Candlestick patterns: Types and how they work in trading

By  Artem Khomenko 900 6 Feb 2023
Photo - Candlestick patterns: Types and how they work in trading

A candlestick pattern is a visual representation of the price behavior of an asset over a specific period.

Japanese candles are one of the elements of the chart's technical analysis. Candlesticks patterns can be used to determine the strength of a price movement, as well as support and resistance levels, and when combined with other factors, they can help you fully analyze an asset.

We've put together information on candlestick analysis and the most popular patterns.

What is a candle?

A candle represents price movement in a "compressed" manner. The chart is compressed more with a longer timeframe. A four-hour candle, for example, looks like this:

A 4-hour candle

A 4-hour candle

And if you expose the candle shown above on the 5-minute timeframe, this is how the segment of the chart looks:

The four-hour candle is exposed on a 5-minute timeframe.

The four-hour candle is exposed on a 5-minute timeframe.

One candlestick is made up of the following structural parts:

■ High refers to the candle's maximum price;

■ Low refers to the candle's minimum price;

■ Open and Close refer to the candle's opening and closing points;

■ Candle body or Real body shows the amplitude of the price change from opening to closing;

■ Upper and lower wicks represent the maximum and minimum amplitudes of the candle during its formation.

The parts of a candle

The parts of a candle

Candles are one of the most convenient ways to show price movement. They make it possible to consistently organize temporal data in various chronological frames. The chart is typically shown in either Japanese candlesticks or bars for technical analysis.

Candles and trading

Candlestick patterns are solely reversal structures, as opposed to patterns or technical indicators that can signal a likely price move up or down. Candles, in other words, are used to identify the point at which prices will reverse.

We'll go over the most popular candlestick patterns and how they're used in trading.

Bullish & bearish engulfing patterns

The engulfing pattern is made up of two candlesticks, with the body of the second candle overlapping (engulfing) the body of the first candle. If the candles are red and then green, there was a bullish engulfing, meaning the bearish candle was "beaten" by the bullish candle. The situation is the exact opposite of a bearish engulfing.

Engulfing is a common chart indicator that could point to a trend change or a strong support or resistance level. It is advised to wait for the next candle to confirm the response to the level.

Bullish engulfing

Bullish engulfing

Bearish engulfing

Bearish engulfing

Dark Cloud Cover & Light Cloud Cover patterns

It is a candlestick pattern similar to the previous one. The difference is that the second candle partially overlaps the first one rather than completely covering it. Usually, you must wait for the next candle to form before making a choice.

Dark Cloud Cover & Light Cloud Cover

Dark Cloud Cover & Light Cloud Cover

Hammer pattern

It has a small real body and a long lower wick. The hammer is formed during a battle between buyers and sellers. When one group predominates over another, they "squeeze out" the price, and the candle closes roughly where it began. At the same time, a long lower wick forms because the price has been moving in a wide range for a long time.

Large vertical trading volumes are an additional indicator of the hammer. This shows that many contracts were traded during the time the candle was forming and that the trend has in fact reversed. 

The bullish hammer

The bullish hammer

The bearish hammer

The bearish hammer

Morning and Evening Star patterns

It is made up of three candles, one for past movement, another for market tension, and a third for a trend change. The Morning Star is a pattern that indicates the start of an upward climb, and the Evening Star signals that a downtrend is going to take place. 

Significant volume trading on the middle candle, similar to the hammer pattern, is a good indicator.

The Morning Star

The Morning Star

The Evening Star

The Evening Star

Doji, Harami, Gravestone, and Dragonfly are also popular patterns. Each one suggests a possible trend reversal. If this pattern is formed after a long decline, it indicates that the asset's upward movement is likely to reverse (or vice versa). 

It's crucial to realize that candlestick patterns perform better the longer the timeframe is. Start trading on the 1H (1 hour) or 4H (4 hours) time frames first because trading on smaller time frames will result in a variety of market conditions, most of which will only confuse the trader.

Additionally, keep in mind that candles are a supplementary type of analysis that should be used in conjunction with other elements like support and resistance levels, trading volumes, technical patterns, and other various indicators.