Candlestick charts are a widely used technical analysis tool that display information about asset price movements.
Traders value them as an easily accessible charting tool that can be used to identify major support and resistance levels, interpret price movements, and read market sentiment.
Bullish, bearish, and reversal patterns are an integral part of candlestick charts. Bullish candlestick patterns are chart formations that suggest an asset will increase in price, creating buying opportunities.
Bearish candlestick patterns suggest that a price may fall in the near future, or a trend may reverse downward. They act as a potential warning to traders to close positions or activate risk management protocols. Reversal patterns may be bullish (downtrend → uptrend) or bearish (uptrend → downtrend).
Candlestick signals work best when used as one component of wider technical analysis. This typically includes trend analysis and other tools such as volume, moving averages, and momentum indicators.
Analysing all of these components together helps to give more accurate insights for informed trading decisions.
What Are Candlestick Patterns?
Reading a candlestick pattern is relatively straightforward once you know how. Each candlestick is representative of one trading day and displays the market’s opening, high, low, and closing prices.
The body of the candle represents the open-to-close price range, and the wicks (also referred to as shadows) indicate the intra-day high and low.
Colours reveal the direction of market movement – dark colours such as red or black typically suggest a good day for sellers and a price decrease. A light candle – usually a green or white body – indicates a price increase.
Bullish Candlestick Patterns Traders Commonly Use
Bullish candle patterns suggest possible upward price movement and weakening selling pressure following a market downtrend. It suggests buying opportunities coming onto the market amid a reversal of price direction.
These signals can be considered alongside other tools such as the moving average to help buyers make decisions.
Hammer Candlestick Pattern
A hammer candlestick pattern is defined by a small body near the top of the candle and a longer lower wick, usually twice the length of the body. It indicates that sellers pushed the price down before buyers drove it back up towards the close of the trading day.
Green hammers suggest the strongest bullish signals, and confirmation is usually done by a higher close or a similar bullish pattern the following day.
Bullish Engulfing Patterns
The bullish engulfing pattern is comprised of two candlesticks – a small, bearish candle and a larger bullish candle, the latter of which completely engulfs the body of the former.
It indicates strong buying pressure, appears after a downtrend, and anticipates a potential reversal.
Morning Star Candlestick Pattern
Appearing at the end of a downtrend, the morning star is a three-candlestick pattern. It comprises a strong bearish candle when the sellers are on top, a second smaller-bodied candle as sellers' hold weakens, and a third bullish candle as the buyers overtake and push up prices.
It is a good indicator of an uptrend, especially when accompanied by increased trading volume.
Three White Soldiers Candlestick Pattern
Representing three consecutive days, the three white soldiers pattern is a bullish reversal pattern and a strong suggestion of a new upward trend.
Stock traders should look for three consecutive strong green or white candles with small shadows, where each candle opens and closes higher than the previous day. Candles with long bodies and small wicks are particularly indicative of a strong pattern.
Bearish Candlestick Patterns and Reversal Signals
Bearish candle patterns are usually seen after an uptrend, signalling weakening momentum, resistance points, and possible reversals.
Hanging Man Pattern Candlestick
The hanging man pattern is a widely recognised candlestick reversal pattern and the bearish equivalent of the hammer pattern.
It is recognisable by its long tail to the downside – typically at least twice the length of the body - and a small, dark body at the top of the candle.
It shows that there was significant activity during the day and sellers were able to push the price markedly lower. Confirmation is usually made at next day’s close if the candle closes lower than the previous day.
Shooting Star Candlestick Pattern
Formed in an uptrend, the shooting star is a bearish reversal candlestick pattern that again appears after an uptrend and signals weakening momentum.
Characterised by a small lower body and a long upper shadow at least twice the length of the body, it is named for the fact that buyer prices reached an intra-day high but fell to a price just above the open and just before close, equivalent to a star falling down to the ground.
A lower close on the next day’s candle usually provides confirmation, especially when accompanied by increased trading volume.
Bearish Engulfing Pattern
Just like the bullish engulfing pattern, this pattern comprises two candlesticks - a small, green bullish candle at the top followed by a larger red bearish candle that completely engulfs the previous candle's body.
It is a strong indicator of shifting market sentiment, higher selling pressure leading to a price slowdown, and the end of an uptrend.
Doji Candlestick Pattern and Market Indecision
Both the doji candlestick pattern and the spinning top candlestick pattern are significant for what they can tell us about current market conditions and potential future price movements.
The doji candlestick formation comprises a practically non-existent body and different-length wicks, with the pattern formed when a market’s opening and closing price points are exactly the same, or very close to identical.
Spinning top candles are slightly different, as the pattern is formed when the opening and closing prices are very close but not identical. The pattern typically comprises a short body with long, equal-length upper and lower wicks.
Both of these patterns reflect major indecision in the market and a struggle between buyer and seller pressure that has effectively reached a standstill.
During the trading session, prices may move significantly in both directions, but neither side is able to establish lasting control by the close.
This highlights uncertainty among market participants and often suggests that the prevailing trend is losing momentum and headed for a price change.
When considered as standalone signals, both doji and spinning top are fairly neutral, although the doji can be found in reversal candlestick patterns, which is particularly significant when it forms after a strong uptrend or downtrend.
The spinning top is most significant for highlighting market indecision and acting as an indicator that current trends are losing momentum, although not as strongly as the doji pattern.
In addition, repeated appearances of either pattern may indicate that a market is entering a consolidation phase before a significant breakout occurs.
Due to the lack of solid direction offered by these patterns, both should be traded within a broader context and confirmed through other forms of technical analysis, such as support and resistance levels, trendlines, and subsequent candlestick formations.
Using multiple sources of confirmation can help traders reduce the risk of false signals and improve the accuracy of trading decisions.
Candlestick Patterns for Trading FAQs
How Do You Read a Candlestick Chart Pattern?
Trading candlestick patterns should begin by identifying the overall trend (uptrend, downtrend, or sideways). Understanding candlestick chart patterns subsequently means learning how to read each candle’s open, high, low, and close prices, where the body shows buying or selling strength and the open-to-close range, while the wicks show intra-day highs and lows.
The colours also depict the type of market movement, where a green or white body shows a price increase and red or black shows a price decrease. This information can then be compared to other key indicators such as volume to confirm market sentiment and current buyer-seller dynamics.
Are There Any Limitations to Candlesticks Trading?
Candlestick patterns are valuable tools for understanding buyer and seller behaviour, but they should not be analysed as standalone trading signals.
Instead, candlestick trading should combine findings with other types of technical analysis such as support and resistance levels in order to avoid misinterpretation and to support accurate decisions. Candle patterns are also more limited to short-term price predictions and therefore best suited to swing or day traders.
What Are the Most Common Candlestick Patterns?
Bullish patterns usually form after a market downtrend, with some of the most common patterns including the hammer, inverted hammer, morning star, and three white soldiers. Some of the most common bearish patterns (formed after an uptrend) include the hanging man, shooting star, evening star, and three black crows.
Traders often use these patterns alongside other technical indicators and volume analysis to improve the reliability of their market predictions.
What Type of Risk Should Candlestick Traders Consider?
Traders should always consider how market conditions can influence the reliability of candlestick patterns. Signals that appear during periods of high trading volume and high-volume market participation are often considered more significant than those formed under quieter conditions.
As with all types of trading, decisions should be made in context and after extensive research into key corresponding factors such as geopolitical/economic events and wider market sentiment.
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