Candlestick charts: all you need to know

How to read a candlestick chart

Candlestick charts are one of the most widely used tools in financial analysis. Developed in the 18th century by Japanese rice trader Munehisa Homma, this charting method visually represents price movements over a specific timeframe. Candlestick charts help traders interpret market sentiment, price action, and trend direction at a glance, making them an essential component of technical analysis.

Each candlestick provides insights into continuation patterns and trend reversals, allowing traders to make informed decisions. Whether analyzing short-term fluctuations or long-term trends, candlestick charts offer a graphical illustrationof how buyers and sellers interact in the market.

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How to Read a Candlestick Chart

Each daily candlestick displays four key price points: open, high, low, and close (OHLC).

The real body represents the range between the opening and closing prices.

The upper wick (or shadow) extends to the highest price reached during the session.

The lower wick (or shadow) extends to the lowest price reached during the session.

A bullish candlestick (typically green or white) forms when the closing price is higher than the opening price. A bearish candlestick (typically red or black) forms when the closing price is lower than the opening price.

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Anatomy of a Candlestick

A candlestick consists of:

Body: Indicates the range between the open and close prices.

Wicks (Shadows): Show the highest and lowest prices.

Color: A green/white body signals a bullish trend, while a red/black body signals a bearish trend.

Understanding candlestick anatomy is crucial when analyzing market sentiment and price action. Combining candlestick patterns with volume indicators can provide stronger trading signals.

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Candlestick Patterns

Candlestick patterns are divided into bullish and bearish formations. These patterns signal possible trend reversals or continuations.

Bullish Patterns

These patterns indicate that buyers are gaining control and a potential uptrend may follow.

Hammer: A single candlestick with a small body and long lower wick, signaling a bullish reversal.

Piercing Pattern: A two-candle formation where a bullish candle closes above 50% of the previous bearish candle.

Bullish Engulfing: A two-candle pattern where a larger bullish candle completely engulfs the previous bearish candle, indicating a strong bullish reversal.

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Bearish Patterns

These patterns suggest that sellers are regaining control and a downtrend may occur.

Hanging Man: A single candlestick with a small body and long lower wick, appearing at the top of an uptrend, signaling a bearish reversal.

Dark Cloud Cover: A two-candle pattern where a bearish candle closes below 50% of the previous bullish candle.

Bearish Engulfing: A two-candle pattern where a larger bearish candle engulfs the previous bullish candle, suggesting a strong bearish trend.

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Hammer 

Hammer is a single candlestick pattern that is formed at the end of a bearish trend. It signals a bullish reversal. 

The real body of the candle is small. The lower shadow is long, it can be twice as long as the real body. The upper shadow is either absent or very short.

Here is an example of the pattern.

Piercing pattern

This is a multiple candlestick pattern. It is formed at the end of a bearish trend and indicates a bullish reversal. 

This pattern is formed by two candles. The first candle is bearish and indicates that the downtrend is going to continue. The second candle is bullish. It closes more than 50% of the previous candle’s real body. It shows that bulls are back, and soon, a bullish reversal is going to take place.

Here is how the piercing pattern may look on a chart. 

Bullish Engulfing

Bullish engulfing is a pattern formed by multiple candles. This pattern is formed to mark the end of a downtrend and the start of a bullish movement.

Bullish engulfing is formed by two candles. The first candle is bearish and indicates that the market is in a downtrend. The second candle is bullish, it engulfs the first candle to show that bulls are back in the market.

Here is how this pattern can be seen in a chart.

Bearish patterns

Bearish patterns signal that bears are back, and soon, a downtrend in the market will start. The most popular bearish patterns are Hanging Man, Dark Cloud Cover, and Bearish Engulfing.

Hanging Man

Hanging Man is a pattern formed by a single candlestick. It is formed at the end of an uptrend and signals the start of a downtrend.

The real body of the candle is small, with the lower shade at least twice as long as the candle’s real body. The upper shadow is either very short or absent.

When the sales opened, sellers pushed the prices down. Buyers were trying to save the situation and pushed the prices up but failed. So the asset prices closed below the opening price.

Here is how this pattern may look in a chart.

Dark Cloud Cover

Dark Cloud Cover is a pattern formed after an uptrend, it indicates the trend reversal. The Dark Cloud Cover pattern is formed by two candles. One candle is bullish and signals that the uptrend will continue. The second candle is bearish, it closes more than 50% of the real body of the previous candle. This candle shows that bears are back in the market.

Here is how this pattern may look in a chart.

Bearish Engulfing

Bearish engulfing is a pattern that signals the reversal from an uptrend to a bearish trend. Bearish Engulfing is formed by two candles. The first candle is bullish and signals the continuation of a bullish trend. The second candle is bearish; it engulfs the bullish candle and signals that bears are back in the market.

Common Candlestick Formations

Candlestick formations play a crucial role in identifying potential price movements. Here are some of the most frequently observed formations:

Doji: A neutral pattern where the open and close prices are nearly equal, signaling indecision.

Shooting Star: A bearish reversal pattern with a small body and long upper wick, indicating a potential downtrend.

Morning Star: A three-candle bullish reversal pattern signaling the end of a downtrend.

Evening Star: A three-candle bearish reversal pattern indicating a shift to a downtrend.

Three Black Crows: Three consecutive bearish candles suggesting strong downside momentum.

Three White Soldiers: Three consecutive bullish candles indicating strong upward momentum.

Bullish Harami: A two-candle pattern where a small bullish candle follows a larger bearish candle, signaling a reversal.

Bearish Harami: A two-candle pattern where a small bearish candle follows a larger bullish candle, indicating a potential decline.

Bullish and Bearish Harami Cross: A variation of the Harami pattern where the second candle is a Doji, adding more significance to the reversal.

Traders often use these formations alongside volume and momentum indicators to confirm trends and make more precise trading decisions.

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Comparative Chart Analysis

Candlestick charts provide more insight than bar charts by visually representing market sentiment. Unlike bar charts, which only show OHLC values, candlestick charts illustrate market emotion through patterns.

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Price Points in Candlesticks

Candlesticks highlight key price levels:

Open Price: The first price of the trading session.

Close Price: The last price before the session ends.

High Price: The highest price reached during the session.

Low Price: The lowest price reached during the session.

By analyzing these price points, traders can identify support and resistance levels, trend strength, and potential reversal points.

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Bottom Line

Candlestick charts have been used for centuries and remain one of the most effective tools in technical analysis. However, they should be combined with other indicators for more accurate forecasts.

Use bullish patterns to identify potential buy opportunities.

Use bearish patterns to detect potential sell signals.

Compare candlestick charts with volume and trend indicators for confirmation.

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