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Looking for the most common candlestick patterns? This guide is for you!
Staying informed of the potential market movements is the key to a trader’s success and in most cases, market knowledge translates into knowing the potential patterns and trading tricks. Also called “candlestick patterns”, those are the forecasted movements of the market, based on its course so far.
So, stay with us to discover the 10 most common candlesticks of the market that every new or advanced trader should know!
Let’s get started!
The Components of a Candlestick
The main three components of a candlestick include:
- Body – The rectangular shape of an asset’s opening and closing price over a period.
- Shadows (Wicks) – Smaller lines extending out of a body, representing high and low values over a period.
- Color Insignias – Green (or white) candlesticks represent bullish price actions (closing price > opening price), and red (or black) ones represent bearish price actions (closing price < opening price).
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Common Candlestick Patterns:
Candlestick patterns are an essential component of the market’s technical analysis every trader should do. They generally separate into bullish (increasing) and bearish (decreasing) candlesticks.
Let’s explore the most popular formations that can happen on the market!
Bullish Candlestick Patterns
The bullish forms occur regularly at a downtrend’s base and indicate a future price move in a positive direction. Knowing these types of candlestick patterns will not only help you survive market volatility, but teach you essentials on how to refine your trading.
Let’s start!
1. Hammer
The hammer shape of a candlestick is a strong bullish sign of a downtrend’s base, with a little body at the price range’s upper edge and a long wick, at least twice in a long distance in relation to its little body. The long wick signifies a big price drop during a trading session, with sellers driving down a price, but buyers taking over and driving it in a positive direction, closing at a price near its opening price.
The direction change in momentum reflects the future direction change, possibly in a bullish direction. To confirm, a strong bullish candle in a successive session is waited for, and in case a future candle in a successive session closes over a hammer’s high, it confirms a strong chance for a direction change in the trend.
Aside from that, a hammer form is pretty effective when accompanied by increased trading volumes, representing high buying volumes. Traders will even seek a level of support at which a hammer forms and such a level can confirm a sign of reversal.
2. Bullish Engulfing
A bullish engulfing is a strong two-candle shape that confirms a future bullish reversal and an essential component of the market trends. It occurs when a small bearish candle accompanies a larger bullish one, and engulfs the first one’s body.
Note: The shape reflects a change in attitude in the marketplace, with buyers dominating sellers and taking prices in a positive direction.
The first one reflects a sustained sales drive, and the second one reflects a strong re-entry of buyers. Increased trading activity in the second one reflects confirmation of success in the shape. The bullish engulfing shape is strong when it occurs at strong supporting price levels and in a long downtrend, reflecting strong demand.
3. Morning Star
The morning star is a three-candle shape that confirms a future bullish reversal.
It consists of three candles:
- A long one that is bearish
- Small-bodied one (which can be bullish or bearish)
- A long one that is bullish.
The second one reflects indecision in the financial market and tends to be a doji or a spinning top, reflecting bears getting exhausted in sales. The third one reflects a reversal, with buyers re-entering and taking the price in a positive direction.
The shape is strong when it occurs following a deep downtrend and at strong supporting price levels. Traders look for an improvement in trading activity in the third one for a reflection of a reversal. Breakage over the morning star high confirms a bullish outlook.
4. Piercing Pattern
The piercing pattern is a two-candlestick configuration, and it is a sign of a probable bullish reversal. It occurs when a bearish candle is followed by a bullish one with an opening below but closing price at a level over the midpoint of the previous bearish candle. This switch is a sign that buyers have taken over at the end of a downtrend.
For confirmation, a closing price at a level higher in the subsequent session is preferable. The best use of the pattern is when it occurs with increased trading volumes. It is a sign that momentum in sales is dropping and an upward direction will follow.
5. Three White Soldiers
The three white soldiers configuration consists of three successive bullish candles with narrow wicks, representing strong buying momentum. All three start in the range of the previous candle’s body and terminate at a level over its starting level, representing ongoing bullish vigor.
The configuration is a strong sign of a reversal, specifically following a downtrend. It is a sign of a change in outlook from bear to bull and is often accompanied by further price rises. Caution, nevertheless, must be exercised when it forms following a prolonged downtrend, in case it reflects overextension.
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Bearish Candlestick Patterns
A bearing form leads to a negative trend. To know when to sell, you must understand the potential bearish candlestick patterns.
Let’s learn more!
1. Shooting Star
The shooting star is a bullish reversal shape that forms at a high in an uptrend. It is a narrow shape at the lower edge of the trading range with a long upper wick, at least double in proportion to its shape. It reflects that buyers struggled to make the price rise but sellers took over and pushed the price down, closing at a level near its opening.
2. Bearish Engulfing
The bearish engulfing is a reversal of its bullish counterpart, a bullish engulfing, and is a small bullish candle, followed by a larger engorging bearish one that engulfs the entire preceding candle in its body. It is a signal of a strong buying move to selling and a possible downtrend reversal.
3. Evening Star
The evening star is a three-candlestick reversal and a sell signal and is a long bullish candle, a small-bodied (which can be bullish or bearish) one, and a long bearish one.
The second one is a signal of indecision in the market, and the third one signals a reversal with buyers losing momentum and sellers gaining control, pushing prices down. Both the morning and evening stars are an essential component of the chart analysis conducted by professional traders.
4. Dark Cloud Cover
The dark cloud cover is a two-candlestick sell signal and a signal of a downtrend reversal. It is seen when a bullish one is followed by a bearish one opening at a high price but closing below the first one’s midpoint. It is a signal of sellers gaining control and an unsteadiness in an uptrend.
5. Three Black Crows
The three black crows are made up of three consecutive bearish candles with small wicks, symbolizing strong sales momentum. All three candles open in a preceding candle’s body and then close below, symbolizing continuous bearish momentum and potential for a continued decline.
Advanced Candlestick Techniques
Although knowing individual candlestick patterns is important, trading with them involves combining them with market direction to make a smarter move.
Some effective techniques for advanced candlestick trading include:
Trend Confirmation
Prior to taking any action with a candlestick pattern, confirm the current direction of the trend. Individual candlestick patterns work best when in agreement with overall direction in the market. For instance, a Bullish Engulfing pattern is even stronger when in an uptrend, suggesting a continued move, but a Bearish Engulfing pattern is even stronger in a downtrend, suggesting a reversal.
Candlestick Clusters
Sometimes individual candlestick patterns work best in clusters. For instance, a Morning Star or Evening Star can work even better when following a sequence of candles with a loss of momentum, a loss of momentum in the move, or an exhaustion in the move. Traders prefer such a scenario for confirmation.
Candles & Volumes
A combination of candlestick patterns with volumes can make a move even more significant for trading. Doji with a high-volume candle can represent a strong reversal sign, especially when appearing at a strong price level. In a similar manner, a Dark Cloud Cover with an increase in volumes can mean a strong bearish reversal.
Retracements and Extensions
Traders use a combination of candlestick patterns with a use of Fibonacci retracements and extensions for a determination of important level for an entry and an exit. For instance, a Bullish Engulfing at a 61.8% level of a Fibonacci retracement can represent a high chance for a reversal, but a Bearish Engulfing at a level of a Fibonacci expansion can mean a strong reversal.
Risk Management in Candlestick Trading
Risk management is critical in any trading style, including in candlestick trading, because price actions can become unpredictable.
Use these advanced forms of risk management and control your losses:
Candlestick Stop-Loss
Utilize the shape of candlestick formations in stop-loss positioning. For instance, following a Bullish Engulfing, position your stop-loss below at the low price of the engulfer candle. In taking such a position, your loss will be kept in check in case your position is reversed in the marketplace.
Risk-Reward
Before entering a position, assess your proportion of risk to reward. For instance, when trading a Morning Star, seek at least a 1:2 proportion of risk to reward. Ensure your reward will dominate your risk with real objectives, such as preceding highs, or significant resistances/supports.
Application of Trailing Stops
To lock in your gain as your direction in the marketplace keeps moving, utilize trailing stops. By utilizing trailing stops, you can re-adjust your stop-loss level in terms of price activity, useful in trends supported with candlestick confirmation. Doji, then a strong directional candle, can generate a trailing stop, safeguarding your gain as your price keeps moving in a direction.
Risk Sizing = Position
Whenever calculating your position, utilize your stop-loss positioning and your tolerance for taking a loss in terms of your overall tolerance for taking a loss in general. In taking such an approach, no position jeopardizes your overall capital risk. As a general principle, don’t expose yourself to a loss in any one position larger than 1-2% of your overall value in your account.
Conclusion:
Candlestick patterns have proven to be a powerful tool in technical analysis, offering investors future price activity information. By combining such patterns with sound trading techniques, investors can make smarter trading choices and maximize trading performance.
FAQ on Candlestick Patterns:
Q: What is a candlestick chart?
A: A candlestick chart depicts the fluctuation in price of an asset over time; it also illustrates the opening, closing, high, and low prices of each period.
Q: How do you read candlestick patterns?
A: Candlestick patterns are read by considering the shape and position of the candles to deduce the trends in prices. Major patterns such as Doji and Engulfing provide information about market trends.
Q: Which is the most reliable candlestick pattern?
A: The Bullish Engulfing and Bearish Engulfing patterns are of the more reliable variety and often result in strong reversals when combined with market context.
Q: Can candlestick patterns be used for day trading?
A: Yes, candlestick patterns work well in day trading because they help a trader make fast decisions based on short-term price movements.
Q: How can I improve my candlestick pattern recognition?
A: The two most important keys are practice and experience. Use demo accounts, study historical charts, and apply technical analysis tools to improve your capability in identifying and interpreting candlestick patterns.
