July 25

Candlestick Guide: How to Read Candlesticks and Chart Patterns

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Last Updated on 25 July, 2022 by Samuelsson

Candlestick Guide: How to Read Candlesticks and Chart Patterns

As a trader, you can’t do without a price chart. There are many types of price charts, such as the line chart, bar chart, point and figure chart, candlestick chart, range bar, and Renko chart, but since its introduction to the Western world by Steve Nison, the candlestick chart has become one of the most popular and widely preferred methods of charting price action.

Candlestick patterns are identifiable shapes formed by a single candlestick or group of candlesticks. Each candlestick represents a trading session, and it is often colored to indicate how the price closed during that session. While traders can use any color combination, green or white is generally used to represent a session where the price closed higher than its opening price. Red or black color, on the other hand, is used to represent a session that closed lower.

This shouldn’t come as a surprise though. The candlestick chart provides a lot of useful information about what price has done within the specified timeframe. And with its color coding and visible shapes and patterns, you can easily see what’s happening in the market at a glance.

So we’ve developed a guide to teach you about candlesticks and how to use them in your trading. In this guide, you will learn:

  • The history of the candlestick chart
  • How to read a candlestick chart
  • If candlestick patterns work
  • Why the timeframe you’re using matters
  • Reading candlestick charts
  • Why you don’t need to memorize candlesticks one by one.
  • How many candlestick patterns is there
  • How to read candlestick charts
  • The different categories of candlestick patterns and how to use each of them to find trade setups
  • Our archive and articles with every Candlestick pattern.

So let’s get to it! We have a lot of material to cover!

The History of Candlestick Patterns

Candlestick Patterns
Candlestick Patterns

Steve Nison is popularly credited with introducing the candlestick charting method to the West in 1989 when he authored an article on candlestick chart analysis in the Futures Magazine.  Later on, in 1991, he wrote a book about this new charting method he learned from Japan and titled it, “Japanese Candlestick Charting Techniques”.

Since then, he has written a couple more books about candlestick charts. According to him, candlestick charting techniques originated in Japan in the 18th century. He traced the origin to a Japanese rice businessman, Munehisa Homma, who was trading rice in the city of Sakata.

Munehisa was born in 1724 to a family of rice merchants, and when his father died in 1750, he started managing his father’s business. Although he’s the youngest, he was allowed to do so because of his exceptional trading ability. It was during this period, while trading in Sakata, Osaka, and Edo (present-day Tokyo) rice exchanges, that he developed a technique for tracking the price of rice coupons.

Rice coupons — receipts for the supply of rice for the next harvest — were introduced to the exchanges in 1710 to facilitate rice trading. Munehisa noticed that the daily variations in the prices of these rice coupons were not only as a result of fundamental factors like weather, stock volumes, and harvest but also as a result of traders’ sentiments. He then developed a way to track traders’ sentiments by charting price movement.

His method of charting the open, high, low, and close prices for each trading session would later give rise to the candlestick chart. But, according to Steve Nison, the technique wouldn’t become popular until the 1850s when more rice traders started using it.

How to Read Candlestick chart patterns?

Reading candlestick charts provide a lot of information about how the security has moved, and just like the bars in a bar chart, each candlestick represents the price movement for the specified period. How can you read them?

That period can be one minute, four hours, one day, one month, etc.

A candlestick clearly shows the following data points for the selected period:

  • Open
  • Close
  • High
  • Low

Structurally, a candlestick consists of the following parts:

  • The Body
  • An Upper wick (shadow) 
  • A lower wick (shadow)

The body is the part between the open and close price, and it represents the price gain or loss for the specified period.

The wicks give you a visual representation of the levels that the security has traded at, but either risen or fallen from before the end of the time period.

Candlesticks are color-coded to make it easy to spot if the price has risen or fallen. Typically, a positive candlestick is green or white, whereas a negative candlestick is red or black

Here is an image that hopefully makes it easier to understand!

how to read a candlestick chart
how to read a candlestick chart

 

Bullish and Bearish Candlesticks

Bullish Candlestick
Bullish Candlestick

A candlestick is said to be bullish if the close price is higher than the open price. As a trader, you can choose any color you want to represent a bullish candlestick, but white or green is normally used to indicate a bullish direction. The upper wick lies between the period’s high and close price while the lower wick lies between the period’s low and open price.

 

Bearish Candlesticks
Bearish Candlesticks

A candlestick is said to be bearish if the close price is lower than the open price. You can represent a bearish candlestick with any color you want, but black or red is usually the color of choice for a bearish candlestick. The upper wick lies between the period’s high and open prices while the lower wick lies between the session’s low and close prices.

 

The Main Benefits of Candlesticks

Since its introduction less than three decades ago, the candlestick charting method has become a widely used alternative to the bar chart and the point and figure chart. There are many reasons why it has gained such acceptance among traders, and here are some of them:

Price action is Easy to Read

Candlesticks are very easy to interpret and even an amateur can easily figure out how the price has moved. The colored bodies of the candlesticks make them easily visible, so a trader can see the price direction at once.

This simplifies chart analysis since you can easily take in the information from the chart and use your time analyzing the market instead of reading it.

Candlesticks can form patterns

A single candlestick can adopt any shape based on how the price has moved, and these shapes have cool names that are easy to remember. Some examples that we will cover later include the hammer, shooting star, hanging man, marubozu, doji, and spinning top.

Furthermore, a group of two or more candlesticks can form patterns that are easily recognizable, and just like the shapes, these patterns also have beautiful names like harami, hikkake, evening star, abandoned baby and tweezers.

All these patterns tell different stories about what the market has been up to, and how supply and demand has shaped the price graph.

It Can Give You an Advantage in the Markets

Since the shapes and patterns of the candlesticks tell us important stories about what happened in the market, that information could be used to try to predict what will happen in the future.

For example, some of the candlestick patterns can indicate potential market reversal levels while others may indicate trend continuation.

In other words, the patterns can help in market analysis. In fact, some price action traders rely heavily on these patterns in their technical analysis.

How to Trade Candlesticks without Memorizing Them

In this guide, we cover A TON of different candlestick patterns, and obviously, they are too many for you to memorize.

However, in order to take advantage of candlesticks, you do not have to learn the exact definition of every candle. The most important thing is to understand how candlesticks mirror market behavior and make it easier to see what the market is doing. Here are some tips on how to read candlesticks without memorizing patterns one by one.

The Pattern’s Close Price

Checking where the last candlestick closed relative to the range of the candle will help you know whos’s in control at the moment.

If the close price is near to the overall high, it shows a strong bullish pressure. On the other hand, if it’s nearer to the low, the control lies with the bears.

For example, in a bullish engulfing pattern, the closing price is close to the high. This shows that the bulls are dominating at that moment. If you look at the bearish engulfing pattern or dark cloud cover, the closing price of the candle is near the low, so the bears are in charge. (these patterns will be covered soon)

Always keep this in mind: to know who’s in control, check where the price closed relative to the range of the candle.

Here, the price closed near the top of the pattern.

Bullish Engulfing Candlestick
Bullish Engulfing Candlestick

Here, the price closed near the low of the pattern.

Bearish Candlestick
Bearish Candlestick

The Size of the Pattern Relative to Other Candlesticks

When you compare the size of the candlesticks in the pattern to the other candlesticks around, you can gauge the level of conviction of the traders behind the move. It tells you the strength of the dominating party — bulls or bears.

If the candlesticks that formed the pattern are larger than the rest of the candles, the move may have some strength and the pattern may play out well. On the other hand, if the candlesticks in the pattern are smaller than the other candles, it may indicate weakness, and the pattern may not play so well.

In the image below, you see that the small bearish reversal candles made a relatively smaller move than the big bullish engulfing candle, which brought a bigger move.

Candlestick Pattern
Candlestick Pattern

However, you should experiment to see if this applies to the particular pattern you want to trade. There might be cases where the exact opposite holds true!

Gaps

Pay attention to gaps, since what happens when the market is closed can be of great significance when it comes to what happens next.

In addition to noting what direction the gaps were, you should also note whether the gaps were filled or not. An unfilled gap could be a sign that the market is not strong enough to revert back and fill the gap.

Of course, such an insight could impact your analysis of the market.

How the pattern fits the overall market structure

Price action often forms structures in the market. Some of the important structures include head and shoulder, inverse head and shoulder, double bottom or top, triangles, flags and pennants, wedges, and rectangles.

For example, a bullish reversal pattern forming at the top of the right shoulder of a head and shoulder market structure may not make much sense, but if it’s a bearish reversal pattern that forms in such a situation, the pattern would make sense because it’s playing along with the overall market structure.

Here, an evening star formed at the top of the right shoulder.

Evening Star Candlestick
Evening Star Candlestick

However, to be honest, chart patterns like head and shoulders tend to not work that well, so be careful with what you choose to add to your market analysis! As always, the key to uncovering what works is to test it yourself, preferably in backtesting software!

How the Timeframe Impacts Candlesticks

Just like other time-based charts, the timeframe you analyze the candlestick chart is very important. The timeframe would determine the significance of the candlestick patterns. A reversal pattern you see on a 1-minute chart will not be as significant as the one you see on a daily timeframe.

Analyzing the candlestick chart on higher timeframes is more important due to the following reasons:

The higher the session, the more the transaction covered

Each candlestick represents all the transactions in one trading session. The volume of transactions that occurs in shorter sessions cannot be compared to those of longer trading sessions.

For example, while a five-minute session may not be enough for the market to absorb a single order from a high-volume trader, a daily session represents all the orders transacted that day. So more transactions are covered in higher timeframes, making such candlesticks more significant.

Higher timeframes have less noise

What appears to be a big move on a lower timeframe may not even be noticeable on the larger timeframes. A trend you see on a 5-minute chart, for example, may just be a single candlestick on the 4-hour timeframe. Price tends to swing more often on the lower timeframes, creating so much noise. The higher the time frame, the less the noise.

Higher timeframes show the predominant trend

The higher timeframes offer a better view of the overall structure of the market and show the direction of the main trend. So you can analyze the candlestick patterns bearing in mind the direction of the market. This will help you make better analysis and avoid going against the predominant trend.

So, Do Candlestick Patterns Work?

The most common way of using candlesticks is to form candlestick patterns that give you some clues about where the price is heading next. Many new traders eagerly embrace candlestick patterns since they provide clear and easy to follow rules, that seem to make a lot of sense. However, things are not always as easy as they seem!

Many of the widely known patterns are not suitable for trading since they are not accurate enough.

Do never try to trade a candlestick pattern all by itself, but use it as inspiration, and try to come up with your own trading strategy. 

In this guide, we are covering the main candlesticks and what they are though to mean by most people. However, keep in mind that many beliefs people hold aren’t accurate, and won’t lead to profitable trading!

Having that said, learning candlesticks patterns is a great way of trying to understand the driving forces of the market. Just don’t take them for the one and only truth there is!

How many candlestick patterns are there?

How many candlestick patterns are there? What number of candlestick patterns are out there? There is probably a limitless number of patterns, where the minority has been named or given a name. Our examination demonstrates there are at any rate at least 64 candlesticks that have a conventional name, see our accumulated rundown beneath.

The Patterns We Will Cover

Candlestick patterns can be categorized based on the number of candlesticks involved or the type of trade setup shown. Here, we will classify them based on the type of trade setup, and on that basis, these are the various types of candlestick patterns:

  • Bullish reversal candlestick patterns
  • Bearish reversal candlestick patterns
  • Bullish continuation candlestick patterns
  • Bearish continuation candlestick patterns
  • Indecision candlestick patterns

Bullish Reversal Candlestick Patterns

This group of candlestick patterns indicates that the current price swing — a bearish swing — has lost momentum, and that the price may be about to change direction to the upside. In other words, the price has been going down before any of the bullish reversal patterns show up.

But the presence of these patterns is not enough to assume that a price reversal is underway; that would be too early. On their own, the patterns don’t carry high odds of success. It is very important to combine them with other forms of technical analysis to increase the odds of the trade. We will get to that soon!

That said, these are some of the most common bullish reversal candlestick patterns:

  • Hammer
  • Bullish engulfing
  • Piercing pattern
  • Tweezer bottom
  • Bullish harami
  • Bullish hikkake
  • Morning star
  • Bullish abandoned baby

Now, let’s go through them one by one!

Hammer

 

Candlestick Guide: How to Read Candlesticks and Chart Patterns

The hammer is a single-candlestick bullish reversal pattern that is seen after a bearish price swing. A similarly shaped candlestick after a bullish swing is not a hammer, but a hanging man pattern (which is covered later under “Bearish Reversal Candlestick Patterns”)

It has a small body which can be of any color. In other words, the security may close higher or lower than it opened.

This is how you can identify a hammer:

  • It has a tiny or no upper wick
  • The lower wick is about twice or thrice the size of the body
  • Its close price is at the upper one-fourth of its range

This is what the hammer signifies:

  1. Sellers were initially in control, pushing the price lower
  2. Buyers later overcome the sellers and push the price up towards or above the opening price

Inverted Hammer

Candlestick Guide: How to Read Candlesticks and Chart Patterns

This candlestick pattern is very similar to the hammer candlestick, but just like the name suggests, it’s inverted.

Here is how to identify the inverted hammer:

  • The candle has a small body (any color) and a small or nonexisting wick
  • It has a long upper wick that is twice or thrice the size of the body

The pattern implies that:

  1. The market was in a downtrend
  2. A sudden burst of buying pressure pushed the price up. However, soon the bears were back and pushed the price back.

Even if the candle did not close in the upper region of the range, the long wick is a sign that the market sentiment may be about to change soon.

 

Bullish Engulfing Pattern 

 

Candlestick Guide: How to Read Candlesticks and Chart Patterns

The bullish engulfing pattern is a 2-candlestick bullish reversal pattern that appears after a price swing low.

Here’s how you can identify a bullish engulfing:

  • The first candlestick is a bearish one
  • The second candlestick is bullish, and its body completely engulfs the body of the first

Just like the hammer, the bullish engulfing pattern tells an interesting story about the market:

  1. Sellers initially pushed the price down, and the first candle closed lower than it opened
  2. Later on, there’s a strong buying pressure, and the second candle closed with a convincing stretch to the upside

The fact that the second candle succeeded to break the open of the first, bearish candle, is a sign of market strength. This is especially true considering that the move of the bullish candle was substantially larger than the preceding bearish candle.

In fact, on the next higher time frame, the bullish engulfing pattern would take the shape of a hammer. For example, a bullish engulfing pattern on the 30-minute timeframe would be a hammer (with a bullish color) on the 1-hour timeframe.

 

Piercing Pattern

 

Candlestick Guide: How to Read Candlesticks and Chart Patterns

This is another 2-candlestick bullish reversal pattern which shows up after a decline in price. It is similar to the bullish engulfing pattern, but the second candle doesn’t completely cover the first.

This is how to identify a piercing pattern:

  • A bearish first candle
  • A bullish second candle that opened below the first candle’s low but closed above its midpoint

This pattern implies that:

  1. Sellers were initially in control, pushing the first candle to close lower
  2. Although the second candle opened with a gap down, buyers quickly took control and pushed it up to close beyond the midpoint of th