Table of Contents:
- What is a candlestick pattern?
- How to read candlestick patterns
- Single candlestick patterns
- Dual candlestick patterns
- Triple candlestick patterns
- Candlestick pattern FAQs
- The bottom line
Investing involves using data to decide whether to buy or sell particular stocks. Data is often presented in charts, where recognized shapes, or patterns, can form. A recognized shape a chart could form is called a pattern. Patterns are used to help investors predict changes in price, but it’s important to note that patterns aren’t useful on their own. In this article, we’ll review candlestick patterns.
What is a candlestick pattern?
Before we can explain what a candlestick pattern is, let’s first dive into a candlestick chart. A candlestick chart gives the following information for each day: the highest value the stock was sold for, the lowest value the stock was sold for, the value the stock was sold for at the start of the day, and the value the stock was sold for at the end of the day. Information for each day is presented in the shape of a “candle”, where all the candles are arranged side by side.
So what are candlestick chart patterns? A candlestick pattern is a form a candlestick chart can take. Traders care about candlestick patterns because they are believed to indicate future price movements. We list many examples below.
- Candlestick charts have been around for centuries (they were used in the 1700s in the Japanese rice trade) and utilized by investors to anticipate pricing trends in the stock market.
- There are many candlestick patterns, and each offers signals of changing directions in bearish and bullish markets.
How to read candlestick patterns
A candlestick has 3 components:
- The body provides the open and close price ranges.
- The wicks (also known as shadows) show the high and low for the day.
- The color indicates which direction the market is headed: A green or white body shows a price increase, and a red or black body indicates a price decrease.
Generally, there are 2 types of markets: a bull market and a bear market. A bull market is when stock market prices are expected to rise, and a bear market is when prices are expected to fall.
Correspondingly, candlestick patterns that suggest prices will rise are called bullish, and candlestick patterns that suggest prices will fall are called bearish. An advantage of candlestick charts is they efficiently give a lot of information, making it easy to recognize patterns.
Types of candlesticks & performance indicators
As a rule, candlestick patterns show the battle between bullish markets and bearish markets over a period of time. In order to understand the wide variety of candlestick patterns, you need to understand a few basic definitions.
- Reverse candlestick patterns – represent an overall change in the direction of stock prices in either an uptrend or downtrend.
- Continuation candlestick patterns – show that a current trend is expected to continue and is the opposite of a reverse pattern.
- Bullish candlestick patterns – can be a good entry point for long trades and can be used to anticipate a change from a downtrend to an uptrend.
- Bearish candlestick patterns – show an existing uptrend is about to reverse to a downtrend.
Although the stock market is known to be unpredictable, investors use a variety of tactics to identify changes in the market to help them decide how to proceed. Some patterns have become popular due to their simplicity.
As with any pattern, candlestick patterns can give you some information about the mood of the market and very limited information about the real-world situation affecting the stock price. They are only useful in combination with insights (e.g., if a company introduces a potentially successful product, then its stocks are likely to rise). However, no matter how well you prepare, it is still possible to lose some or all of your investment.
An uptrend of a stock is a period over which the price of the stock generally increases. That is, the price can wiggle on a small scale but must generally be increasing on a large scale.
When a trader is considering a pattern in a particular chart, they want to be sure of two things:
- What the pattern suggests is happening is actually happening.
- It is going to keep happening long enough for it to be worth making a trade.
If the candlesticks in a pattern are long compared to the surrounding candlesticks, this is evidence for the first statement but maybe evidence against the second statement.
Single candlestick patterns
Compared to larger candlestick patterns, smaller candlestick patterns are more common and correlate even less with future market behavior.
A hammer candlestick occurs during a downtrend and has similar opening, closing, and high prices but a much lower low price. It looks like a hammer with the long bottom wick being the handle and the body of the candle being the head of the hammer. Hammers are considered to be bullish.
An inverted hammer candlestick occurs during a downtrend and has similar opening, closing, and low prices but a much higher high price. Inverted hammers are considered to be bullish.
A hanging man candlestick pattern occurs during an uptrend and has similar opening, closing and high prices but a much lower low price. This pattern is considered to be bearish, which is appropriate, because of the morbid form it takes.
A shooting star candlestick occurs during an uptrend and has similar opening, closing and low prices, but a much higher high price. It’s thought to be a bearish candlestick.
Dual candlestick patterns
Two black gapping
Two black gapping is a continuation pattern that suggests a bearish market trend will continue. It usually develops after an uptrend with a dip that falls lower and lower and is seen as a predictor that the decline will continue into a full-blown downtrend.
The piercing line pattern is a bullish 2 candlestick reversal pattern positioned at the bottom of a market downtrend. It may precede a trend reversal from bearish to bullish. The first candle is red and closes properly above where the second candle opens. The second candle is green and closes above the halfway point between the open and close of the first candle. The larger the candles, the stronger the indication is. However, remember indication is never very strong or long term (it is a simple pattern, so it is common whatever the underlying market conditions).
Dark cloud cover
The dark cloud cover is the opposite of a piercing line. It follows an uptrend and has two candlesticks. The first is green and closes properly below the opening of the second candlestick. The second candlestick is red and closes below the middle of the body of the first candlestick. This pattern is thought to suggest the market is going to enter a downtrend.
Bullish and bearish engulfing candlestick patterns
These both are two candle patterns with the body of the second candle covering the body of the first candle. For a bullish engulfing candlestick pattern, the first candle is bearish, and the second candle is bullish. For a bearish engulfing candlestick pattern, the first candle is bullish, and the second candle is bearish.
A bullish engulfing pattern indicates a reversal when it appears in a downtrend, while the bearish engulfing pattern indicates a reversal when it appears in an uptrend.
Triple candlestick patterns
Three candlesticks form an evening star candlestick pattern if:
- The first candle is large and green.
- The middle candle is short and lies above the first (not including the wicks).
- The third candle is large and red.
- The bottom of the third candle is within the lower half of the first candle.
This pattern is thought to suggest that the stock’s price will decrease in the following days.
The morning star pattern is the opposite of the evening star pattern. Three candlesticks form a morning star candlestick pattern if:
- The first candle is large and red.
- The middle candle is short and lies below the first (not including the wicks).
- The third candle is large and green.
- The top of the third candle is within the upper half of the first candle.
When this pattern occurs after a bearish period, it is thought to suggest that the stock’s price will increase in the following days.
Evening doji star
A doji is a candle that is very short, corresponding to a day when the opening and closing prices were very similar. An evening doji star pattern is an evening star pattern satisfying the extra condition that the middle candle is a doji. This extra condition is thought to make these patterns more significant.
Morning doji star
As you might expect, a morning doji star pattern is a morning star pattern satisfying the extra condition that the middle candle is a doji. This extra condition is thought to make it more significant.
Bearish abandoned baby
The bearish abandoned baby is another kind of evening star pattern. The extra condition this time is that the middle candle is above the last candle as well as the first. As with the evening star pattern, the abandoned baby is a reversal pattern which means that it is thought to herald a change in the direction the price of the stock is moving, in this case from up to down. It is rare and is thought to be a strong indicator.
Bullish abandoned baby
A bullish abandoned baby is another type of morning star pattern (you have probably spotted the pattern now). To count as a bullish abandoned baby, a morning star pattern must have a middle candle that is below the third candle as well as below the first. As with the bearish abandoned baby, the pattern is thought to be a strong indicator that the direction of the market is going to change, this time from bearish to bullish.
Three black crows
The three black crows pattern consists of 3 long red candlesticks (black is sometimes used instead of red, hence the name).
Each candle should have a short bottom wick, and the second candle should close lower than the first candle. The third candle should close lower still.
If this pattern occurs during an uptrend, it is thought to suggest that the market has lost confidence in the stock, and it’s price will fall. Though, if the price has fallen significantly over the 3 days of the pattern, then it may have done all the falling it is going to do.
Three white soldiers
The three white soldiers pattern is the opposite of the three black crows. Where three black crows pattern after an uptrend suggests that prices may start to fall, three white soldiers after a downtrend suggests that prices may start to rise.
Three white soldiers pattern is formed by 3 green (white is sometimes used instead of green) candlesticks, each closing higher than the last and with short top wicks.
Three line strike
The three line strike candlestick pattern is a 4-candle pattern. It has a bullish version and a bearish version (which is the same as the bullish version except everything is upside down).
A bullish three line strike has 4 candles:
- The first 3 candles have progressively lower closes.
- The fourth candle opens lower than the low of the third and closes higher than any of the highs of the earlier three candles.
- The fourth candle also has a short bottom wick.
After a period of price decline, the bullish three line strike is thought to herald a period of a price increase. Correspondingly when after a period of price increase, a bearish three line strike is thought to herald a period of a price decline.
Symmetrically, a bearish three line strike has 4 candles:
- The first 3 candles have progressively higher closes.
- The fourth candle opens higher than the high of the third candle and closes lower than any of the lows of the earlier 3 candles.
- The fourth candle also has a short top wick.
Candlestick pattern FAQs
Q: How many candlestick patterns are there?
Although there should be an easy answer to this question, the fact is that there are different answers depending on the source. Some say 16, while others report 35, and even say it is as many as 64. Of course, some candlestick patterns are simple, while many are more complex and challenging to identify.
Q: Are candlestick patterns reliable?
Short answer is “no”. Long answer is: “combined with real-world analysis, they are more reliable than the real-world analysis by itself.”
The bottom line
Candlestick charts are a useful way of looking at stock price movements. There are many candlestick patterns, each making a prediction with varying degrees of reliability. They need to be understood in the context of the rest of the chart and the real-world situation they are presented in.
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