Candlestick patterns are the backbone of technical analysis. They predict future price movements more accurately. We will learn about them and various candlestick chart patterns to make your trading more rewarding.
Candlestick charts are the most popular charts used in technical analysis. The reason is that the candlesticks display more information about the stock price action.
The candlesticks make an extremely important part in the arsenal of a technical analyst. There are four types of technical charts available for stock analysis. These are line, mountain and OHLC and Candlestick Charts.
The information the candlestick chart analysis provide about a security earns it a special place in the technical analysis arena.
This is the information used to predict the future market behavior from the stock charts. Each candle is a source of information. Understanding candlesticks is very important to know the psychology of the majority of the traders and take informed decisions in stock trading or forex trading.
Candlesticks originated in Japan, hence popularly called as Japanese candlestick. They were named as candlesticks due to their appearance to a candle. Japanese candlestick charting techniques were used in earlier times to trade the financial markets on the basis of these candle charts.
These charts consist of combination of candles plotted on a graph. A candlestick depicts the behavior of a security in a specific time frame.
In a daily candlestick chart, a single candle shall shows the behavior of the security in a single day of trading. Likewise, we can select candlesticks for hourly, weekly, monthly or yearly time frames.
Table of Contents
- What are Candlesticks ?
- How to Read Candlesticks Charts?
- Bullish Candlestick Patterns
- Bearish Candlestick Patterns
What are Candlesticks ?
Candlestick analysis shows that typical candlestick consists of a middle thick body and two shadows – on the upper and the lower end of the body (see the figure).
The whole length of the candle shows the entire price range of the security in a particular time frame. Here we talk of a candle formed by single trading session movement of a security or a stock.
When the market opens, the stock also opens at a particular price level. This is the opening price of the stock. After that, the stock touches the highest and the lowest price of the day. It is represented by the upper and lower shadow respectively, before closing at a price, the closing price.
Depending upon this price action, the candle can be green (bullish) or red (bearish) in color.
When a stock opens at a lower price and closes at a higher price at the end of the day, it makes a green candle on the daily candle chart. Some charting software represent the green candle by blue colour. All in all, these candles make Bullish Candles. It means that stock prices have moved higher at the end of the day.
If a stock opens at higher price level in the morning and after making highs and lows closes at lower price level than the opening price, a red candlestick is formed on the candlestick chart. This is called a Bearish Candle and it indicates that the price of the stock has moved lower in the trading session.
How to Read Candlesticks Charts?
For chart reading, you need a candlestick chart software. You can buy any popular premium software like Metastocks or NinjaTrader or use free charts at stockcharts website for reading candlestick charts.
A candlestick in itself explains the behaviour or psychology of the majority of the traders and thus provides cues to a trader in taking trading decisions.
A green candle with a large body and short shadows indicates that buyers are very aggressive in that particular stock.
Similarly, a large body red candle with small or no shadow indicates that sellers are dominating in the particular script.
A candle with small body and large shadows on upper and lower end depicts indecision in the minds of traders.
Long shadow on the upper end shows that stock moved higher but could not sustain there and closed at lower price. Thus it indicates resistance or supply at higher levels.
Similarly, long shadow at lower end depicts that after touching lows for the day, the stock moved up and closed above the lows. This indicates that buying support is there at lower levels. Hence, the stock can be considered for buying for short-term swing trading.
Candlestick chart patterns tell us about the psychology of market participants or traders on the chart.
Although Bar charts also reveal the same information. But the candlestick charts do that in a more appealing and illustrative way.
Candlesticks make some short term patterns on a chart. If you can identify these patterns, that is going to be really useful to you for taking informed trading decisions.
That will keep you ahead of majority of the market traders and increase your success rate in trading.
Candlestick chart patterns can be bullish or bearish depending upon the formation.
A bullish pattern tells us that the stock prices or any security prices are likely to move higher in near future.
A bearish pattern predicts the price declines in stock prices in future.
We know there are two types of candlesticks on a chart :-
- White (or green or blue) candlestick forms when the prices close higher than opening price
- Black (or red) candlestick forms when the prices close lower than opening prices.
The names of these Japanese candlestick patterns are really interesting and a joy to read and learn.
However, you must remember that these patterns do not confirm the price prediction on their own.
Reading them along with other technical indicators like moving averages (importantly 50 day and 200 day simple moving average), relative strength index (RSI), stochastics oscillators makes much sense and gives more positive impetus for our trading decisions.
Moreover, the basic criteria of trading “trend is your friend” must be followed along with necessary risk management. Trading candlestick patterns in the direction of larger trend in the market is more rewarding.
The bullish patterns in downtrend and bearish patterns in uptrend should be traded cautiously. You can use the candlestick patterns for day trading as well as swing trading. The candlestick patterns can be reversal chart patterns or continuation chart patterns.
Let us have a look at all candlestick patterns !
Bullish Candlestick Patterns
A candlestick pattern bullish on charts indicates the potential bullish behavior in the stock price. It means that there is probability of stock price rising higher. Some are candlestick reversal patterns while others are continuation candlestick patterns.
Hammer Candlestick Pattern
Bullish reversal candlestick pattern hammer forms after a correction or fall in the market. Formation of hammer indicates that the down trend in prices is coming to an end and buying is emerging at lower levels.
After a bearish red candle, next day the prices again opened lower, moved significantly lower during the day. Then, the buyers step in and push the prices higher. At the end of the day, prices close higher than the opening price after making an intraday high.
This price action leads to the formation of green or bullish candlestick which looks similar to a hammer. It has a small body, long lower shadow (indicating support at lower level) and a small upper shadow. For a hammer in candlestick pattern, the upper shadow should be smaller than the lower shadow.
It needs a confirmation with a bullish candlestick next day. if it happens, the short term traders can buy the stock, keeping a stop loss just below the lowest price made by the lower shadow of the hammer.
Bullish Engulfing Candlestick Pattern
Bullish engulfing pattern, as the name indicates, is a bullish pattern. Usually, it is a reversal pattern but it may also happen as a continuation pattern.
The engulfing candle pattern is considered as a powerful pattern. It has a big body candle which overlaps the body of previous day candle completely. This shows the power of the bulls or the buyers.
Read more details about the bullish engulfing candle and the method to trade it at this article.
Morning Star Candlestick Pattern
Morning star pattern is a bullish reversal pattern. It is named after the planet in our solar system, the Mercury.
Like hammer, this pattern also forms at the end of a market down trend. However, it is a three candlestick pattern. That means three candlesticks are needed for a morning star candlestick pattern.
Read more details about this candlestick pattern and the method to trade it at this article.
Doji Dragonfly Candlestick Pattern
Generally, Doji candlestick has long shadows above and below with very small or no real body. The opening and closing prices are almost same. Doji candle shows the indecision in the minds of traders.
Doji candlestick pattern can form in any trend, uptrend downtrend or sideways markets. Doji are the regularly seen candlesticks. They themselves do not indicate any trend.
However, another variant of Doji, the dragonfly, is also seen sometimes. That’s very infrequent, in fact. It indicates the potential change in trend in near term.
A dragonfly formed at the bottom after a downtrend indicates the trend is coming to an end and up trend may start. Formation of dragonfly in an ongoing up-trend indicates that the buyers are unable to control the prices and sellers are getting equally active.
The absence of upper shadow or a very small upper shadow is what makes a dragonfly different from a typical doji. It looks similar to the letter ‘T’. The colour of the candlestick is not of much significance.
Formation of a dragonfly doji after a downtrend indicates that the prior trend is coming to an end. The buyers are emerging at lower levels and prices may start moving higher in the short term.
On the day of formation of dragonfly, prices already in downtrend, start moving lower after opening. However, during the trading session, the buyers step in and push the prices higher towards the opening price. In the end, the closing is almost at the opening price.
You can trade a dragonfly doji pattern after the formation of the pattern or better after seeing a confirmation with a bullish candlestick in the next trading session.
The stock can be bought near the closing price of the dragonfly. Stop loss should be placed just below the lows of the dragonfly. Targets can be taken as the upper resistance levels.
In case the dragonfly doji pattern forms in an ongoing up-trend, it indicates the buyers are unable to close prices higher than the opening prices. Selling or profit booking is setting in. Thus buyers need to be careful.
Piercing Line Candlestick Pattern
Piercing line is a bullish candlestick pattern. This is a powerful reversal pattern. It forms after a downtrend in the prices.
Piercing candlestick has a big body green candlestick. The upper and lower shadows are small. This shows the power with which the bulls or buyers taken the control after initial selling.
Big body bullish candlestick gives confidence to the buyers that the downtrend has come to an end and the prices are likely to move higher.
After the day of a strong selling shown by a big red candlestick, the prices open lower in the next trading session. However, soon the bulls or the buyers get active and prevent prices moving further lower.
During the day, the buying gathers pace. At the end of the day, the prices close higher than the mid-point of the previous day bearish or red candlestick body.
For piercing line pattern, it is important that the closing is above the mid-point of the previous day red candlestick real body.
Short term traders can consider buying on the next day keeping stop loss just below the lows of the previous trading session.
Morubozu candlesticks are very easy to find on candlestick charts. Marubozu is a japanese term which means baldness.
They are solid body candles with no upper or lower shadows or wicks. Sometimes, you may see a very small wick on upper or lower side of a marubozu candlestick.
A bullish marubozu is a big body green candlestick. It may appear during an ongoing uptrend or after a downtrend. In uptrend, it indicates that the price rise may continue for some more time. A marubozu after a downtrend shows that the selling is over and the buyers have made their entry with full force.
On the day of formation of marubozu candlestick, the prices open at a price, do not move any lower or very small downward movement. After that, the buying continues and it is so strong that buyers want to buy at any price. At the end, prices open at the highest level of the day with very small or no upper shadow at all. Marubozu is similar to a engulfing candlestick except that it has little or nil wicks.
Marubozu shows that price rise may continue for few more days. It may or may not rise in coming days, that is another thing. But as a trader, you can decide to go long the next day, keeping your stop loss at the lowest price made by the marubozu.
Very small or very big marubozu in comparison the average candlestick size should be avoided for trading. The small marubozu does not give the confidence the buyers need while in a big candle, the stop loss will be very deep and risk will be more.
Rising Three Candlestick Pattern
Rising three candlestick pattern is a five candlestick bullish pattern. This is seen as a continuation pattern in already present uptrend.
The pattern tells us that the bullish momentum in prices is likely to continue still further.
Rising three pattern consists of first big green body candle, followed by three or sometimes four small red body candles and the fifth candlestick again having a larger green body.
During the formation of rising three pattern, first candlestick signifies strong buying momentum. Prices close at day’s high. For the next three days, the prices keep closing lower consecutively. This is usually due to the profit booking by the already long traders.
All the three red candles remain contained within the body of the first green candlestick.
However, on the day of fifth candlestick formation, the bulls come with full strength. Prices open near or above the closing price of fourth day red candlestick. Finally, the bulls succeed in pushing the prices higher and giving close above the level of first day green candlestick.
Important things in rising three candlestick pattern:
- First candlestick is big body green candle.
- The red candles remain contained within the body of the first green candle.
- The fifth big green candle closes above the closing price of the first candlestick.
Traders can consider buying the stock on the day of formation of fifth candle, just before the market closing, if the prices are trading near day’s high. However, it is better to go long the next day, keeping stop loss at the most recent swing low. You may get a low price to buy on next day, usually near the middle of the fifth candlestick.
Bullish Harami Candlestick Pattern
Bullish harami candlestick pattern is a reversal pattern. It appears after a sustained downtrend in stock prices.
This patterns is just opposite of the bullish engulfing pattern.
Harami is a Japanese word which means pregnant. Harami is a two candlestick pattern. First candle (mother) is a big bearish or red candle and the second candle (baby) is small bullish or green candle contained within the body of first candle.
The bullish harami candlestick pattern is formed when the prices are in a downtrend. A big bearish candlestick is formed with closing near day’s low.
Next day, out of nowhere, there is a gap-up opening. The buying continues and never returns to previous day lows. In the end, prices close higher than the opening prices but lower than the previous day’s opening. Consequently, a small green body candlestick is formed, contained within the body of previous day candlestick.
Gap-up opening with higher closing after a sustained downtrend indicates the potential trend reversal. Bears loose control and bulls take charge of the price control.
Bullish harami is a offers a very good trade from risk reward ratio point of view if it is confirmed on the next day with a green candlestick. This is because our stoploss is not very deep and we are buying almost at the bottom.
Buying can be initiated on confirmation of the pattern, keeping stoploss just below the big bearish red candlestick (mother candle).
Important things to remember in bullish harami pattern-
- There must be a prior downtrend in force.
- The bullish green candlestick must be enclosed within the body of the previous red candle.
- Position of green candlestick should be in the middle or more towards the upper half of the red candlestick for more reliability of the pattern.
- Position of green candlestick more towards the lower half of red candlestick shows lower strength of the bulls.
Bearish Candlestick Patterns
A candlestick pattern bearish on charts indicates the potential bearish behavior in stock price. It means that the stock price is likely to move lower. Some of these patterns are reversal patterns while other are continuation patterns.
Like bullish patterns, some are single candle patterns while some are multiple candle patterns.
Bearish Engulfing Candlestick Pattern
Bearish engulfing candlestick pattern can be a continuation pattern or a reversal pattern.
In this pattern, there is a formation of a big body bearish or red candle which completely covers or engulfs the previous day candle body.
On the day of formation of bearish candlestick pattern, the prices open with gap up above above the previous day closing price. However, unable to sustain due to selling pressure, the price falls down and close below the previous day opening price.
Consequently, a big red body candlestick is formed which shows the rule of bears or the sellers on that day. This indicates that the coming trend may be bearish for stock prices.
Traders may watch next day trading session to confirm the pattern with another red body candlestick formation.
Aggressive traders can take the short selling position on the same day, 15-30 minutes before the market close. Others may go for short selling on the next at prices somewhere near the middle (if market gives the chance) of the bearish engulfing candlestick.
Stop loss for the trade is the high price of the day of the formation of bearish engulfing candlestick pattern.
It is important to watch the trading volumes on the day of formation of this pattern. it should be higher than the average trading volumes to make it more significant.
Evening Star Candlestick Pattern
Evening star pattern is a bearish pattern and is a short term trend reversal pattern. This pattern is just the opposite of morning star pattern which is a bullish pattern.
Evening star pattern is a three-candlestick pattern. The first candle is big bullish green candlestick from the prior up trend in prices. On the day of second candlestick, prices open higher with gap up and start moving higher.
However, during the later part of the trading session, the sellers or the bears become active and make price close below the opening price. On the day of formation of third candlestick, prices open with gap down and start moving lower. At the end of the day, prices close near lows of the day while negating the gains of first big bullish candlestick.
The pattern indicates that the bullish momentum is over for the short term. The trend has reversed and stock prices are likely to head lower.
Short term traders can initiate short selling positions with stop loss above the highest level seen during the day of formation of second candlestick of the pattern. The target for the trades is lower support price levels.
Gravestone Doji is a bearish pattern. It is named as because it looks like a grave and marks the grave of the traders. The traders are likely to see losses as it digs the grave for the bullish traders.
You can identify a gravestone doji easily as a candlestick with long upper shadow and nil or very miniscule lower shadow. There is either no body or very small red candlestick body making it look like an inverted alphabet ‘T’.
The long upper shadow in a gravestone doji indicates the resistance to prices at higher level.The prices open lower followed by the attempt of bulls to push prices higher. However, the sellers step in during the later part of the trading session and push the prices lower with closing at or below the opening prices.
See in the daily chart below, how two gravestone doji candlesticks are followed by a bearish trend in the next few days.
The traders can short the stock next day with stop loss above the high of the gravestone and expect lower prices at next support levels.
Bearish marubozu shows the power and the dominance of the sellers on a given trading session. It is usually a continuation pattern appearing in an ongoing bearish trend.
Marubozu is a bald candlestick with either nil or little upper or lower shadows and a big body. It sets the pattern for further bearish behaviour in that stock.
Bearish marubozu is just opposite of the bullish marubozu with prices opening at the highest levels of the day. Prices may move little higher making small upper shadow or just starts sliding lower with closing at or near the lowest level.
You can trade a bearish marubozu by taking short trade next day keeping a stop loss above the highs of the marubozu candlestick. The problem in trading a marubozu candlestick is that you have slightly wider stop loss
See in the above daily candlestick chart, multiple bearish marubozu candlesticks appear in bearish trend in the stock.
Bearish harami is again similar to but opposite to bullish harami candlestick pattern. It is a reversal pattern in an ongoing bullish trend. It indicates that the future price moves may be headed lower.
On the day of formation of bearish harami candlestick pattern, the prices suddenly open gap down in an uptrending market. An attempt is made to move higher but it is overpowered by the sellers which keep pushing the price lower. The price closes near the lows with the whole candlestick enclosed within the body of the previous bullish or green candlestick. This sets tone for bearish trend for the coming days.
The daily chart below clearly depicts the formation of a bearish harami candlestick pattern and its consequences. Traders can short the stock on next day by keeping stop loss just above the highs of the previous day bullish candlestick. Your target price for the trade shall be the next support levels.
Hanging man candlestick pattern is a frequently seen pattern. It is a reversal pattern. It is seen at the end of an uptrend in the stock price. The pattern is similar to a hammer candlestick pattern which is made at the bottom of a downtrend.
At the day of formation of hanging man pattern, the prices open high with a gap up as per the prevailing trend. However, soon the selling pressure sets in and it pulls the price much lower than the opening price. The buyers see an opportunity to get in the up going stock but the sellers dominate the price action. Finally, the prices close above or below the opening price while making a long lower shadow.
The price action needs to confirmed next day with prices heading lower. This indicates that the prices are now likely to move lower and you should consider exiting your short term long positions or even short selling the stock.
Traders can short sell the stock on the next day of formation of hanging man pattern with a stop loss just above the highs of the hanging man candlestick. Our target price is lower support levels.
Shooting Star Candlestick
Shooting star is a reversal candlestick pattern. It is seen at the end of the current uptrend and sets tone for the bearish trend in the short term.
Shooting star resembles a hanging man pattern with the difference being the position of the body of the candlestick. Shooting star candlestick has a long upper shadow and small lower shadow with a small candle body.
Shooting star candlestick forms when in an ongoing uptrend, the prices open higher with a gap up. The prices start moving higher but then the sellers become active and start pushing prices lower, Finally, the prices close below the opening price, making a red body candle with a long upper shadow and small lower shadow.
The short term traders can short the stocks on the next day of the pattern formation with a stop loss at the swing highs of the pattern with targets of lower support levels.
These are the main candlestick chart patterns which you can consider to take your trading decisions.
Identifying these patterns and applying in our trading system gives you an edge over other traders.
Market moves can never be predicted accurately. But using these patterns gives an insight into the markets at least.
Using these candlestick patterns, we actually follow what markets tell us. This is definitely good for us for taking our trading decisions.