Today candlestick patterns have become one of the most powerful tools for predicting the price movement of an asset.
Used by many technical analysts, candlestick patterns can represent multiple timeframes into a single color-coded candle.
What is a Candlestick?
Candlestick pattern is a type of price charting technique used in technical analysis which helps a trader/investor to identify the high, low, open, and closing price of an asset for a specific timeframe.
Candlestick patterns can be used to chart different asset types like stocks, derivatives (futures and options), currencies, cryptos, etc to assume their future price movement.
A brief history of candlestick patterns
Back in the 18th century, candlesticks were used by rice traders of the Ojima Rice market to analyze the price of rice.
It was one of the earliest technical charting tools which were used by Munehisa Homma, a rice trader from Sakata, Japan. It became popular much later around 1850.
Eventually, the United States and other trading communities around the world started using them for stock market trading.
Let us now understand the basics of candlestick patterns.
How to Read Candlestick Patterns?
Candlestick patterns are most popular among technical traders in comparison to line charts or bar charts. The reason is that candlestick charts can deliver more data points to technical analysts compared to other charting techniques.
The green candle represents the strength in the market (Open < Close) and the red candle represents the weakness (Open>Close) in the market.
In general, a candlestick, despite being red or green has below data points:
- Open Price
- Close Price
- High Price
- Low Price
It is the price at which the stock opens in the market when the trading session begins. If the price moves above the open price then the candle will turn green, and if the price moves below the open price, then the color of the candle will turn red.
The upper shadow indicates the highest trading price of that trading session.
For red candle, no higher shadow means open=high. For green candle, no higher shadow means close=high.
The lower shadow is an indicator of the lowest price of that trading session.
For red candle, no lower shadow means close=low. For green candle, no lower shadow means open=low.
Closing price refers to the last price at which a stock trades during a regular trading session.
When the closing price is higher than the open price, the candle turns green, indicating a bullish market. When the opening price is higher than the closing price, the candle turns red, indicating a bearish market.
The direction of the price is evident from the color of the candle. If the market is in favor of the bears,i.e., when the closing price is below the opening price, the candle is red and if it favors the bulls, i.e., the closing price is above the opening price, then the candle turns green.
Range is the difference between the highest and the lowest price in the duration in which the candle was formed. To calculate the range, subtract the lowest price of the candlestick from the highest (High price-Low price).
Here are a few assumptions most specific to candlestick charts that are to be consciously considered while reading the candlestick pattern.
- While the definite definition of the candlestick pattern may state certain criteria, it is possible for the readings to show slight variations from the textbook definition depending on the market conditions.
- Always look for a prior trend. A bullish reversal pattern will have a prior trend that is a bearish pattern and a bearish reversal pattern will have a prior trend that is a bullish pattern.
List of 28 Important Candlestick Patterns
There are a great many candlestick patterns used by technical analysts. But the general categorization of candlesticks consists of three major patterns.
3 Catagories of Candlestick Patterns:
Bullish reversal patterns
Bullish reversal candlestick pattern indicates that the ongoing downtrend is about to end and that it may soon reverse into an uptrend.
The bullish candlestick pattern can be either a single candlestick pattern or multiple candlestick patterns.
A bullish reversal pattern must form at the end of a downtrend, failing upon which it will act similar to a continuation pattern. It is important to confirm the reversal signal emitted by the bullish reversal pattern with indicators such as high trading volume.
Bearish reversal patterns
A bearish candlestick chart pattern occurs when there is an ongoing uptrend that may end soon and reverse to the bearish trend or downtrend. The bearish reversal candlestick can also appear as single or multiple candles.
It is important to keep in mind that if the bearish reversal patterns don’t appear at the end of the downtrend then it will act just like a continuation pattern.
Continuation patterns suggest the movement of price in the same direction as it did before. The continuation pattern also has several variations that technical analysts use to determine that the price may continue to trend.
Although, it is equally important to understand that not all patterns result in the continuation of the trend. The pattern is most reliable when the trend moving into a pattern is strong and this pattern is relatively small in comparison to the trending waves.
We will have a detailed look at these variations of the continuation candlestick patterns in the later section of the blog.
Bullish Reversal Candlestick Patterns:
Let us now have a look at different bullish reversal signal and their indications and usage in the technical analysis.
Hammer Candlestick Pattern
If a hammer candlestick pattern occurs after the prices have seen a significant decline, then it is a strong indication of a potential bullish trend reversal. For additional confirmation of a bullish trend reversal wait for the price to cross the high of the Hammer.
The real body of this type of candle is small in size and is ideally located at the top and has a lower shadow that is more than twice the size of the real body. This type of bullish pattern candlestick has little or no upper shadow at all.
When the hammer has formed, a trader can either open a trade and wait for the potential reversal or wait for the future candle to close above the hammer, which is bullish, then enter a trade to capitalize on the reversal.
Piercing Candlestick Pattern
The piercing candlestick pattern is a multiple candlestick chart pattern, formed with two candles. If it occurs after a meaningful price decline, it acts as a potential sign of a bullish reversal.
For additional confirmation, wait for the price to cross above the high of the piercing pattern.
The first candle in the piercing pattern is a bearish candle and indicates the continued downtrend. The second candle, however, is a bullish candle, that opens a gap down. It closes above 50%of the real body of the previous candle signaling the arrival of the bullish reversal in the market.
Bullish Engulfing Candlestick Pattern
Bullish engulfing pattern is another multiple candlestick pattern. If this pattern occurs after a meaningful price decline, it indicates a potential bullish reversal.
For additional confirmation, wait for the price to close above the high of the bullish engulfing pattern.
This pattern is formed by two candles where the second candle engulfs the first candle, the first candle being the bearish candle, indicating the continuation of the downtrend. The second candle, being a bullish candle engulfs the first candle and indicates that the bulls are taking over the market.
Morning Star Candlestick Pattern
Morning star candlestick pattern is yet another multiple candlestick pattern. If it is formed after the price has declined significantly, it indicates a bullish reversal. Additional confirmation will be the price closing above the high of the Bullish green candle.
This pattern has three candlesticks. The first is a bearish candle, the second one can be a Doji/Spinning bottom, and the third candlestick is the bullish candlestick.
Like in the above patterns, the first candle is to indicates the continuation of the downtrend and the third candlestick indicates that the bulls are back in the market. In between these two, the second candle is to depict the indecision in the market.
The Doji/Spinning bottom should be completely out of the real bodies of the first and third candles.
On the formation of the last candle, the traders should wait for the price to close above the high of the pattern as an additional confirmation of a bullish reversal trend.
Three White Soldiers Candlestick Pattern
Three white soldiers candlestick pattern is a multiple candle pattern. If it is formed after a downtrend,it indicates that the bulls are back in the market.
For additional confirmation of a bullish trend reversal wait for the price to close the high of the bullish pattern.
These patterns are made up of three long bullish bodies without any wicks and are open within the real body of the previous candle.
Here, traders who are short on security look for an exit, and others look for an entry opportunity into the market.
Bullish Marubozu Candlestick Pattern
Bullish marubozu candlestick pattern is a single stick pattern. It indicates the stock traded strongly in one direction throughout the session and closed at its high price of the day.
These candlesticks have a long bullish body without any wicks and indicate the buying pressure exerted by the bulls.
When bullish marubozu is in action, it is advised that the sellers practice caution the moment the price crosses above the high of the marubozu body.
Three Inside Up Candlestick Pattern
Three inside up candlestick pattern is multiple candlestick patterns. If this pattern occurs after the prices have been declining, then it is a strong indication of a potential bullish trend reversal. This pattern consists of three candles.
The first is a long bearish candle, the second is a small bullish candle in range of the first candle and the third is a long bullish candle. The third candle confirms the bullish reversals in the market. For additional confirmation of a bullish trend reversal wait for the price to cross the high of the third candle.
Bullish Harami Candlestick Pattern
Bullish harami candlestick pattern is another multiple candle pattern. If it forms after a meaningful price decline, it acts as a potential sign of a bullish reversal.
For additional confirmation, wait for the price to cross above the high of the Bullish Harami.
This pattern is made up of two candles, first being a tall bearish and the second a short bullish candle, in range of the first candlestick. The first one is to show the continuation of the bearish trend in the market and the second one is to show the bulls taking over the market.
Tweezer Bottom Candlestick Pattern
Tweezer bottom candlestick pattern is another multiple candle pattern. If it forms after a meaningful price decline, it acts as a potential sign of a bullish reversal.
For additional confirmation, wait for the price to cross above the high of the Tweezer Bottom.
Of the two candlesticks that form this pattern, the first one is bearish and the second one is bullish. Both candlesticks in this pattern are found to be the same low and when this pattern forms, the prior trend should have a significant downtrend.
Inverted Hammer Candlestick Pattern
Inverted hammer candlestick pattern if it formed after a significant downtrend it is usually taken as a bullish reversal but if this candlestick pattern is formed after a significant uptrend then it is also called a shooting star. signals a bearish reversal. Usually, traders wait for the prices to close above the high or low of the pattern to decide the trend.
This candlestick pattern is exactly opposite to the hammer where this is having a long upper wick that is at least twice the size of a small body. This candlestick pattern will have a small or no lower wick. This pattern indicates that the buyers took the prices up but encountered severe selling pressure from sellers and eventually the prices came down and closed close to the open price of the day.
Three Outside Up Candlestick Pattern
Three outside up candlestick pattern is another multiple candle pattern to announce the bullish reversals.
It has three candles, the first one is a short bearish candle and the second and third are large bullish candles. The first and second candles must follow the pattern of bullish engulfing, thus confirming the market is being dominated by the bulls.
This increases the bull confidence and sets off buying signals.
On-Neck Candlestick Pattern
In on-neck candlestick pattern, there is a long red candle followed by a smaller real body bullish candle that gaps down on the open but then closes near the prior candle’s close. The pattern gets its name from the closing prices across the two candles which are almost the same and ends up forming a neckline for both the candles.
This strong price strategy raises the confidence of bullish investors while pushing the bears to analyze positions and be wary of an impending reversal.
Bearish Reversal Candlestick Patterns:
Following are the different Bearish patterns in detail.
Hanging Man Candlestick Pattern
Hanging man candlestick pattern is a single stick pattern if it gets formed after a good uptrend it indicates bearish reversals.
This is a small-bodied candlestick located at the top and has a lower shadow that is twice as big as the candle. This pattern has little or no upper shadow.
As an additional confirmation of Bearish reversal, it is better to wait for the price to close below the low of this candlestick pattern
Dark Cloud Cover Candlestick Pattern
Dark cloud cover candlestick pattern is multiple candlestick pattern if it gets formed after a significant uptrend then it indicates a potential bearish reversal in the market.
The first is a bullish candle which acts as an indicator of the continued uptrend and the second is a bearish candle. This opens as a gap up and closes below 50% of the previous bullish candle and indicates that a bearish reversal is about to take place.
Traders utilize these candlestick patterns for exiting the longs and wait for the prices to close below the low of the pattern for going short.
Bearish Engulfing Candlestick Pattern
Bearish engulfing candlestick pattern is another multi-stick pattern if formed after a significant uptrend it indicates a potential bearish reversal.
The first one is a bullish candle and the second is a bearish candle. The second one engulfs the first candle signifying the rise of bears in the market.
A bearish engulfing pattern is a hint that a market may have formed a top. These patterns should only be traded at swing highs and also wait for the prices to close below this pattern as an additional confirmation.
Evening Star Candlestick Pattern
The bearish evening star candlestick pattern is a multiple stick pattern formed after an uptrend to signify bearish reversals.
The first candle, a bullish one, indicates the continuation of the uptrend and the third candle indicates an impending bearish reversal. The middle one can be a doji/spinning top and it represents indecision in the market.
The evening star pattern is considered a very strong indicator of future price declines. So a trader may decide on whether to hold on to his securities or sell them off depending on that.
Three Black Crows Candlestick Pattern
Three black crows candlestick pattern is a multiple candlestick pattern formed by three long bearish candles at the end of an uptrend.
These candles do not have long shadows and are opened within the real bodies of the previous candles. These as well are indicators of the bearish reversals in the market.
This increases the bear’s confidence and sets off selling signals
Bearish Marubozu Candlestick Pattern
Bearish marubozu candlestick pattern is a single candlestick pattern with a bearish body and no shadows.
This indicates the pressure exerted by the sellers and that a bearish reversal is about to happen. This is when the buyers should practice caution and close their buying positions.
Three Inside Down Candlestick Pattern
In three inside down candlestick pattern, there are three candlesticks that come together to create this formation.
In this multiple candles pattern, the first is a bullish candle, the second is a small bearish candle in the range of the first one and the third is a long bearish candle confirming the bearish domination of the market.
For a bearish three inside down, a trader could enter short near the end of the day on the third candle, or wait for the price to close below the low of the third candle.
Bearish Harami Candlestick Pattern
Bearish Harami candlestick pattern is multiple candlestick patterns formed at the end of an uptrend and indicates bearish reversals.
Of the two candles, the first is bullish and the second is bearish which is in range of the first one. First is an indicator of the continuation of the bullish trend and second is to show that the bears are back in the market.
For additional confirmation, wait for the price to close below the low of the pattern
Shooting Star Candlestick Pattern
The shooting star candlestick pattern is an inverse of the hanging man pattern.
In this pattern, a candlestick is located at the end with no long upper shadow. This formation is seen when the opening and closing prices are close to one another and the upper shadow is twice the size of the body.
Tweezer Top Candlestick Pattern
The tweezer top candlestick pattern has two candlesticks, the first one bullish and the second bearish.
Both are at almost the same high. This pattern is formed when the prior trend is an uptrend. This is another multiple candlesticks pattern that is formed at the end of an uptrend and indicates potential bearish reversals.
Three Outside Down Candlestick Pattern
The three outside down candlestick pattern is a multiple candle pattern, with three candlesticks.
The first is a bullish candle the second is a bearish candle that engulfs the first one and the third is also a bearish candle that confirms the bearish reversals.
This price action raises a red flag, telling bears to take profits or tighten stops because a reversal is possible.
Continuation Candlestick Patterns:
Next, we’ll look at different variations of continuation candlestick patterns.
Doji Candlestick Pattern
Doji candlestick pattern indicates indecision in the market when the bulls and bear tug at each other to control the price and neither succeeds.
There are three main types of Doji
- Normal Doji – this is a single candlestick with no major interpretation on its own. To understand this Doji better, traders must read the past data of what led to the Doji.
- Gravestone Doji – Gravestone Doji is a bearish pattern that suggests a potential reversal followed by a downtrend in the price action. This gravestone Doji makes more meaningful if it happens after a significant uptrend.
- Dragonfly Doji – this type of Doji if it appears after a significant fall in price can signal a potential reversal in trend.
Spinning Top Candlestick Pattern
The spinning top candlestick pattern is similar to Doji as this indicates indecision in the market as well.
The only difference is that the real body of the spinning top is larger as compared to a Doji. However, the lower and the upper wick will almost be of the same size. It means that neither buyers nor sellers could gain the upper hand.
Falling Three Methods Candlestick Pattern
Failing three methods candlestick pattern is a bearish pattern with a five candle continuation that signals an interruption and not the reversal of an ongoing trend.
This formation has two long candles in the formation of the trend and three short ones in the counter-trend direction, right in the middle. This indicates the lack of power of bulls to reverse a trend.
Rising Three Methods Candlestick Pattern
Rising three methods candlestick pattern is another five candle continuation pattern indicating an interruption.
As opposed to the previous method, this pattern indicates the lack of strength in bears to cause a reversal. This formation also follows the same pattern as above with two candles in the direction of the trend and the remaining three in the middle in the direction opposing trend.
Mat-Hold Candlestick Pattern
Mat hold candlestick pattern formation indicates the continuation of a prior trend.
This pattern begins with a large candle followed by a gap higher and three smaller candles which move lower. This pattern can be a bullish or bearish mat-hold pattern depending on whether the formation begins with a bullish candle or a bearish candle.
How can Candlestick help you enhance your trading strategy?
As we learned at the beginning of this article, candlestick patterns tell us the four price points – opening, closing, high and low, of a specific trading period as chosen by the trader. Thus, the candlestick pattern is used by the traders to determine the price movements that are possible based on past candlestick patterns.
Many algorithms we see today are based on the price information as depicted by this candlestick pattern. Since trading is more than often driven by emotion, the candlestick charts help in decoding the buying pressure and selling pressure, thus helping a trader to make the right decision while entering and exiting a market.
The candlesticks are a great financial instrument for technical analysis, that helps the traders in devising their trade strategies. From the previous articles, we’ve learned the importance of technical analysis in trading, and to effectively perform technical analysis, candlesticks come into play as a great tool.
Since the candlesticks are created by the up and down movement of the price, these may sometimes seem random. But at other times, they form patterns that traders use for technical analysis and decide their market entry and exit.
Thus, by depicting the opening and closing prices, and market movement, a candlestick analysis help in predicting price direction which is an important aspect of devising trade strategies.
Time Frame Required for Candlestick Pattern
It is interesting that traders use monthly, weekly, four hourly, hourly, fifteen minutes as well as even one-minute time frames for candlestick patterns. There are several traders and even more trading styles.
Most of the candlestick patterns are formed over a period of one to three days and are deemed valid for one to two weeks. The time frame required for each candlestick pattern also changes accordingly.
For example, hammer candlestick patterns and shooting stars need just one day. Engulfing patterns, like bullish engulfing patterns and bearish engulfing patterns, piercing line patterns and dark cloud cover patterns require about two days. The morning star pattern and evening star pattern will need about three days.
Also, a candlestick pattern may signal the start of a pullback or bounce.
Let’s look at the chart time frames a little in detail and what time frame suits which type of investment.
- A swing trader focuses on daily charts for making decisions. So for him, a weekly chart can be used to define the primary trend and a Daily/hourly chart can be used to determine short-term trends.
- A day trader trades off of 15-minute charts. For him, the primary trend can be defined with the help of an hourly chart and the short-term trends can be defined by the 15-minute charts.
- A position trader who trades for a long term can focus on the weekly charts. To define a primary goal, a monthly chart would be the right pick, and to define the entries and exits, he can use the daily charts.
Let us have a detailed look at the charts of different duration.
Monthly candle charts
Monthly candle charts are meant to be used by long-term investors. It is not recommended for traders unless they have a long-term buy. The price data in these charts spread over several months.
Weekly candle charts
Weekly candle charts are used by medium-term investors, for a minimum of six months time periods. A weekly chart will indicate the highs, lows, open and close prices on that particular week, but will not show the day-by-day data.
Daily candle charts
Daily are charts are typically the ally for traders who hold their stocks for about three weeks to two months. These charts also tell the investors about the potential long-term investments.
Intra-day candle charts and 15-minutes candle charts
Intra-day candle charts give the price movements for that day, while the fifteen minutes candle charts tell you about trends that will last for 120 minutes.
Now that we’ve learned about the time frames of a candlestick pattern and different aspects where they are used, let us try and understand the accuracy of trading based on the candlestick pattern reading.
How Reliable is Candlestick Trading?
So, does candlestick trading actually work? Yes, it does!
With the help of market price actions, the candlestick charts can generate a reversal signal as well as a continuation signal. These patterns are more effective when they are used in confluence with other reversal signals and continuation signals such as support and resistance levels.
However, not all candlestick patterns are quite as reliable, but some are. These reliable candlestick patterns can help a trader in forming a successful trading strategy. That being said, the reliability of a candlestick pattern is dependent on certain factors like the market you trade,the time frame, and other relevant conditions related to the trading strategy.
To get the optimum results out of the candlesticks, it is advised to use them in your technical analysis along with other methods that give your information about the market structure, trend directions, overbought or oversold conditions, and support & resistance levels.
To increase the reliability of the candlesticks, it is important to consider a few factors that impact the patterns’ reliability. Given below are those patterns summarized into points.
The time frame
Short time frames are less reliable than long ones. The candlestick pattern as we know by now is based on the trader’s emotions. Hence the short time frames are more volatile as the trader sentiment is prone to frequent changes.
In short, the higher the volumes are dealt with, the more reliable the candles are. Some candles work for forex, while other candles may work better for stocks. What’s important is the traded volume or liquidity.
The chart pattern
The environment in which the candlestick pattern is being analyzed matters a lot. The trade is more likely to work out if there are resistance or support lines nearby.
The pattern size
The larger the patterns get, the more reliable the candlesticks tend to get. Also, when there are significant price movements, they give out stronger continuation and reversal signals.
The candlestick pattern
It is known that different candle patterns have different reliability levels. But one general rule of thumb is that the more candles there are in a piece of information the more reliable it is. But, unfortunately, it does not appear quite so often.
Which candlestick pattern is most reliable?
Bullish or Bearish engulfing patterns are considered reliable. But the reliability of all candlestick patterns depends on various other factors as well like the methods used for technical analysis, nature of the market, and time frame.
How many candlestick patterns are there?
There are more than 40 candlestick patterns of which the most important 28 are enlisted here.
Is candlestick trading profitable?
Candlestick trading is one of the most profitable in the trading industry.
How do you plot a candlestick chart?
A candlestick chart is plotted with the data that has the information regarding the open, close, highs, and lows of the market.