Understanding candlesticks and their meaning is a deadly arsenal for any trader. A candlestick pattern consists of data with multiple timeframes, and by simply interpreting a candle formation, a trader can make reasonable assumptions about what will happen next in the market. It can be difficult to make assumptions using a single candlestick, but when combined with other candlesticks, it strengthens beliefs and decisions, reducing risks. This article will share an in-depth guide on how to trade using candles. But before that, we will detail what a candlestick is, how it arises, and how to read it.
What is a candlestick pattern?
While this question may already be very mundane, and almost all traders know by heart what a candlestick pattern is, it is always best practice to refresh our minds and skills regarding trading. Bitunivex followers have strategies and new ideas that we can use to improve our trading performance further.
A brief history of candlesticks
Using Candlestick for commerce was known from the 1700s to the early 1800s by the rice merchants who traded their Japanese goods to the other regions. Research by Steve Nison, a trade writer, introduced candlesticks to the Western World in the early 1850s. He published a series of books about candlestick patterns in 1991; that book drew the world’s attention to these patterns and graphic techniques. Nowadays, more and more developed Candlestick charting techniques and designs are available. Using candlesticks instead of traditional lines or bars on a chart is highly favoured by traders because of its reliability, readability, accuracy, and detailed information on price action.
What are the results of using candlesticks?
There are two expected outcomes when using such patterns or techniques: a reversal pattern and a continuation pattern.
It is a reversal pattern in which a candlestick pattern signals a trend reversal in the market. This issue means that if the trend starts with an uptrend and the candlestick pattern forms, the following price action will either be against the movement or be bearish. Reversal patterns are the best tools when a trader wants to create an entry or exit points on long trends. If prices go up, they will always go down – knowing that the reversal pattern knows when prices will go the other way.
If a candlestick pattern indicates a continuation, the trend will continue in the future. The price will continue to rise for an emerging market, making it an excellent decision to continue investing in the stock. On the other hand, when dealing with a bearish market, it would be best to sell the positions if the candlestick pattern continues a downtrend.
These patterns are essential and helpful in reducing the risks involved in trading and optimising profits. While these are equally important to any trader, it is also necessary for a trader to understand how to read and interpret these patterns to take advantage of them.
Let us also identify its parts and uses so that we are fully aware of the Candlestick.
Parts of the Candlestick
Like the regular candle, the Candlestick for trading consists of a body and a pair of wicks. Often, the wicks may be longer or shorter than the other, and other times the body is so long that the wicks are no longer visible. Depending on what the pieces look like, a trader may make assumptions about a particular trade.
Price High (H)
The wick that lies above the candle body is called the high price. This matter shows the highest price the price action has reached at a given time. This upper wick is also called the upper tail or upper shadow of the candle by other traders.
Opening and Closing Price (O and C)
The opening and closing price makes up the actual body of the candle. If the price is up, the opening price is at the bottom, and the closing price is at the top. If the price movement is downward, the opening price is at the top, and the closing price is at the bottom.
Low Price (L)
On the other hand, a low price is the equivalent of a high price. It shows the lowest price reached by the price action within a certain period. It is the lower tail or lower shadow of the candle.
Platforms use bicolour indicators to indicate whether a price is rising or not. Today, white candles indicate an uptrend or upward price movement, and a black candle suggests a bearish trend. A few years later, traders preferred to use green for uptrends and red for downtrends. This colour combination allowed for better access and interpretation of candlesticks knowing that the general rule is easier to remember – that is, red means “stop” and green means “go.”
Best inverted candlestick patterns
There are dozens of candlestick patterns used in the market today. And every year, there are new models introduced to traders. However, for this particular guide, Bitunivex will share the most common or best candlestick patterns, which will help traders gain an edge in their trading.
Hammer and inverted hammer pattern
The hammer is the first and probably the most basic candlestick pattern every trader should know. The hammer is a pattern that indicates a bullish reversal – meaning that the next price is to rise or turn bullish after the downtrend. As the name suggests, the candle is like a standing hammer with its head and long handle.
It sometimes consists of an upper tail or shadow, a body that is a quarter of the candle, and a shadow or lower tail or shadow two or three times longer than the body.
This pattern shows the price started with a lower cost, but at the end of the trade, severe buying pressure caused the price to rise. The pressure from the buyers was extreme as the closing price approached the opening price.
The inverted hammer is also the same as the result of the hammer pattern. It indicates a trend reversal from a downtrend to an uptrend. This candle appears when the opening and closing price is close to the candle’s low or lower tail. It is easily recognised thanks to its long upper wick compared to the lower wick.
The engulfing (inclusive) bull pattern
Another bullish reversal candlestick pattern is a bullish engulfing pattern. This condition includes two candlesticks showing a price decline. Candle number one closes with a bearish price, and the second candle suppresses the body of the first candle and has a bullish price.
The uptrend indicates that the price declines as sellers take advantage. However, the enormous buying pressure stifled the sellers’ performance, making it possible to overwhelm them in future price movements further.
Another two candlestick pattern that indicates a trend reversal is a piercing pattern. This pattern develops after the price drops or after a substantial price drop.
This pattern has a long bearish candle for the first candle and a second bullish candle with a much smaller body than the first. The second candle has a closing price above the 50% mark of the first candle.
The piercing pattern is pretty much the same as the bullish swallow pattern and indicates that the sellers are aware of the price of the first candle. However, in the second candle, buyers tried to hold the trend. With this price action from the two candles, the price will rise or reverse to a bullish market.
Tweezers Bottom Mold
The Tweezers bottom pattern is another two candlestick pattern that usually appears after a price drop. The first and second candles that look similar in almost every way indicate this pattern. The first candle shows an open at the top of the candle, and the second candle shows the close at the top at the same level as the first candle.
The Tweezers bottom pattern shows that sellers wanted to push the price further but could not continue the buying pressure on the first candle. The sellers wish to lower the second candle’s costs but get stopped due to the intense buying pressure. Many sellers wanted to continue the downtrend, but the buyers stopped the downtrend, and now maybe the prices will go up.
Morning Star Pattern
A popular pattern is the Morning Star Pattern, not only because of its name but also because it signals a bullish reversal. It consists of 3 candles and usually occurs after a price drop.
The Morning Star pattern includes three candles where the first candle is bearish, a small mid-range candle, and a bullish one larger than the first candle.
This pattern is a sign of the dominance of the sellers from the first candle, followed by the indecision of both buyers and sellers, showing the small body of the second candle. This candle indicates a trend reversal in an uptrend, or in other words, the price is about to rise due to intense buying pressure.
Three White Soldiers Pattern
Another 3-candlestick pattern showing an upward reversal is the Three White Soldiers Pattern. This pattern requires three consecutive candle formations like the Morning Star.
The Three White Soldiers occurs during a downtrend and indicates a trend change towards an uptrend. This pattern consists of 3 consecutive bullish candles with minor wicks, each closing slightly higher than the previous day’s close.
Stable bullish candles for three consecutive days show the strength of the buyers and are assumed to continue for the following price action.
Hanging Man Pattern
The Hanging Man Pattern is another 1-candlestick pattern that signals a return to a downtrend or downtrend. It has the same characteristics as the Hammer Pattern but in a different colour, with a small upper wick and developed at the end of an uptrend.
The candle consists of an open and a close. This candle indicates that sellers have overwhelming power, although buyers can push the price higher. As there are more sellers in this trading range, there is also a good chance that the next price will favour the sellers – which means the price will go down.
Shooting Star Pattern
Another candlestick pattern that looks like a hammer is the Shooting Star Pattern. This pattern signals a bearish market or a downside reversal, unlike the hammer or inverted hammer.
The Shooting Star Pattern also has the same shape as the hammer but has a red colour – as the symbol for the bearish candle. At the end of the uptrend, it opens and closing closes at low prices, and its tail makes up more than 50% of its body.
A Shooting Star Pattern says that buyers are off to a good start to push the price up, but intense selling pressure at the end of the trade takes advantage to push the price down. This kind of pattern shows the dominance of the sellers who want the price to go down.
Swallowing Bear Pattern
The equivalent of the Bull Engulfing Pattern is the Bear Engulfing Pattern. This pattern is also a 2-candlestick that indicates a trend reversal towards a bearish market.
This pattern develops at the end of an uptrend and consists of a bullish first candle followed by a second bearish candle with a body covering the first candle. The Engulfing Bear Pattern shows that buyers dominate on the first day, but sellers dominate on the second day. Since the body of the second falling candle is much larger than the first rising candle, the next candle or price action will get low.
Evening Star Pattern
If we have a Morning Star Pattern, its counterpart is the Evening Start Pattern. This pattern signals a trend reversal towards a bearish market or price drop. This candlestick pattern consists of three candlesticks formed at the end of an uptrend.
This pattern starts with the first bullish candle with an open and closed price near the ends of its body, a short bullish candle, and a bearish third candle whose body is better than the first candle following it.
When this pattern appeared, buyers gained momentum on the first candle but remained weak on the second. In the third falling candle, the sellers dominate the trade, and the considerable body shows the overwhelming force that caused the next candle to drop.
Three Black Crows Pattern
The Three White Soldiers Model corresponds to Three Black Crows. It is a 3-candlestick pattern that indicates a trend reversal towards a bearish market.
It consists of three consecutive bearish or red candles with short, even non-existent shadows or wicks at the uptrend and shows that the selling pressure is extreme and pushes the price lower for the next candles.
Tweezers Top Model
If there is a Tweezer Lower Die, there is also a Tweezer Upper Die as its counterpart. This pattern is a 2-candlestick pattern that indicates a trend reversal towards a bearish market.
The Tweezer Top Pattern is a rising first candle followed by a bearish candle with overwhelming selling pressure. Like the Tweezer Subpattern, the opening price of the second candle starts precisely at the closing price of the first candle. The buyer traders push the price higher after the first candle, but the seller traders surpass them. A solid selling force from the second candle may cause the next candles to drop or bring the price down.
Best Continuing Candlestick Patterns
Doji Candlestick Pattern, the Rising Three Methods, Falling Three Methods, and Rotating Top Pattern are three common patterns that are called Continuing Patterns.
The Doji Candlestick Pattern is a 1-candlestick pattern that indicates the continuation of a trend. This pattern is a small body with the opening and closing prices very close. It looks like a plus sign or a cross, and the wicks vary.
The small body of this pattern says there is indecision between buyers and sellers. Neither side has enough power to dominate the candle, so it makes no gains. On its own, the Doji pattern points to continuity due to the neutral outcome of the buyer-seller struggle. Still, combined with other candles, such as the morning and evening star, it can suggest reversal.
The Rising Three Methods
The Rising Three Method is a 5-candlestick pattern that indicates a continuation of the uptrend. If this pattern appears, subsequent candles go much higher.
It is three consecutive-bearish candles between two central bearish candles. This pattern occurs when the buying pressure is significant on the first day, followed by short selling on the second, third and fourth small bearish candles. The fifth bullish Candlestick shows that buyers are gaining momentum, and prices are moving higher from the previous high.
Falling Three Methods
Another 5-candlestick pattern pointing to its continuation is the Falling Three Method. This pattern signals the continuation of a trend in a downtrend and is a bearish first candle with its substantial body showing the seller’s strength. After that, three consecutive bullish candles with a small body took over the previous trades and showed profits appeared. Unfortunately, the purchasing power of these three candles is not large enough to beat the first bearish candle, so the bearish gives way to the fifth candle.
Rotating Top Pattern
A 2-candlestick pattern also used by many traders is the Spinning Top Pattern. It consists of two Doji-like candles of equal size and indicates the continuation of the current trend.
It is a two-candle whose opening and closing prices are very close, expressing neutrality between buyers and sellers. This pattern indicates consolidation or a moment when the price has stalled and has not made any significant moves.
What are the characteristics of candlestick patterns?
We need to understand the basics to understand how to use these candlestick patterns. So, what are candlestick patterns? First of all, candlesticks are price charts used and used for technical analysis. It shows the ups and downs and the openings and closings of a market in a given time frame. Its use dates back to ancient Japanese times when rice traders used candlesticks with traders to keep track of prices and the daily momentum of their wares.
The broad or thick part of a candle is the body, often called the ‘true body,’ while the thin slice at the ends is called the ‘wick’ or sometimes the ‘tail.’ There are two types of candles – bullish candle and bearish candle. A bullish candle is a green candle that signals an “up” or uptrend market. On the other hand, a red candle represents the bearish candle and is a signal for a ‘bearish’ or downtrend market. The opening price is at the lower end of the body for a rising candle, while the closing is at the upper end. On the other hand, the opening price of the bearish candle is at the upper end of the body; the ending is at the lower back.
Candlestick patterns can consist of a single candlestick or a collection of candlesticks in a given time frame, representing the movement of a price range within a chart over some time. Traders resort to candlestick patterns to predict the possible next move of a price. While there is no concrete proof that candlestick patterns can predict the market’s future with 100% accuracy, they can provide reasonable predictions about the following price action.
Frequently Traded Candlestick Patterns
Here are commonly traded candlestick patterns: Pocket Options.
Marubozu Candlestick Pattern
A single candlestick pattern that is easy to see is the Marubozu candlestick pattern. It is easy to find because the candle has a solid body with few or no wicks. This candlestick pattern usually appears on a highly volatile chart and can be in the middle or end of a trend. Also, this pattern could be the result of solid fundamentals or news about a particular asset.
To trade the Marubozu candlestick pattern, you must consider the trend of the market and the location of the way on the chart. When an ascending Marubozu pattern emerges during a strong uptrend, it signals a possible trend continuation where buyers dominate the trade. The ideal entry point, in this case, would be the close of the bullish candle. On the other hand, dealing with a bearish Marubozu pattern in an uptrend could indicate a trend reversal. The ideal starting point for this situation would be the closing point—a bearish candle. The same goes for the pattern appearing in a downtrend. Perfect entry and exit points are a bullish candle and the close of a bearish candle, respectively. Other traders wait for a confirming candle after the formation to confirm the trend direction.
Rotating Top Pattern
As the name suggests, the spinning top pattern shows the image of a ball with a small body and a small tailor wick. This body is a standard single candlestick pattern that indicates indecision in the market. This pattern suggests that one side has become more potent than the other. The swirling top design is often a sign of a trend reversal.
To apply the Rotating Top on the actual chart, consider the trend and the size of the candles before pattern formation. Thinning candles are often signs of trend reversals. For an uptrend, forming a top at the end of the trend signals a possible trend reversal. Confirm the reversal through a series of thin candles. For long runs, the ideal exit will be at the tip of the crown body. The same goes for a top that appears to be in a downtrend. The perfect entry for long positions would be at the same price as the body of the top.
Another candle that signals the traders in the market is the Doji candle. Although this pattern contains only one candle, it is an important signal for many traders. Its shape resembles the letter ‘T’ for a bearish Doji and an inverted ‘T’ for an uptrend Doji. Now, to apply the Doji candle to a chart, let’s look at some variations of it.
As the name suggests, the Neutral Doji indicates neutrality on the chart where both buyers and sellers are in a stalemate. Its shape resembles a crosshair with tails of almost equal length at both ends. The best entry or exit point of a neutral Doji is at the end of the queue.
Another form of the Doji candle is the Long-Legged Doji, which indicates indecision in the market. Its shape shows a cross with a long tail. The opening and closing prices meet simultaneously, meaning delay and just like the Neutral Doji. While this signal has the same interpretation as the neutral candle, longer tail lengths indicate higher volume from the respective buyers and sellers. When you encounter the Long-Legged Doji, trade at the end of the tails. You can expect a confirmation candle after the pattern as a safety precaution.
Dragonfly Doji forms a capital’ T.’ It is not a very common candle on a chart, but it indicates that the trend continues when it appears. The bears start forming this pattern, but the bulls flock to push the price higher. This pattern is at the end of an uptrend. The best point for this pattern is at a price level above the closing price. The perfect stop loss level would be below the tail.
The equivalent of the Dragonfly Doji is the Tombstone Doji, which is an inverted capital ‘T.’ In the formation of this formation, the bulls initially had the advantage, but eventually, the bears took over the market. This pattern appears at the end of a bullish market or uptrend. To trade this pattern, sell or open at the closing part of the candle.
Two types of hammer candles are the bullish hammer and the bearish hammer. The bear attractor shows a candle with a small body with a long tail hanging at the bottom. This shape indicates a trend reversal from an uptrend; the ideal exit for long trades would be a level below the opening price.
On the other hand, a bull hammer is in a downtrend market. This candle formation signals a bearish to a bullish trend reversal. The ideal entry would be from the body’s closing price for long trades.
To sum up the most traded Candlestick patterns
Candle formations are a trader’s best friend. The pattern advises them and shows them the possible future of the market. Of course, the accuracy of the predictions from candlestick formations depends on how the trader interprets them. The best way to increase your accuracy in interpreting candlestick formations is through experience. An excellent way to gain experience trading in real-time markets is using a demo account and listening to Bitunivex experts. As soon as you gain enough confidence in trading candlestick patterns, you can switch to real-time trading with live funds.
Some risk warnings of using Candlestick patterns
Trading products offered by companies on their website carry a high level of risk and may result in the loss of all your funds. You should never trade money that you can’t afford to lose. So, let’s learn some useful points to analyse the patterns in the best way.
Elliott Wave Analysis
Traders use the Elliott Wave principle as technical analysis to analyse market cycles and predict market trends by determining the extremes of investor psychology, highs, and lows for prices and other collective factors.
Elliott Wave traders believe that markets get influenced by collective investor psychology, or crowd psychology, and move between optimism and pessimism in natural sequences.
It seems like an appropriate discipline for cryptocurrency traders as, at the moment, they are only driven by investor psychology as there is no real underlying foundation supporting price growth; just aggressive buying due to limited supply has this responsibility. To master Elliott Wave analysis takes years of experience, but some cryptocurrency traders feel they have a good grasp of the fundamentals to apply them to markets like Bitcoin.
Fibonacci levels are a branch of Elliott Wave Analysis is a way to find possible support and resistance levels in the cryptocurrency market.
For example, after creating a high/low range, traders expect a market to follow 38.2% to 61.8% of that range to make the next potential buy or sell opportunity. Both are Fibonacci levels.
Conversely, after making a bottom, for example, a trader will try to predict the next rally by applying math to the price action. Traders use the Fibonacci level to predict trend length and trend retracements.
Stochastic and Relative Strength Index (RSI)
Stochastic and Relative Strength Index (RSI) is known as oscillators in technical analysis because they move between 0 and 100 high. It determines the strength of a trend or predicts highs and lows due to overbought and oversold conditions. As Bitcoin prices are generally high in volatility due to an overbought or overbought trading situation, the RSI indicator signals traders to enter or exit a particular position.
During a long downward move, the oscillators will be close to 0, indicating that a bottom may be tight. During a long upward movement, the oscillators will approach 100, which suggests that a top may be close. Bitcoin is currently at 81.92 (RSI) in the attached chart, meaning Bitcoin is overbought, and a correction will happen.
MACD or Moving Average Convergence/Divergence
MACD is an indicator. It consists of two exponential moving averages that help measure the momentum in a cryptocurrency.
The MACD compares short-term and long-term momentum within the cryptocurrency market to indicate the current momentum direction rather than the price direction.
When the MACD is positive, the momentum of the cryptocurrency is up. When the MACD is negative, the rate is low.
An Ichimoku Cloud is an indicator that identifies support and resistance areas, determines trend direction, measures momentum, and provides trading signals. “Clouds” are formed between the moving averages of six months and the midpoint of the 52-week high and low plotted six months ahead.
The overall trend rises when prices are above the cloud, falls when prices are below the cloud, and flattens when in the cloud itself.
Get better use of the Candlesticks and their analysis
When trading cryptocurrencies such as Bitcoin using various technical analysis tools, it is essential to believe what you are trying to achieve.
For example, suppose you are a trend trader and use a trend indicator tool. You may not want to blur your analysis with an oscillator because this could indicate that a market is overbought or oversold. In other words, learn the specifics of each technical tool before applying it to a real need. With its lack of fundamentals, technical analysis indicators in cryptocurrencies, especially Bitcoin, is essential for every crypto trader.
Hundreds of technical indicators are available for traders. It is good to limit your analysis to three or four indicators that measure different aspects of price action. Cryptocurrencies, particularly Bitcoin, tend to follow technical indicator rules. The following three indicators consider volatility, retracement levels, trend, and oscillation.
Bollinger Bands are indicators that plot bands that contain most of the price action of a security based on its standard deviation and moving average. The lower band gets calculated by subtracting a certain number of standard deviations from a given moving average. The upper band is easy to calculate by adding the same standard deviations to the mean amount. The parameters are 20 periods for the moving average and two standard deviations; other parameters can get used, too.
Traders use Bollinger bands in several ways, and we highlight four of these methods.
- Trending bullish price action embraces the upper band. Traders can start long positions with a trailing stop. The reverse is true for prices surrounding the lower band.
- Short positions can get initiated when the price moves down with a target in the lower band. The reverse is true for long positions and the rising moving average.
- A trend change can usually be detected when the price first rejects one of the bands and then breaks the band at roughly the same level. The lower Bollinger Band initially provided support but later replaced it, showing that the downtrend is in its proper place.
- When the pattern of the previous example is not complete, it can confirm the continuation of the last wave. So, the price rejects the upper band and then fails to touch the upper band on the second attempt, signalling that the market is still weak and the downtrend is likely to continue.
Commodity Channel Index
The Commodity Channel Index compares average price movements and then displays those movements as a value above and below zero. About 80% of the price action will keep the CCI between -100 and +100; any activity outside this range will be extreme.
The most reliable way to trade on CCI is to identify the trend and trade in the movement direction when there is an extreme move in the opposite direction. In the example above, the trend is bearish. Short positions happen when CCI rises above 100 and then falls below 100 again. When CCI reaches -100, profit will happen, or short classes can get held with a trailing stop loss.
Flags and Pennants
Flags and pennants are continuation patterns marked as a short period of consolidation before the previous move continues. The design is usually a sharp increase or decrease in the asset’s price. Flags and pennants are often used interchangeably because of the shape they form.
A flag or pennant appears when the price rises or falls sharply, followed by a slight sideways movement. This lateral movement can form a rectangular flag or a small triangle (pennant). The sharp rise or fall in price before a flag or banner is the flagpole.
Trend lines along with the highs and lows of the sideways price action identify a breakout from the lateral movement—a decisive move following the breakout direction when a flight occurs.
In the case of a bullish flag, when a flag or pennant pattern appears, the stop loss is just below the lower trendline. So, if price action has bearish behaviour, the stop loss flag or pennant is just above it.
To determine the target price at which the trend can break, traders can measure the price of the flagpole and then add that length below the flag or pennant for a bullish pattern. In a bear pattern, the flagpole length comes from the top of the flag or banner.
In trades based on flag/pennant patterns, the potential for reward often outweighs risk by three or more indicator factors. Buy and sell on upside breakouts for bullish patterns and downside breakouts for bearish patterns.
Our final thoughts
All these patterns can be daunting and hard to memorise in one sitting. However, knowing about these patterns can enable a trader to make safer and more accurate trading decisions. Also, while most of the time, these patterns do indeed end up reversing or continuing, it’s always best to get a “confirmation” of their default outcome. Good confirmations to use in this context are support and resistance levels, trend lines, and even indicators like MACD, RSI, and Stochastics to confirm reversals.
Having a good grasp of what the pattern looks like does not guarantee that you will make firm decisions in trading. A good trader should always do due diligence to validate a particular way by researching, reading company descriptions or announcements, checking history, etc. Additionally, a good trader also needs a good amount of practice in applying such patterns. Through diligent research and continued practice, the eToro platform increases its chances of making a profit.
With the Japanese Candlestick, each candle will tell a story. Correctly interpreting these candles improves one’s trading skills. In this article, we will share frequently traded candlestick patterns—pocket Option. We will also share some techniques and strategies to change these patterns for better chances of success.