Updated: Jan 18
Candlestick charts and their patterns are invented in Japan over 300 years ago, and it is the most popular chart pattern among traders and investors.
Both the bar chart and candlestick chart provide the same data. However, the candlestick chart is easier to read and visually more appealing.
Japanese Candlestick charting techniques are very popular among traders and allow for achieving more than average profits according to a 2014 study published about candlestick chart patterns.
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How to Read the Candlestick Chart?
A chart that has open, close, high, and low data in a candle form for any selected period is a candlestick chart.
Falling periods (when the closing price is lesser than the open price) will be represented by a red candlestick body called a Bearish candle.
Similarly, rising periods (when the closing price is greater than the open price) will be represented by a green candlestick body called a Bullish candle.
In a daily timeframe candlestick chart, a candle represents a day. Similarly, you can view the same candlestick chart for the smaller time frame (such as a 1-hour, 30 minutes chart) by changing the time frame settings.
If you observe candlestick charts over a period of time, some patterns occur repeatedly. If a trader develops the ability to identify these patterns and uses it correctly, it gives an extra edge in his trading.
Bullish Candlestick Patterns – Bullish Engulfing, Hammer, Bullish Harami are some of the examples.
Bearish Candlestick Patterns – Bearish Engulfing, Hanging man, Bearish Harami are some of the examples.
Reversal Candlestick Patterns – Spinning Top, Island Reversal Hammer are some of the examples.
There are thousands of candlesticks patterns present in the technical analysis world. Studying and memorizing all these patterns are practically impossible.
It is better to shortlist the patterns based on the “Impact” and “Repeated Occurrence.”
Because if a candlestick pattern has less impact, then it is not useful. Similarly, if a candlestick pattern is powerful, but if it rarely occurs, then again, it is of no use.
Considering these two parameters, below are some powerful patterns and occur very frequently in every timeframe.
Bullish Engulfing Pattern
Engulfing candles tend to signal a reversal of the current trend/swing in the market. This specific pattern involves two candles, with the latter candle ‘engulfing’ the entire body of the candle before it.
Engulfing Pattern is one of the shortlisted patterns in the Expert Systems with Applications study.
The above image shows a bullish engulfing formation. The second candle is the bullish candle that engulfed the first bearish candle.
The above image shows an example of a bullish engulfing pattern. It occurred at the support trend line and the price reversed from that point.
Bearish Engulfing Pattern
Engulfing candles tend to signal a reversal of the current trend/swing in the market. This specific pattern involves two candles, with the latter candle ‘engulfing’ the candle's entire body before it.
The above image shows a bearish engulfing formation. The second candle is the bearish candle, which engulfed the first bullish candle.
The above image shows an example of the bearish engulfing pattern. It occurred at the resistance trend line and the price reversed from that point.
When a stock price trades significantly lower than the open price, it bounces back due to the sudden entry of bulls and closes a little below or above the open price, which results in the Hammer pattern.
If it occurs at a critical support level, then there is a high probability of reversal in the price chart.
The above image shows an example of a hammer pattern. It derived its name as the shape looks like a hammer. In this pattern, the lower shadow is at least twice the size of the real body.
Hanging man Pattern
It occurs at the end of the uptrend and resembles a hanging man from the top. Hence, it’s got its name. It indicates the potential reversal of the price from the uptrend.
If it occurs at a critical resistance level, then there is a high probability of reversal in the price chart.
The above image shows an example of a hanging man pattern. Here, the price was in an uptrend, and the price displayed hanging man precisely at the resistance line.
It indicates that the buyers have lost their strength to push the price on the upside. Hence, there is a higher probability of price reversing from that level.
Bullish Harami and Bearish Harami
Similar to Engulfing we have two harami patterns:
The word ‘Harami’ means a pregnant lady in Japan.
Bullish Harami includes a big bearish candle first, followed by a small bullish candle in the middle. It indicates that the selling is over, and there is a high probability of the price going upward.
Bearish Harami includes a big bullish candle first, followed by a small bearish candle in the middle. It indicates that the buying is over, and there is a high probability of the price going in the downside direction.
Image-10 and Image-11 shows an example of the Bullish Harami and Bearish Harami pattern respectively.
Candlestick Patterns for Day Trading
Intraday trading looks very attractive to many people who are just stepping into the market. Nevertheless, it can be challenging for beginners and even intermediate-level traders to face losses and go through emotional issues. Hence, it is better to extra cautious in intraday trading.
I am an intraday trader for over a decade now, and I have observed a few patterns that occur every trading day.
1) A combination of Hammer and Bullish Harami at Support
2) Pinbar at Resistance
The previous day range plays a crucial role for today. The price will show either "Initiative" or "Responsive" trade opportunities concerning the last-day range. These are core concepts of the market profile and are highly beneficial for intraday traders.
The above pattern is helpful to take 'Long' trades in intraday trading.
The price looks like it will break the support (previous day low in intraday trading), but it gives double confirmation via 'Bullish Harami' and 'Hammer,' hence a clear rejection at the support level. Hence, there is a higher probability of the price going upside.
Intraday traders can plan a long trade above the hammer candle's high, keeping a strict stop-loss below the low of the same hammer candle.
Please note this pattern will be negated if the price breaks the low of the hammer candle.
The above pattern is helpful to take 'Short' trades in intraday trading.
The price looks like it will break the resistance (previous day high in intraday trading), but showed a pin bar which indicates a clear rejection at the resistance level. Hence, there is a higher probability of the price going down.
Intraday traders can plan a short trade below the pin bar candle's low, keeping a strict stop-loss above the high of the same pin bar candle.
Please note this pattern will be negated if the price breaks the high of the pin bar candle.
Other Important Candlestick Patterns
The above six candlestick patterns are powerful, and they occur very often in all the timeframes. A trader should try to locate these patterns on as many charts as possible to be in a better situation to use them in a live market.
Apart from these six candlestick patterns, there are a few more candlestick patterns that help understand the movement of the price. They are mentioned below:
In a Doji pattern, the open and close prices will be equal for the selected time period. It is a neutral pattern that indicates indecision.
The above image shows different variations of Doji. In all three types, the price closed at the open level. However, based on the location of open/close, it is possible to identify the sentiment behind it.
In Gravestone Doji, the open & price level will be at the bottom. This indicates that buyers made an attempt to push the price upside in this time period, but they lack the power to drive the price upside. Hence, it is closed at the same open level. We can expect only a downside move until the price negates this pattern.
In Dragonfly Doji, the situation is precisely the opposite. In this case, sellers tried to push the price downside, but they failed, and hence price closed at the top.
Therefore, we can expect only an upside move until the price negates this pattern.
In Normal Doji (also called Long Legged Doji), there is not much clarity in the price.
Besides, it also indicates the equal fight between buyers and sellers. Hence, it shows perfect indecision. It’s always better to wait for the next candle completion if we get a normal doji.
Morning Star Pattern
A morning star pattern consists of three candlesticks that occur in a downtrend and often indicate the beginning of the uptrend.
It is often accompanied by 1-2-3 formations in a downtrend, indicating the sign of the trend. The first candle is bearish, and the second candle indicates indecision, and the third candle indicates the bullish behavior of the price.
Evening Star Pattern
It is similar to Morning Star but in the opposite direction. Again this pattern consists of three candlesticks that occur in an uptrend and indicate the beginning of the downtrend.
In contrast to Morning Star, this pattern is also accompanied by 1-2-3 formations but in the opposite direction. It indicates the sign of the uptrend. The first candle is bullish, and the second candle indicates indecision, and the third candle indicates the bearish behavior of the price.
Best Books to Study Candlestick Patterns
Steve Nison has written many books on candlestick patterns, and all his books are wonderful to study candlestick patterns.
We recommend the below books to learn more about candlestick patterns:
1. Japanese Candlestick Charting Techniques by Steve Nison
2. How to Make Money Trading with Candlestick Charts by Balkrishna M Sadekar