Guide To Candlestick Patterns: Overview and Techniques

Analyzing, simplifying, and understanding market fluctuations can be very easy for regular traders. However, beginners may find it an overwhelming task. Thus, candlestick chart patterns are valuable tools to tackle the unpredictability of the stock. They help traders make better market decisions by providing detailed insights into market patterns, trading opportunities, and price movements.

There is a wide range of patterns available for traders with unique functionalities and characteristics. These candle patterns help traders analyze the market accurately and help them identify potential trading opportunities and also use Stock Market Software effectively. This blog will help you know better about the candlesticks.

What Is a Candlestick Pattern?

Candlestick patterns are key indicators of financial technical analysis which visually represent price changes from the opening to the closing of a market within certain periods. It essentially shows whether the market is bullish or bearish thereby providing insights into the future direction of prices.

Each candlestick is made up:

Body: The thick or filled part in the chart is a body and specifically shows open and closed prices. If the closing price exceeds the beginning price, there will be a bullish phase. Conversely, a bearish phase is indicated if the opening price exceeds the closing price

Shadows: The lines extending below and above the body are shadows, representing the highest and lowest prices in a period. The upper line shows the highest price and vice versa.

How to Read Candlestick Patterns?

A candlestick chart represents the following:

• Open: The price at which the market opened for the day.
• High: The highest price reached during the day.
• Low: The lowest price reached during the day.
• Close: The price at which the market closed for the day.

The color of the candlestick indicates whether the price went up or down:

• Green or white: The price went up (closed higher than it opened).
• Red or black: The price went down (closed lower than it opened).

There are mainly three types of candle chart patterns: Reversal Patterns, Bearish Reversal Patterns, and Continuation Patterns

1. Bullish Reversal Patterns

Bullish Patterns are other types of reversal patterns that suggest an end to a downtrend and start toward upward movement.

A. Hammer: This bullish pattern has a small body on the top and a long lower tail with less or no upper tail. It represents that the stock is ready to reverse its trend after downtrend.

B. Inverted Hammer: An inverted hammer, also known as an upside-down hammer, has a long wick on the top and a small body. It indicates a reversal from a downtrend to an uptrend of asset prices.

C. Bullish Engulfing: This candle pattern is made up of two candlesticks. The first one is small and has a red body. The second one is large and has a green candle. The larger candle engulfs the smaller candle, which signifies a potential bullish reversal.

D. Piercing Line: Piercing line candle consists of two large candle sticks, representing a short-term reversal from downtrend to uptrend.

E. Morning Star: This is a three-day pattern where the first long red candle represents a continuous downtrend. The second candle can be red or green but should be Doji which is a special pattern and short length. The third green candle confirms the reversal.

2. Bearish Reversal Patterns

Bearish Reversal Patterns show a probable price change from upward to downward. It represents that the rising trend is going to end soon.

A. Hanging Man: This pattern consists of a single candle and has a long lower shadow below the small body. It appears at the end of the uptrend. It is a shift from an uptrend to a downtrend.

B. Shooting Star: This pattern is similar to an inverted hammer. The only difference is that it is formed in an uptrend. It shows a reversal from the uptrend.

C. Bearish Engulfing: Bearish engulfing formed with two candles that show possible trading signals from uptrend to downtrend. The first candle represents upward movement, and the second candle completely engulfs the first one.

D. Dark Cloud Cover: This trading candlestick pattern is a bearish reversal where the down candle opens higher and then closes below the midpoint of the body of the previous candle.

E. Evening Star: It’s a three-day pattern that suggests a potential bullish reversal. A large red candle, a small-bodied candle, and a red candle.

3. Continuation Pattern

Continuation Pattern is a chart formation that shows a prevailing trend that will continue after some time. The current pattern whether upward or downward will resume once the pattern is complete.

A. Rising Three Methods: This is a bullish continuation pattern that shows a continuation of an uptrend after some retracement. This pattern is formed with five candlesticks, a long bullish candle, three small bearish candles, and another long bullish candle.

B. Falling Three Methods: This candlestick chart pattern suggests temporary interruption to a downtrend. This pattern helps traders to make the right decisions in an uncertain market.

C. Upside Tasuki Gap: The Upside Tasuki Gap pattern indicates that the uptrend is starting to continue after a brief gap. It formed with three candles, the strong bullish candle, the bearish candle, and the strong bullish candle. The gap is created between the first and second candle, helping traders to identify opportunities and validate trade decisions.

D. Downside Tasuki Gap: The pattern shows a continuation in a downtrend after some consolidation. It is similar to Upside Tasuki Gap, the only difference is it works for downtrend. This helps traders by providing clear and deep insights into the stock market.

E. Rising Window: The rising Window candle pattern suggests a potential bullish trend and it happens when a new candle opens just above the closing of the previous candle. The gap between the candles is referred to as a window or gap. It indicates that the price will continue to rise higher. This pattern is usually used to identify buying opportunities and reflects strong buying interest.

F. Falling Window: This candle pattern is the opposite of the rising window pattern. In this pattern, a new candle opens just below the closing of the previous candle pattern. This creates a visible gap referred to as a window. This pattern shows selling pressure or interest.

Factors to Consider while Interpreting Candlestick Patterns

• Market Trend: Make sure to identify the market trend before making any decision as candle patterns work differently based on market direction or trends.
• Time Frame: Considering the time frame (day, week, month, etc.) is crucial when choosing any pattern. For instance, a daily chart might be less effective than a weekly chart.
• Volume Confirmation: A high-volume pattern may have high significance. It indicates active participation in the movement of price.
• Technical Indicators: Considering other technical indicators is also significant for better trading conditions in the stock market.
• Risk Management: It is essential to consider risk tolerance before trading and implement relevant risk management strategies while trading based on candlestick patterns.

Tips to Choose Accurate Patterns

• Practice: Mastering candlestick chart patterns only needs consistent practice. You can analyze historical charts to improve your skills.
• Create Template: Creating and using templates for systematic analysis of patterns is another key tip to identify potential trading opportunities.
• Do not Overreliance: Relying on a single candlestick might be riskier for your trading decisions. Make sure to consider other technical tools for better insights.

Common Practices to Avoid While Analysing Candlestick Patterns

• Avoid Overtrading: Do not decide to trade based on a single candle pattern. Make sure to confirm first from other indicators as well.
• Lack of Backtesting: Backtesting is a very important practice before trading. Lacking this and solely depending on a single candlestick can increase trading risk.
• Ignoring Risk Management: Make sure to perform risk management while trading. Even if the candlestick pattern suggests a particular trade, make sure to apply some risk management strategies.
• Misinterpreting: Understanding candle patterns is essential to making the right trading decisions and identifying more trading opportunities. Misinterpreting is one of the common practices that traders should avoid.

Conclusion

Mastering candlestick patterns is a valuable skill for traders whether they are beginners or experts. By understanding the patterns, formation, practices to avoid, and factors to consider, you can make useful trading decisions. This ultimately helps you to improve your trading performance and provides the ability to find new trading opportunities easily.

However, make sure to not solely depend on the candle pattern as various other elements take part in the trading process. Thus, it is crucial to practice regularly, observing overall market trends and using other technical indicators to master trading.

FAQ About Candlestick Patterns