The emotions of traders drive markets; there’s little doubt about that. The decisions they make, their moments of fear and greed, all and all, form what moves the prices up and down. Candlestick charts provide a visual representation of those collective emotions. The Japanese developed candlestick patterns way before western financial experts came up with their visual representations of the market. Candlestick charts are simple. They show the direction and the size of price movement using different colours for an upward or downward trend. A “candle demonstrates each price movement in a given time.” Green candles for price rises and red ones for price drops. Traders try to find reliable patterns in the candles, their sizes, colours, and formations to predict the price in the future. Mastering the essentials of candlestick charts gives traders an edge when making decisions in financial markets.
Candlestick Patterns, what is it made of?
Candlestick charts are made of candles. Each candle consists of several different components:
- High: The candle represents the highest price of the asset in a given time.
- Open: The opening price of the candle. The starting price.
- Close: The price of the asset when the candle ends.
- Low: The candle represents the lowest price of the asset in a given time.
As mentioned before, candles come in two colours. If the price direction is upward, the candle would be green. And if the direction of the price is downward, it would be represented by a red candle. In some charts, upward movements are shown by white, and black candlesticks show downward movements.
Each candle has a body. The candle’s body ranges between the opening and the closing price. A green candle means the closing price is higher than the opening price, whereas, in a red candle, the price of the asset failed to close higher than where it started on that specific candle, with its specific time frame.
Basic Candlestick Patterns
Candlesticks represent price movements. Sometimes patterns can be found in candlesticks and their formations. Traders use these patterns to forecast the price and its movements. There are many candlestick patterns. However, they do not guarantee price movements but rather show price tendencies and trends. Traders analyze price patterns and many other factors to decide whether to sell or buy assets. However, candlestick patterns alone cannot be used as buying or selling signals. They should only be used to analyze market tendencies and directions. Therefore, these patterns should always be interpreted in the context.
Candlestick patterns are mainly divided into two groups; Bullish or Bearish. If the price is likely to go up, the pattern is known as “bullish,” and if it is expected to drop, then the pattern is known as “bearish.” These two terms define the general tendency of the market. Here are some popular candlestick patterns that are worth keeping in mind:
Candlestick Patterns: Bearish Engulfing Pattern
This pattern occurs in upward price movements when sellers take back control after a price rise. It is visually represented by a large red candle engulfing a smaller green candle with a large body. This shows a change of hands in the market. It shows that the buyers refuse to buy more and that the sellers are stepping in. Not only did they stop the price from moving further up, but they proved to be more prominent in numbers and drove the price lower than the previous candles open.
Bullish Engulfing Pattern
This pattern is the opposite of the previous one. A bullish engulfing pattern occurs in a downward price trend. The price goes down until it reaches a critical buy zone. Sellers stop selling. Buyers buy excessively, and they gain control of the trend by moving the price upper than the previous candle’s opening price. This phenomenon is demonstrated by a large green candle engulfing its last red candle—a visual representation of a change of control in the market.
Bearish Evening Star
A bearish evening star occurs when the last candle in the pattern opens below the small body of the previous day’s candle. The small body of the previous candle can be red or green. However, the last candle closes below the candle’s body, related to two days before. This shows a halt in the buying frenzy, resulting in an aggressive sell-out. As the price moves lower, more sellers get in the game. Eventually, the candle can close way below its recently achieved peak. In this scenario, buyers would also be too scared to step in, so no significant force would be pushing the price up.
A bearish Harami occurs in an uptrend. After a series of green candles, the last candle is a small red one, entirely inside the previous day’s body. This signals indecisiveness in the market. Neither the buyers nor the sellers are not sure whether the rally could still go on. A move from each side could provide a sense of relative certainty to the market, and the traders would follow. An upward move might cause a large green candle, whereas a dump would further slide in the price.
Bullish Harami is the exact opposite of the previous pattern. It occurs in a downtrend, halting the price drop: a small green candle forms, its body entirely inside the body of its previous day. Further participation of buyers could reverse the trend, whereas the sellers could regain control if they managed to push the candle downward.
Bullish Rising Three
This pattern starts with a large green candle, indicating a significant price pump. This candle is then followed by three small red candles, pushing the price down. However, these three candles remain in the body of the first large, green candle. Although the price has been moving down for three consecutive days, it has not yet seen a new low. The pattern is then completed by a fifth candle, a large, green one. The buyers regain control after they show little power over the market, and they move the price up again.
In a variation of this pattern, initially, two green candles emerge instead of one. The first candle is usually large, and the second one is relatively small. Everything else in the pattern remains the same. This variation is referred to as a “Bullish Mat Hold” pattern.
Bearish Falling Three
However, in a bearish falling three, the starting candle is a large red one, followed by three small green candles trying to save the price from sliding further down. These candles are within the starting red candle; therefore, they do not achieve a new high. Sellers re-enter the fifth candle, lowering the price than the starting candle.
A hammer is the last candle in a downtrend, usually with a wick twice the size of its body. This indicates that the price has finally reached a critical buy zone after an intense selling phase. Buyers are now buying large amounts, and they are reversing the trend. A hammer can be red or green, but green hammers indicate more buyers stepping in, resulting in a strong trend reversal.
Candlestick Patterns: The Hanging Man
This pattern is the bearish equivalent of the hammer. It occurs at the end of a bullish trend. It is represented by a red candle with a wick twice its size below its body. This shows that after a long buying phase, a sell-off occurred. But the buyers did not cease buying and thus managed to move the price a little upward, but not as much to form a green candle. This might indicate an end to the bull run, as the buyers no longer show interest. More red candles most likely follow the pattern.
An inverted hammer is a lesser indication of a trend reversal than a hammer. This pattern occurs at the end of a downtrend when the wick of the last candle is twice its body size, and it is on top of its body. This shows that sellers stopped selling, buyers stepped in for a while. However, the sellers did not stabilize the price above the previous day’s body. In a sense, this pattern is very much similar to a bullish Harami. Both indicate the rising possibility of a trend reversal.
Candlestick Patterns: Shooting Star
A shooting star is formed when a small body with a long wick on its top appears at the end of an uptrend. This pattern is similar to the inverted hammer pattern. The long wick indicates that the sellers have outnumbered the buyers in the game and stopped the upward price move. This might mean that a trend reversal is imminent. As no more buyers are willing to step in, a sell-off is triggered, leading to more red candles.
Three White Soldiers
This pattern consists of three green candles, each opening within the body of its previous candle but closing further above its high. This shows continuous support from buyers. The wick sizes can be analyzed to predict future movements and trend strength. Ideally, smaller wicks and larger bodies are more dominant signals of a bullish trend. In contrast, long wicks indicate a lack of power from the buyer side to maintain high price levels.
Candlestick Patterns: Three Black Crows
The Three Black Crows pattern is the bearish equivalent of the Three White Soldiers pattern. In this case, three red candles follow a large green one, each opening within its previous body but closing below its last low. This indicates a constant presence of sellers, leading to more red candles. Analyzing the body and wick sizes of candles is essential to determining the trend’s strength.
Dark Cloud Cover
Dark Cloud Cover occurs after a green candle; a red one appears that opens above the close of the green candle but closes way below the mid-point of its previous candle body. A surge in volume often accompanies this phenomenon. It can indicate a shift in power and ultimately a trend reversal.
A Doji pattern occurs when a candle closes at a price close to its opening price. The high and low of the candle might be way distant from each other, but a Doji candle closes very near its starting point. This situation might mean a state of indecisiveness in the market. Buyers and sellers are not yet convinced to step in. Doji patterns should be interpreted in the context. They can be signals of various scenarios depending on their context.
According to its exact definition, a Doji candle opens and closes at the same price. However, volatility is exceptionally high in crypto markets, and candles usually close at a different price than their opening price. Therefore, in the cryptocurrency market, the term Doji is also used for candles with a closing price near the opening price. Typically, these candles are called “Spinning Tops,” but they are known as Doji patterns in crypto.
Price Gap Patterns
Many of them are related to price gaps when it comes to candlestick patterns. A price gap occurs when a candle opens at a price different from its previous close. This happens due to low liquidity or markets not working 24/7. Since crypto markets work round the clock, seeing price gaps can be rare.
Candlestick Patterns in a nutshell
Different candle patterns are essentially visual representations of how buyers and sellers exchange power. Every wick and every candle body holds a piece of the price story. Every candle reveals the trend’s tendency, and every trend is continued or reversed by the power of its candles. By analyzing the candles, the short future of the market can be predicted. But the patterns should be examined in their context. Each candle should be interpreted side to side with its next candles. And finally, patterns should not be used as buying or selling signals. Instead, candlestick patterns should be used in conjunction with other valuable tools and indicators to forecast the future movement of the market.