There are different ways to show price data in financial markets. As such we have various charting types and tools that help us in this way. For instance, there are the widely applied line charts or bar charts. There is another charting option known as candlestick charts. It is from these charts that we get candlestick patterns. Patterns that hold the utmost valuable information for technical analysis and provide us with insight to make decisions about our next move in the market.
In this article, we are going to take an in-depth look at the concept of candlestick charts and patterns and then go through the top 10 most important candle patterns.
What Are Candlestick Patterns?
As we mentioned briefly in the intro, candlestick is simply a method of charting used for the representations and visualization of market data. The history of candlestick charting finds its roots, interestingly like some other financial concept, to the Japanese tradition of trading.
As it is apparent from the name, candlestick charting is when we use candlesticks to represent market data, most importantly price movements in a given period of time.
The aggregation of these candlesticks together will form the overall candlestick chart. Each candle can include the following information:
- Open: The price at which the asset started trading during the period.
- Close: The price at which the asset ended trading during the period.
- High: The highest price reached during the period.
- Low: The lowest price reached during the period.
The way all of this information is presented can be seen in the candle. The body of the candle will represent whether the trajectory of price change was positive (green body) or negative (red body). It will also represent the extent of the price change – which is reflected in the length of the body of the candle.
The candle will also have wicks, otherwise known as shadow. The wicks can extend above and also below the body of the candle. These wicks will represent the range of the price change in either an uptrend or a downtrend. So, when there is an upper wick, it means the price is being pushed toward an uptrend. And when there is a lower wick, it means the price is being driven toward down. The length of the wick is also very important and telling in the final interpretation of the candle.
The 10 Most Important Candlestick Patterns
1. Doji
Doji is one of the most well-known candlestick patterns among traders. This pattern signifies indecision and uncertainty in the market. The formation of this pattern involves little variation in opening and closing prices of the candle, thus leading to a very small body. But there are long wicks on either side of it due to the high volatility of prices. Of course, the small body means the price is not really being pulled to either side, thus referring to uncertainty in the market.
Aside from the pattern itself, which can be interpreted as is, it is also important where the pattern takes form:
- Bullish Doji: If it appears at the bottom of a downtrend, it could signal a potential reversal.
- Bearish Doji: If it appears at the top of an uptrend, it could indicate a trend reversal to the downside.
Read more about Doji candlestick here
2. Hammer and Hanging Man
A concept that we will see from here on out is that basically the same pattern can have two different names given its context of appearance. This is the case with the hammer and hanging man.
The formation of both of these patterns is the same. We have a very small body, indicating close opening and closing prices. And the signifying long lower wick. Both the hammer and hanging man have a long lower wick but their difference is in the color of their body and also where the appear:
- Hammer: it has a green body, signifying the closing price was higher than the opening price, though it is still a very small body. It is a bullish reversal pattern that occurs after a downtrend.
- Hanging Man: it has a red body, indicating that the closing price was lower than the opening price. This pattern is a bearish reversal pattern that occurs after an uptrend.
Read more about Hammer candlestick
3. Engulfing Pattern
The interesting thing about candlestick patterns is that you can fully understand what they are from their name. The engulfing pattern is just that – i.e. one candle engulfs another. This means there are two candles in the formation of this pattern where one is much bigger than the other. We have two types of engulfing pattern:
- Bullish Engulfing: This pattern occurs when a small bearish or red candle is followed by a large bullish or green candle that engulfs the previous one. It indicates that buyers are starting to take control and could signal the start of an uptrend.
- Bearish Engulfing: This pattern forms when a small bullish or green candle is followed by a large bearish or red candle. It suggests that sellers are gaining control and that a downtrend could be imminent.
Read more about Engulfing candlestick
4. Morning Star and Evening Star
Here we have another group of two indicators that are similar but indicate opposing information. Both the morning start and the evening start are candle patterns with three candlesticks in their formation. These patterns are used to signal a potential change in the trajectory of market trends.
- Morning Star: A bullish reversal pattern that occurs after a downtrend. The formation of this pattern includes three candles: a long bearish candle, a candle with a small body (either bullish or bearish), and a large bullish candle. The Morning Star indicates that the market is likely to reverse upwards.
- Evening Star: A bearish reversal pattern that occurs after an uptrend. This pattern also has three candlesticks in its formation: a long bullish candle, a candle with a small body in the middle, and a long bearish candle. The Evening Star suggests that the uptrend is near its end and a reversal to the downside may occur.
Read more about Morning Star candlestick
5. Shooting Star
There are single candlestick patterns that provide valuable and important insight. The shooting star is one of those. The single candle in its formation has a very small body which indicates the opening and closing prices do not differ much. Its signature feature is the long upper wick. The long upper wick clearly means that buyers were pushing the price upwards, but there was resistance in the market so the closing price for the day went down near the opening price. We can conclude from these signals that the shooting star is a reversal sign downward.
Read more about Shooting Star candlestick
6. Dark Cloud Cover
Here we have another pattern with two candlesticks. The first candle is a long bullish or green candle. The second candle is bearish or red and it starts higher than the previous candle, but closes around its midpoint. Both candles have a substantial body so the wicks do not matter much.
The dark cloud cover pattern occurs during an uptrend. It is a signal that the uptrend is near its end and a bearish reversal is close. This can be seen in the second candle which is a rather sizable bearish candle after a long bullish one.
7. Piercing Line
This is the opposite of the dark cloud cover pattern. This means the piercing line also has two candles in its formation, but in exactly opposite form. So, it forms when there is a downtrend in the market. The first candle is a long bearish or red candle which is in line with the already existing trend in the market. The second candle is a bullish or green which starts lower than the close of the previous candle but closes around its midpoint. The formation of the second green candle is a reversal sign toward an uptrend.
8. Three Black Crows
This is one of the most powerful bearish patterns among candlestick patterns. As the name suggests, the three black crows have three candles in their formation. All three candles are heavily bearish, usually with long bodies. The way they stand next to each other is that the starting price of each candle is within the body of the previous candle but closes lower than its closing price. This means, we will have three red candles in a descending order. Naturally, this forms a powerful bearish pattern.
9. Three White Soldiers
The three white soldiers’ pattern is the opposite of the three black crows. In the formation of the three white soldiers, we have three ascending greed or bullish candlesticks. The way they are formed is that each candle’s opening price is within the body of the previous candle, but it closes higher than its closing price. This way we will have three bullish candles in an ascending order indicating a strong bullish signal.
10. Rising and Falling Three Methods
Some patterns in technical analysis and candlestick charting are known as continuation patterns. This means they do not signal a change or a reversal in the trend, but rather a signal that the trend will continue as it is. These two patterns are continuation patterns which are as follows:
- Rising Three Methods: This bullish continuation pattern consists of a long bullish candle, followed by three small bearish candles, and then another long bullish candle. It suggests that despite some short-term selling, the uptrend will continue.
- Falling Three Methods: This bearish continuation pattern consists of a long bearish candle, followed by three small bullish candles, and then another long bearish candle. It suggests that despite some short-term buying, the downtrend will continue.
Final Remarks
In this article we delved deep into the notion of candlestick charting through the discussion of the 10 most important candlestick patterns. Candlestick charts are among the most popular and also the most powerful charting tools for any financial market. The patterns that are seen in this chart type, i.e. candlestick patterns, hold invaluable information about trader sentiment and potential upcoming price movements in the market. If used properly, they can be extremely reliable for basing your decisions on them as to what move to make in the market.
As a general rule of thumb, please keep in mind that proper use of candlestick patterns for maximum reliability is in conjunction with other technical indicators. This is a method that is recommended for any and all types of analysis tools. When used in conjunction, they can provide confirmation for each other, thus making the insight more reliable and dependable for the decision-making process. So, make sure to apply this rule when using candlestick patterns.
