Candlesticks show that emotion by visually representing the size of price moves with different colors. Traders use the candlesticks to make trading decisions based on regularly occurring patterns that help forecast the short-term direction of the price.
KEY TAKEAWAYS
- Candlestick charts are used by traders to determine possible price movement based on past patterns.
- Candlesticks are useful when trading as they show four price points (open, close, high, and low) throughout the period of time the trader specifies.
- Many algorithms are based on the same price information shown in candlestick charts.
- Trading is often dictated by emotion, which can be read in candlestick charts.
Candlestick Components
This real body represents the price range between the open and close of that day's trading. When the real body is filled in or black, it means the close was lower than the open. If the real body is empty, it means the close was higher than the open.
Basic Candlestick Patterns
Candlesticks are created by up and down movements in the price. While these price movements sometimes appear random, at other times they form patterns that traders use for analysis or trading purposes. There are many candlestick patterns. Here is a sampling to get you started.
Patterns are separated into bullish and bearish. Bullish patterns indicate that the price is likely to rise, while bearish patterns indicate that the price is likely to fall. No pattern works all the time, as candlestick patterns represent tendencies in price movement, not guarantees.
1. Hammer
Hammer is a one candle pattern that occurs in a downtrend
when bulls make a start to step into the rally. It is so named because it
hammers out the bottom. The lower shadow of hammer is minimum of twice the
length of body. Although, the color of the body is not of much significance but
a green candle shows slightly more bullish implications than the red body. A
positive day i.e. a green candle is required the next day to confirm this
signal.
2. Inverted Hammer
Inverted
hammer is one candle pattern with a shadow at least two times greater than the
body. This pattern is identified by the small body. They are found at the
bottom of the decline which is evidence that bulls are stepping in but still
selling is going on. The color of the small body is not important but the green
body has more bullish indications than a red body. A positive day is required
the following day to confirm this signal.
3. Hanging
Man
The hanging
man appears during an uptrend, and its real body can be either red or green.
While it signifies a potential top reversal, it requires confirmation during
the next trading session. The hanging man usually has little or no upper
shadow.
4. Shooting
Star
The
Shooting Star is a single line pattern that indicates an end to the uptrend. It
is easily identified by the presence of a small body with a shadow at least two
times greater than the body. It is found at the top of an uptrend. The Japanese
named this pattern because it looks like a shooting star falling from the sky
with the tail trailing it.
5. Bearish Engulfing Pattern
A bearish engulfing pattern develops in an uptrend when sellers outnumber buyers. This action is reflected by a long red real body engulfing a small green real body. The pattern indicates that sellers are back in control and that the price could continue to decline.
6. Bullish Engulfing Pattern
An engulfing pattern on the bullish side of the market takes place when buyers outpace sellers. This is reflected in the chart by a long green real body engulfing a small red real body. With bulls having established some control, the price could head higher.
A bearish harami is a small real body (red) completely inside the previous day's real body. This is not so much a pattern to act on, but it could be one to watch. The pattern shows indecision on the part of the buyers. If the price continues higher afterward, all may still be well with the uptrend, but a down candle following this pattern indicates a further slide.
8. Bullish Harami
The bullish harami is the opposite of the upside down bearish harami. A downtrend is in play, and a small real body (green) occurs inside the large real body (red) of the previous day. This tells the technician that the trend is pausing. If it is followed by another up day, more upside could be forthcoming.
9. Bearish Piercing
Bearish Piercing is look at in an existing uptrend, which consists of a long green candlestick followed by a gap higher open during the next session, but which closes at least below halfway (50%) into the prior green candlestick’s real body.
10. Bullish Piercing
The first thing to look for is to spot the piercing pattern in an existing downtrend, which consists of a long red candlestick followed by a gap lower open during the next session, but which closes at least above halfway (50%) into the prior red candlestick’s real body.
11. Evening Star
The Evening Star is a top reversal pattern that occurs at the top of an uptrend. It is formed by a tall green body candle, a second candle with a small real body that gaps above the first real body to form a “star” and a third red candle that closes well into the first session’s green real body.
