
This pattern is displayed by having a long bearish candle for its first candle, and a second bullish candle which has a body that is much smaller than the first. The second candle has a closing price that is above the 50% mark of the first candle.
The piercing pattern is almost the same as the bullish engulfing pattern and it indicates that the sellers are in control of price movement in the first candle. However, on the second candle, buyers tried to take hold of the trend. with this price movement from the two candles, the price is expected to go up or reverse to a bullish market.
Tweezer Bottom Pattern
Another 2-candle pattern that usually shows up after a price drop is the tweezer bottom pattern. This pattern is displayed by a first and second candle that almost look similar in all aspects. The first candle shows an opening that is at the top of the candle, and the second candle shows its close also at the top of the candle which is at the same level as the first candle.
The tweezer bottom pattern indicates that sellers wanted to further drop the price however were halted by buying pressure in the first candle. In the second candle, sellers still wanted to drop the price however they were totally stopped by the strong buying pressure. In other words, many sellers wanted to continue with the downtrend however buyers put a stop to the bearish trend and now the prices have a good chance of going up.
Morning Star Pattern
A popular pattern not only because of its name but because it signals a bullish reversal is the Morning Star Pattern. It is composed of 3 candles and usually shows up after a price drop.
The Morning Star pattern is composed of three candles with the first candle having a bearish close, a small mid-range candle for the second candle, and a bullish third candle that is much bigger than the first candle.
This pattern shows that the sellers are dominating from the first candle, followed up by indecision from both buyers and sellers which shows the small body of the second candle. Lastly, the buyers prevailed which displayed a strong bullish candle on the third day. This signals a trend reversal to a bullish market or in other words, the price is about to go up because of the strong buying pressure.
Three White Soldiers Pattern
Another 3-candlestick pattern that displays a bullish reversal is the Three White Soldiers Pattern. Just like the Morning Star Patter, this pattern requires three consecutive candle formations to confirm the pattern.
The Three White Soldiers pattern occurs during a downtrend and indicates a change of trend towards a bullish trend. This pattern involves 3 consecutive bullish candles with small wicks and each close a bit higher than the closing price of the previous day.
The steady bullish candles for three consecutive days display the strength of the buyers and it is assumed to continue for the next price movements.
The Hanging Man Pattern
Another 1-candlestick pattern that signals a reversal to a bearish trend or downtrend is the Hanging Man Pattern. It has the same features as the Hammer Pattern however in a different color, a small upper wick and it develops at the end of a bullish trend.
The candle is made up of an open and close that is near the price high, and a tail that is longer than half of the whole candle. This candle shows that there had been an overwhelming strength of sellers though buyers were able to push up the price. Since there is a greater number of sellers during this trading range, the odds are also great that the next price will be in favor of the sellers – which also means that the price will drop.
Shooting Star Pattern
Another 1-candlestick pattern that looks like the hammer is the Shooting Start Pattern. Unlike the hammer or the inverted hammer, this pattern signals a reversal towards a bearish market or price drop.
The shooting Star Pattern likewise has the same figure as the hammer however it has a red color – as a symbol for a bearish candle. It forms at the end of an uptrend with its open and close near the price low and its tail making up more than 50% of its body.
A Shooting Star Pattern tells that buyers had a good start in pushing the price up however at the end of the trade, strong selling pressure took advantage to push the price low. If this pattern shows, the dominance of the sellers pushing the price lower is expected to reoccur.
Bearish Engulfing Pattern
The counterpart of the Bullish Engulfing Pattern is the Bearish Engulfing Pattern. This pattern is also a 2-candlestick pattern which signals a trend reversal toward a bearish market.
This pattern develops at the end of a bullish trend and is made up of a bullish first candle followed up by a second bearish candle with a body that covers the first candle. The Bearish Engulfing Pattern suggests that the buyers dominated during the first day, however, were overpowered by sellers on the second day. Since the body of the bearish second candle is much bigger than the bullish first candle, the next candle or price movements are expected to go lower.
Evening Star Pattern
Of course, if we have a Morning Star Pattern, we also have its counterpart – the Evening Start Pattern. This pattern signals a trend reversal toward a bearish market or price drop. This candlestick pattern is made up of three candlesticks and forms at the end of a bullish trend.
This pattern starts with a bullish first candle with a price open and close near the ends of its body followed by a short bullish second candle and a bearish third candle whose body outmatches the first candle.
Whenever this pattern forms, it signifies that the buyers were gaining momentum on the first candle however went weak on the second. At the bearish third candle, the sellers dominated the trade and the considerable body shows their overwhelming strength which projects a bearish next candle.
Three Black Crows Pattern
The counterpart of the Three White Soldiers Pattern is the Three Black Crows. It is a 3-candlestick pattern that signals a trend reversal toward a bearish market.
It is composed of three consecutive bearish candles or red candles having short or even non-existent shadows or wicks. This pattern shows up at the end of a bullish trend and it suggests that the selling pressure is too strong that it pushes the price to go lower for the next candles.
Tweezer Top Pattern
If there’s a Tweezer Bottom Pattern, we also have a Tweezer Top Pattern as its counterpart. This pattern is a 2-candlestick pattern that signals a trend reversal toward a bearish market.
The Tweezer Top Pattern is characterized by a bullish first candle and followed by a bearish candle with overwhelming selling pressure. Just like the Tweezer Bottom Pattern, the opening price of the second candle starts exactly at the closing price of the first candle. This means that buyers attempted to push the price higher after the first candle, but the sellers overpowered them. Now a strong selling power from the second candle is likely to make the next candles bearish or drop the price.
Top Continuation Candlestick Patterns
Doji Candlestick Pattern
The Doji Candlestick Pattern is a 1-candlestick pattern that signals a continuation of a trend. This pattern is characterized by a small body with its opening and closing price very close to each other. It resembles a plus sign or a cross and the wicks may vary.
The small body of this pattern tells that there is indecision between the buyers and the sellers. Both sides don’t have enough power to dominate the candle thus resulting in no gain. Alone, the Doji pattern signals continuation due to the neutral result of buyer-seller struggle however when combined with other candles such as the morning and evening star, it could suggest reversal.
Rising Three Method
The Rising Three Method is a 5-candlestick pattern that signals a continuation of a bullish trend. If this pattern appears, the next candles are expected to go much higher.
It is characterized by three consecutive bearish candles in between two large bearish candles. This pattern forms when the buying pressure is great on the first day, then followed-up by short sells on the second, third, and fourth small bearish candles. The fifth bullish candle shows that the buyers regained momentum and prices are expected to go higher than the previous high.
Falling Three Method
Another 5-candlestick pattern that signals a continuation is the Falling Three Method. This pattern signals a bearish continuation of a trend and is displayed by a bearish first candle with considerable body displaying seller strength. After which, three consecutive bullish candles with small bodies took over the preceding trades – showing profit-taking. Unfortunately, the buying strength of these three candles is not great enough to overpower the first bearish candle thus leading to a bearish fifth candle.
Spinning Top Pattern
A 2-candlestick pattern that is also used by many traders is the Spinning Top Pattern. it is made up of two Doji-like candles with equal dimensions and signals a continuation of the existing trend.
It is characterized by two candles with the open and closing prices very close to each other signifying neutrality between the buyers and sellers. Usually, this pattern signals consolidation or a moment where the price rests and does not do any significant movement for a duration.
Our final thoughts
Now all these patterns can be really intimidating and can be difficult to memorize in one sitting. However, having knowledge of these patterns can really enable a trader to make safe and more accurate decisions when trading. Also, while most of the time these patterns indeed resulted in reversals or continuation, it is always best to have a “confirmation” regarding its assumed results. A good confirmation to use in this regard would be support and resistance levels, trend lines, and even indicators such as MACD, RSI, and Stochastics to confirm reversals.
Having a good grasp of how the pattern looks like isn’t a guarantee that you’ll make sure-fire decisions in trading. A good trader should always do his due diligence to confirm a specific pattern by performing research, reading company disclosures or announcements, checking for history, and many others. In addition, a good trader should also have a good amount of practice in implementing such patterns. Only through diligent research and constant practice through the eToro platform can one increase his or her chances of ensuring profits.
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