Candlestick Patterns Explained

Candlestick patterns are a form of technical analysis and charting used in the shares, currencies, indices, and other markets. These patterns are a visual representation of price movements. In this article, we will delve into the world of candlestick patterns, explaining what they are, how they work, and the various types of patterns traders commonly use.

What are Candlestick Patterns?

Candlestick patterns are a type of chart pattern that originates from Japan. They were used in the 18th century by a Japanese rice trader named Homma. He discovered that, while there was a link between price and the supply and demand of rice, the market was strongly influenced by the emotions of traders.

Candlesticks show the open, high, low, and close prices for the market they are tracking. While the hollow or filled portion of the candlestick is termed the “body,” the long thin lines above and below the body represent the high/low range and are called “shadows” (also referred to as “wicks” and “tails”). The high is marked by the top of the upper shadow and the low by the bottom of the lower shadow.

Understanding Candlestick Patterns

To understand candlestick patterns, it’s essential to understand the fundamental concepts behind them.

1. Bullish and Bearish

In trading, you will often hear the terms “bullish” and “bearish.” These refer to rising and falling market trends, respectively. If a candlestick is filled (or colored), it means the closing price for that period was less than the opening price, indicating a bearish trend. Conversely, if the candlestick is hollow (or not colored), it means the closing price was greater than the opening price, indicating a bullish trend.

2. The Body and Shadows

The body of the candlestick represents the range between the opening and closing prices of the period. If the body is filled, the top of the body gives the opening price, and the bottom gives the closing price. For a hollow body, the bottom of the body shows the opening price, and the top shows the closing price. The shadows, on the other hand, represent the price extremes for the period.

Common Candlestick Patterns

There are many types of candlestick patterns that traders use to identify market trends and make trading decisions. Here are a few of the most common ones:

1. Doji

A Doji is a pattern that indicates uncertainty or a struggle for positioning between buyers and sellers. The pattern is formed when the opening and closing prices are virtually equal.

2. Hammer

A Hammer is a bullish pattern that forms during a downtrend. It is named the hammer because it hammers out a bottom. The lower shadow should be at least twice the length of the body, and there should be little or no upper shadow.

3. Hanging Man

The Hanging Man is a bearish pattern that appears at the end of an uptrend. It has the same shape as the Hammer, but it forms at the end of an uptrend.

4. Engulfing

The Engulfing pattern is a reversal pattern that can be bearish or bullish, depending on whether it appears at the end of a downtrend (bullish engulfing) or an uptrend (bearish engulfing).

Understanding candlestick patterns can be a powerful tool for any trader. They provide a visual representation of market activity that can help predict future price movements. It’s important to remember, however, that no single technical indicator is foolproof and that they should be used in conjunction with other indicators and strategies.