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Candlestick patterns are a vital part of the technical analysis process, and they give traders and investors a visual representation of price action within a given timeframe. For anyone trying to understand what is happening in the market and make educated decisions based on technical analysis, it is important to first learn candlesticks. The goal of this guide is to clearly explain what candlesticks are and what they look like, and explain how to identify and read candlestick patterns, which are foundational knowledge for beginners.
What Is A Candlestick Pattern?
Essentially, a candlestick pattern is a visual representation of price action during a specified time period. Candlesticks originated in Japan over 500 years ago when the Japanese used these charts to trade rice and track prices in agriculture. Since then, candlesticks have evolved and are used today on a global scale as a standard for visualizing financial market data. Each "candlestick" contains 4 key pieces of data within one bar, and they are the open price, the high price, the low price, and the close price during a given timeframe. While you could simply view prices using a line chart to only look at closing prices, candlestick charts allow for a much greater understanding of what has happened during that time period by showing the behavior of buyers and sellers, and how the market feels towards price action.
Candlestick charts, compared to other forms of analysis, provide a more visual way to depict price action and can give traders and investors a clearer picture of past price action and help to see where potential changes in momentum may occur in the future. For this reason, they are a very valuable tool as part of the technical analysis process and can give traders and investors information valuable to their decision-making, alongside other processes of analysis such as fundamental analysis when investing and trading stocks, for instance.
Understanding the Candlestick Pattern Basics
One of the first things to understand when reading candlestick charts and candlestick patterns is the anatomy of a single candlestick. A candle is a component piece of information that, when put together with other candlesticks, creates a price story:
The Body
The broader part of the candlestick represents the open and closed price range.
Green (or White) Body: A green body signals that the closing price is higher than the opening price, which indicates buying pressure and is bullish.
Red (or Black) Body: A red body indicates that the closing price is lower than the opening price, which indicates selling pressure and is bearish.
The magnitude of the body indicates the strength of buying or selling pressure: if the body length is rather large, this indicates significant momentum during that period. Conversely, if the body length is small, this indicates less significant price movement and possible indecision.
The Wicks (or Shadows)
These are the thin lines that extend vertically above and below the body.
Upper Wick: The top of the upper wick is the highest price reached during the period.
Lower Wick: The bottom of the lower wick is the lowest price reached during the period.
The wicks reveal some information about volatility and price rejection as well. Long wicks tell you there were periods when prices moved quite a ways from the open/close, but were pulled back; in other words, these tell you approximately where there might be resistance or support.
Now that you understand the anatomy of a candlestick chart, in some ways, you are ready to interpret more complicated candlestick patterns (such as single candlestick, multi-candlestick, three-line, and even common combinations of these examples above).
How to Read Candlestick Charts?
When reading candlestick charts, you are not just observing candles, as you are observing patterns and context. Here is a general process to follow:
Analyze Each Candle: The first step is to look at each candle, which means looking at the color and size of the candle's body and the length of its wicks. A long green candle represents significantly strong buying, while a long red candle suggests significant selling. Short bodies with longer wicks (for example, Doji or Spinning Tops) often suggest indecision or a possible turning point.
Identify Trends: Next, look at trends, possibly involving multiple candles or just a couple, depending on your time frame of interest. A series of higher green candles suggest an uptrend, while lower red candles suggest a downtrend. Candles give a detailed reading of the greater trend that is important for each strategy, for example, the difference between Swing Trading and Day Trading strategies.
Support and Resistance: Candles are also good for spotting areas of significance, or points of buying or selling pressure. For example, seeing a series of lower wicks at a certain price may indicate a good support level.
Volume for Confirmation: Lastly, make sure you always check the volume of trading as well, for proper confirmation of patterns before making any trades. Strong volume on a key candlestick pattern only strengthens your chances of success.
Common Candlestick Patterns for Beginners
While there are hundreds of forms of candlestick patterns, a new trader can improve their ability to read the market by focusing on just a handful of common patterns. Many of these candlestick patterns provide possible signaling for the reversal or continuation of a price trend.
Bullish Reversal Candlestick Patterns
Bullish reversal candlestick patterns can indicate a potential reversal from a downtrend to an uptrend.
Hammer: A hammer candlestick has a small body located in the upper region of the trading range; a long lower wick (at least two times the length of the body); and a negligible, if not nonexistent, upper wick. The hammer occurs after a downtrend and is interpreted bullishly because the sellers lower the price, but buyers turn around, trying to push the price back up before the close.
Bullish Engulfing: A bullish engulfing pattern is made up of two candlestick patterns. The first candlestick is a small red (bearish) candlestick. The second candlestick is a large green (bullish) candlestick that completely engulfs the red candlestick. The engulfing pattern means that buyers are confidently reversing sellers' momentum.
Morning Star: A morning star pattern is a three-candlestick pattern that occurs after a downtrend, and starts with a long red candlestick. The next candlestick is a small body where the price gaps lower into a new price range. Also, the last candlestick is a long green candlestick that closes well into the body of the first red candlestick. The morning star candlestick pattern is a bullish continuation pattern indicating the bottom and reversal of the price trend.
Bearish Reversal Candlestick Patterns
When it comes to bearish reversal patterns, it suggests a potential shift from an upward trend to a downtrend.
Hanging Man: Similar from the outside, but forms following an uptrend. The long lower wick indicates that there was selling pressure at some point during the period, yet buyers were able to control enough buying to get the price to close higher. It can be seen as a warning sign of a possible top formation.
Shooting Star: As outlined in our article, Shooting Star Candlestick Pattern, this pattern indicates bullish price action with a body that is near the bottom of the trading range, a long upper wick, and little to no lower wick. It forms after an uptrend: prices opened, moved up, and were rejected by sellers at the move's high; closing near the open price or on the low of the candle.
Bearish Engulfing: The opposite behavior of the previous pattern, this two-candle pattern has a large red candle that completely engulfs the preceding smaller green candle. The two-candle pattern indicates that sellers took strong control and is likely the start of a downtrend.
Evening Star: This three-candle pattern depicts a three-candlestick formation appearing after developing a clearly defined uptrend. It consists of a long green candle, followed by a small-bodied candle that has a gap higher, then a strong red candle that closes well into the body of the first green candle, suggesting a possible top and reversal.
Continuation Patterns
Concise patterns, like the Doji and Spinning Top, may also indicate indecision or a consolidation period before following through on the present trend. Similarly, understanding concepts like Open Interest in Derivatives may also serve to confirm whether the trend is strong or weak. These times of indecision could be tricky, but what we know of each situation will help us narrow our conclusions.
Conclusion
Studying candlestick patterns for beginners is an essential life skill, especially for those considering trading in any financial market. Once you understand each candlestick at face value, and you then learn to identify each pattern, you will have a powerful lens for viewing changes in price action and sentiment.
The principles of analyzing price action through candlesticks are universally applicable across various financial instruments, from equities to different types of commodity markets.
This is only the starting point of your process to understanding market dynamics. If you want to gain more knowledge and develop the skills to understand how to navigate stock markets and the basics and beyond, consider taking a structured program like our stock market training courses.
While these patterns have valuable observations and provide you with helpful clues about the direction of price movement, there is never a foolproof pattern of price action. Always use candlestick analysis with other Top Technical Analysis Tools, and also the larger market context. Continue to explore and learn with Online NIFM to gain knowledge that contributes to your financial literacy.
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