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Andreas Zanin
Learn to Trade CFDs, Learn to Trade Forex, Learn to Trade Shares | June 20, 2023

Candlestick Patterns Introduction

Candlestick Patterns date back to ancient Japanese markets but endure as one of the best methods to identify short-term price movements. Once you can identify the major patterns, they can be used to trigger trade entry points and exit points.

Candlestick Bodies and Wicks

Candles are made up of two components: 

The body is made up of the open (the first price traded in the given time period) and the close (the last price traded in that same time period). The body represents the difference between the open and closed prices. It is typically white or green if it closes higher than it opened, or black or red if it closes lower than it opened. The wick is a line extending from either end of the candle body, showing the high or low price reached during the same period.

 

Source: MyTradingSkills

What do the bodies and wicks tell us?

A large body indicates strong buying or selling pressure. 

A small body indicates indecision or a lack of control for either buyers or sellers. 

A long wick tells us that there was a lot of volatility during the time period, meaning buyers and sellers were fighting for control of prices. 

A short wick suggests that one side won out or that there was little activity.

Candlestick Vs. Bar Charts

Bar charts are considered a more basic version of candlesticks. In fact, they show exactly the same information, i.e. the OHLC (open, high, low and close). 

Candlesticks gained popularity simply because they are visually much easier to identify specific recurring patterns that can be used as trading signals.While bar charts are also useful for analyzing price action, candles make it easier to interpret by providing more color-coded information, instead of having to look at three separate lines on a traditional bar chart.

How to interpret Candles

When looking at a candle chart, traders should focus on the open/close relationship in order to identify trends. If the close is higher than the open, it’s typically seen as bullish; if the close is lower than the open, it’s typically interpreted as bearish.

Interpreting candlesticks can be achieved by looking at different patterns formed by the candles. Each pattern reveals something about where prices are headed, whether they’re going up or down, etc. 

To accurately interpret a candlestick pattern, you need to pay attention to not only the open and close prices but also the size of each body, distance between bodies and the length of the wicks

Top 5 Candlestick patterns 

The five most common candlestick patterns are the Doji, Hammer, Shooting Star, Tweezer Tops and Tweezer Bottoms, and Engulfing Patterns. Let’s take a closer look at each one:

1) Doji

 

Source: Learnstockmarket.com

A Doji is a candle with an open and close price that are near equal. This indicates indecision in the market and can be interpreted as either bearish or bullish depending on previous price action and what follows after it. A doji candle has an open and close price that are near equal. It is typically represented as a small body in the middle of two long wicks, indicating volatility in the market

How to trade the Doji

The doji is often considered a reversal pattern, which means that it could be signaling a potential trend change. Traders should pay close attention to the price action following a doji candle in order to determine if a trend reversal is likely or not. It’s also important to note that the Doji alone isn’t enough information – it is best to look at multiple candles as well as indicators such as volume and momentum before making any trading decisions.

2 Hammer

Source – Bybit.Learn

The Hammer candle is a single-candle bullish reversal pattern. It’s typically seen after significant selling activity and signals that buyers are taking control of the market and pushing prices back up. The body should be small, preferably located near the lower end of the candle’s range, with a long wick extending from it.

How to trade the hammer

Since the Hammer is a single-candle pattern, it’s important to look at other candles and indicators before making any trading moves. Additionally, the longer the wick is, the more reliable the signal. If you see a hammer with a long wick extending from it, then it could be an indication that prices are starting to reverse and go back up.

3 Shooting Star

Source – LearnPriceAction.com

The Shooting Star candle is another single-candle bearish reversal pattern. It’s often seen after significant buying activity and signals that sellers are taking control of the market and pushing prices down. The body should be small, preferably located near the upper end of the candle’s range, with a long wick extending from it.

Price action following a Shooting Star candle can provide insight into the psychology of the market. Since it’s often seen after significant buying activity, this could mean that buyers are losing confidence in the stock or currency and selling off their positions. Alternatively, if prices start to rise after a Shooting Star pattern, then this could indicate that buyers are regaining control of the stock and pushing prices back up.

4 Tweezer Tops/Bottoms

Source: AnotherTechs.com

The Tweezer Top

The tweezer top is a two-candle pattern that signals a potential bearish trend reversal. It’s typically seen after significant buying activity and indicates that sellers are taking control of the market and pushing prices back down. The two candlesticks should have similar highs and lows with identical candle bodies.

The Tweezer Bottom

This is a bullish reversal pattern that signals a potential trend reversal. It’s typically seen after significant selling activity and indicates that buyers are taking control of the market and pushing prices back up. The two candlesticks should have similar highs and lows with identical candle bodies.

The tweezer top and bottom patterns are often seen after a period of intense buying or selling activity, signaling that prices have reached an equilibrium level. The psychology behind these patterns is that buyers and sellers have both reached an agreement on a particular price point and are no longer prepared to trade at higher or lower levels.

5 Engulfing Patterns

Engulfing patterns are two-candle reversal patterns that indicate a possible trend change. They can be either bullish or bearish depending on the direction of the pattern.

Source: WallStreetMojo.com

Bullish Engulfing Pattern

The Bullish Engulfing Pattern is typically seen after significant selling activity and signals that buyers are taking control of the market and pushing prices up. The first candle should is usually bearish with a small body and prices closing near its low. The second candle should be a larger sized candle and close above the high and low of the previous candle’s range – hence the name engulfing. This indicates that buyers were able to push prices through resistance levels and could signal a potential trend reversal.

Bearish Engulfing Pattern

This is a bearish reversal pattern that signals an impending trend change from bull to bear. The first candle is usually bullish and should have a small body, with prices closing near its high. The second candle is usually bearish and should then close below the high and low of the previous candle’s range – hence the name engulfing. This indicates that sellers were able to push prices through support levels and could signal a potential trend reversal.

Conclusion

Candlestick Patterns are one of the most useful tools for traders who want to analyze market movements and identify opportunities more quickly. The patterns provide visual insight into price movements, making them easier to interpret compared to traditional bar charts. 

FAQs

Which candlestick pattern is best?

The best candlestick pattern depends on the specific situation and market conditions. However, some of the more commonly used patterns include the hammer, inverted hammer, shooting star, and doji. Each of these patterns has its own strengths and weaknesses, so it’s important to carefully consider the market conditions before choosing a particular pattern.

Do candlestick patterns work?

Candlestick patterns are one of the most popular techniques used by traders to analyze price data and predict future market movements. While there is no guarantee that these patterns will always work, they can be a helpful tool in identifying potential trading opportunities. There are a variety of different candlestick patterns that can be used, and it is important to understand how each one works before using them in your trading strategy.

How can I learn candlesticks?

Practice makes perfect. A Key To Markets demo trading account enables you to practice trading strategies before you take them live. You can also find books on candlesticks, which can provide you with a more in-depth look at this topic. This will help you to get a feel for how they work and how to use them effectively.

 

 

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