How to Read Candlestick Charts? (The Battle of 2 Species)

What is a Candlestick chart?

As the name suggests, a candle chart uses candles to show price action. These candles show the back-and-forth struggle of bulls and bears in the selected timeframe. Although all candles share a common anatomy, each tells a different tale.

Let’s begin the tour by exploring the background of candles and candle charts. The candle charts go back to the 18th-century Japanese rice market. Munehisa Honma was a rice trader from Sakata, Japan, sometimes referred to as “The God of Markets” because of his performance in the mid-1700s. Many believe he may have been the father of the candles chart.

Although candle charts were common in 18th-century Japan, western financial activists would not use them until centuries later.  Each candle tells a different story, but all share the same overall anatomy. A candle usually consists of a body, an upper, and a lower wick/shadow, though sometimes its body parts might grow in size or not form at all.

What details can these candles tell us? As mentioned in my types of charts article, similar to the bar charts, candle charts show a detailed view of Opening-High-Low-Closing (OHLC) prices.

Assuming the daily timeframe is selected, the body shows the asset price range from the day’s opening to the closing price. If the closing price is above the opening, a green candle, and if it’s below, a red candle forms.

The lower wick shows how low, and the upper wick shows how high the price has gone during the day. If an upper wick is much larger than the body, it is called an upper shadow. The same applies to long lower wicks.

It is interesting to know that candles might not have a body, and others might lack the lower, upper, or both wicks. For example, the Doji candle does not have a body but usually has an upper and lower wick. I will discuss Doji patterns later on.

Now that you know what battle reports are, you must learn to analyze each report and understand what information each candle communicates. Only then would you be able to find who has the upper hand.

How to read Candlestick charts?

Candle charts are one of the most popular tools traders and investors use to analyze stock prices and market trends. By understanding how to read candle charts, you can gain valuable market data and make more informed decisions.

Each battle has three possible outcomes: either the bulls win, the bears win, or the battle ends in a draw. The draws are usually unclear; they don’t tell much about upcoming battles and how each faction might perform. They only show that both factions have almost identical power.

A draw in the reports (candles) is referred to as Neutral Doji candles. These candles usually signal a sideway market (range market) with no major up/downward moves. This exhibit shows four Doji candle types: The Neutral Doji (Cross), Dragonfly Doji, Gravestone Doji, and Long-legged Doji.

• Neutral Doji:

The Neutral Doji candlestick Pattern is a technical indicator that can be used to check the strength of a trend in the market.  A Doji candle shows a draw between buyers and sellers or a pause in price action. The Neutral Doji candlestick pattern forms when the opening and closing prices of the security are at the same level, with relatively small upper and lower wicks.

The neutral Doji pattern provides little to no information on what the price will do next. However, there are strategies involving multiple Dojies, such as Double Doji Strategy, that some traders use as a trigger.

To predict how this Doji affects the price, you must analyze further factors such as where it is located, what other indicators tell, and if you can see other candlestick patterns. For example, depending on what other indicators state, if the neutral Doji is on the top of an upward trend, it might signal the end of the upward movement.

• Dragonfly Doji:

Looking for this pattern can be a great way to find potential trade entry or exit points. If a Dragonfly Doji forms at a market bottom, depending on its surrounding candles, it can signal a potential trend reversal.

Like Neutral Doji, finding a Dragonfly Doji alone is not enough, and a strong trading decision demands a further analysis of the chart and indicators (such as the Relative Strength Index (RSI), Bollinger Bands, Stochastic, or Moving Average Convergence/Divergence [MACD]).

• Gravestone Doji:

The Gravestone Doji is one of the technical analysis’ most recognizable candle patterns. This signals to traders that while bulls have pushed prices higher during the period, bears were strong enough to beat the bulls and close the candle where it opened. If a Gravestone Doji forms at a market top, it means reaching a resistance level and bears increasing dominance.

• Long-legged Doji:

Long-legged Doji is characterized by a long upper and lower shadow, with the opening and closing prices being the same. The Long-legged Doji is like the Neutral Doji’s taller brother. It shows the same activity but with much larger price volatility. This formation means that both factions are willing to win a glorious victory, one that brings a series of wins for the stronger team.

Unlike Dojis, decisive battles have larger bodies and relatively smaller wicks. A candle with a large green body shows a decisive bull victory, resulting in price upward movement. On the other hand, a large red body shows the bears’ victory over the bulls, resulting in a downward price movement.

The second factor you must consider is Trading Volume. You can usually find the trading volume column chart below the price candle chart. In addition to the candle’s large body, a high trading volume adds to the battle’s decisiveness.

As you can see in the example, a large green candle with high enough volume is a decisive bull victory and has the power to start a winning streak for the green team. It also applies to the red team.

Some candles have a small cube-like body and small wicks. Similar to the cross Doji, they also signal a ranging market. Small candlesticks represent days when the stock price hasn’t changed much from its opening price. This means that the buyers and sellers of those stocks were mostly in balance, showing there was neither strong bullish nor bearish movement in the markets on that day.

Although understanding candles and their psychology is important in analyzing the price action, you will need much more than a single candle to predict future battles accurately. In addition to how the candle looks, you must also consider the market trend, other surrounding candles, and patterns able to predict future movements.

Grab your pen and paper; in the next part of the tour, you will learn about these patterns and how each can help you.

How does Candlestick chart pattern work?

We have a lot of candlesticks, but many of them are not practical. I have chosen the most important ones that are more common and used in the market – seven bullish, seven bearish, and three continuation candlestick patterns. Let’s begin!

I’ve mentioned the “course of the war” a few times so far. You might ask what that means. In the financial world, it means the market trend. If the bulls grow in power, they can start a price rally upward. On the other hand, stronger bears can begin a downward movement in price.

To find out what the price will do next, you must use these candlestick patterns to compare the power of bulls to bears. Making such comparisons for every candle requires a look at its surrounding candles and where the candle is located.

Keep in mind that when candlestick patterns form at important areas such as support and resistance levels, they are more valid than forming at random places on the chart. Additionally, when higher time frames are selected, candlestick patterns send stronger signals. First, we’ll go over the single candle patterns. You might be familiar with some of them.

Single Candle patterns:

Single candle patterns are much easier to spot than multi-candle patterns. Although it is the report of a single battle, it can have a huge impact on the direction of the war (trend). Let’s begin with the Hammer pattern.

• Hammer

The Hammer pattern normally appears at the bottom of downward trends and acts as a bullish reversal candle. The Hammer candlestick pattern has a small cubic body and a long wick at the bottom (at least twice or triple the size of the body) with a small or non-existing upper wick.

A Hammer shows that the price has gone down during the day, but it went back up because of a strong will to buy (bulls’ strength). The body can be any color, but green hammers are better since they show a bullish victory against the bears. Regarding the pattern validation, the taller the lower wick is the more valid the pattern gets.

Note that the body of the two surrounding candles should not share price with the Hammer lower wick. Also, the lower wicks of the mentioned candles must not go below the Hammer handle. If the pattern validly forms at the bottom of a downward trend, it signals a possible change in the direction of the price.

• Failed Hammer:

A failed Hammer also forms in a downward trend, but unfortunately, bulls fail to support the pattern and push the price high after it forms. For the Hammer to fail, bears must beat the bulls and win a decisive victory over bulls, a red candle with a large body that passes the Hammer’s handle price.

A failed Hammer acts as the exact opposite of a Hammer. Instead of reversing the trend, it acts as a continuation pattern.  Hence, the failed Hammer pattern is a good selling opportunity. Generally, most failed patterns work opposite to their valid counterpart; a bullish pattern turns bearish, and vice versa.

• Inverted Hammer

Inverted Hammer is our good old Hammer friend but only reversed; it has a larger upper wick (at least twice the size of the body) and a minor or no lower wick. The inverted hammer works like a normal Hammer, acting as a bullish reversal pattern.

It shows that there was a push to buy, followed by a push to sell that wasn’t strong enough to make the market price go down. The Inverted Hammer usually signals bulls’ near control of the market. The only downside is that in comparison to a normal Hammer, an Inverted Hammer is less likely to form and less reliable. However, a tall upper wick adds to the pattern’s validity.

• Hanging Man:

The hanging man candlestick pattern is a bearish reversal signal found on technical charts that might signal that a bullish trend is coming to an end. Although it may look the same at first glance, the Hanging Man is not like a hammer at all. The hanging man pattern forms at the end of an upward trend. The longer the Hanging Man’s lower wick, the stronger the bearish reversal signal.

Traders can leverage the Hanging Man pattern to open a short position, add to open short positions, or exit long positions knowing that a possible price drop might come. When analyzing this candlestick pattern, it is key to know whether or not volume backs it up or not. An increase in trading volume in the following red candle is recommended.

• Shooting Star:

The Shooting Star looks exactly like an Inverted Hammer; the only difference between them is where they form. The shooting star forms on the top of an upward trend.

The body is small and cubic, and the top wick is long, piercing through the resistance zone like a needle. The Shooting Star shows that the trading session ended with an increase in selling pressure and signals a reversal to bearish momentum.

While shooting stars don’t guarantee success every time, they can provide useful data about the price reversal’s potential when you find them in key support and resistance levels. The Shooting Star is much more reliable and popular than the Hanging Man pattern.

• Marubozu:

Marubozu tells the story of a battle in which one side has dominated the other. A Marubozu candlestick has a large, lengthy body and a tiny wick (or no wick), making it hard to miss. This large body shows a powerful movement in both upward and downward directions. Depending on the candle type, bullish/bearish, the absence of upper/lower wicks adds to the pattern validity.

When a bullish (green/white) Marubozu forms, it means that the price rose steadily from the time it opened until it closed and would rise even higher if time was not limited. In the bullish version (green or white), the highest price is at the closing price of the trading period. Unlike the bullish version, the bearish (red or black) lowest price is at the closing of the trading period.

Many amateurs confuse the Marubozu candle pattern with the random wickless large-bodied candles of range markets. A Marubozu only refers to candles in the same direction as the market trend. For example, a green Marubozu only forms in upward trends, signaling buyers’ huge interest in the asset.

Therefore, since Marubozu continues an ongoing trend, the Marubozu candle is considered a continuation pattern. Additionally, Marubozu candles are mainly used as valid breakout candles if they are backed by sufficient trading volume. You will be introduced to breakouts and their validity in future articles.

Have you taken notes on the single candle patterns? If yes, the tour must move on to the double candle patterns.

• Bullish Engulfing:

Ah, the Bullish Engulfing candle pattern. It’s so simple, but also so satisfying! As Isaac Newton said, “Nature is pleased with simplicity.” I love simplicity too, Isaac. Bullish Engulfing signals the current downward trend reversal when it appears at the bottom of a downward trend.

This candlestick pattern forms when a small red bearish body is completely engulfed by a large green bullish body – further confirming the reversal because the market is now closing higher than its open. Additionally, if the Engulfing candle covers other previous candles from top to bottom, it further increases the pattern’s strength.

If you’ve read my article on price chart gaps, you’ll probably notice a small gap between the red candle closing price and the green candle opening price. Can you tell me what type of gap it is? If your answer is an exhaustion gap, then you are right.

This exhaustion gap shows that bears are tired of fighting and are passing the market to the bulls. More bulls in the market means an upward price movement is coming.

An exhaustion gap between the two candles further increases the validity of the pattern. However, in markets like cryptocurrencies (never), forex, and commodities, you hardly find any gaps. Therefore, the pattern keeps its validity without a gap in such markets. The next battle report is as interesting, if not more; let’s move on to the story of the bulls’ big defeat.

• Bearish Engulfing:

The Bearish Engulfing candle pattern is a two-candle reversal formation that suggests a potential change of trend in the underlying asset price.  This pattern consists of two candles; the first is a small green candle, and the second is a big red candle that fully ‘engulfs’ the body of the first candlestick.

It usually appears at market tops and is a sign that momentum is shifting to the downside, meaning there could be further bearish price action ahead. Traders can use the trading volume indicator to confirm this pattern before acting upon its signal.

The same exhaustion gap as the Bullish Engulfing pattern can be seen here. You can see a price jump from the small green candle close to the Engulfing red candle open.

This exhaustion gap tells the story of bulls leaving the market as more bears join in. However, when using Bearish Engulfing in cryptocurrencies, forex, and commodities markets, you must keep the gap’s rarity in mind.

• Bullish Piercing Line:

The Bullish Piercing Line candlestick pattern is a two-candle formation that signals a bullish reversal in the current downtrend. The first candle is usually bearish, showing an overall downward trend. In contrast, the second candle opens lower than the previous candle’s close and closes higher than its midpoint.

This second candle provides bullish confirmation and suggests that buyers are beginning to push prices up. For the pattern to be valid, the same exhaustion gap from the Engulfing patterns must also form between the red candle’s close and the green candle’s opening price.

Basically, you can consider the Piercing Line pattern a half-finished bullish Engulfing pattern with less reliability. Generally speaking, this pattern has better success rates in highly oversold markets. You can mostly see the Piercing Line pattern in the stock market.

• Dark cloud cover:

Look out, traders – the skies are darkening. This bearish candlestick reversal pattern consists of two candles, the first candle having a long green body and the second candle having a red body that opens after a gap up above the prior green candle closing. This second candle must close when it covers at least half the body range of the first candle.

This pattern signals that a former bullish trend may soon turn bearish and should typically be followed by a gap down on the next trading day.  Similar to its counterpart, the Piercing Line pattern, the Dark Cloud pattern can mostly be seen in the stock market. When you see Dark Cloud Cover in stocks, get out of the market as soon as possible because it is a bearish reversal pattern.

Have you seen a pregnant candlestick pattern before? If not, you are going to love the next pattern.

• Bullish Harami:

In Japanese, harami means “pregnant”. Traders call this pattern Harami because a baby-sized green candle forms in the body range of an older red candle. A Bullish Harami candlestick pattern has candles, with the second bullish candle having a small body and the first bearish candle having a long body and short wicks.

This shows that buyers are beginning to enter the market, reversing the previous downward momentum and bringing a possible price increase. The location of the baby candle (relative to the mother candle) and its length also matter; the higher the baby candle and the bigger its body, the stronger the pattern.

If there is a gap between the first candle’s closing price and the second candle’s opening price, you can consider this pattern a strong bullish signal. In the stock market, a gap between the two candles adds to the pattern validity. However, in other markets where gaps are hard to distinguish, I suggest you wait for a third confirming candle before counting the pattern as valid.

You can see an example of such in the Gold (XAU/USD) chart I provided below. There is another structure where the second candle is a Doji, called a “Bullish Harami Cross.”  This pattern has less validity compared to the Hammer and Bullish Engulfing patterns. Although reversals may not always form, you can add to Bullish Harami’s effectiveness by combining it with technical indicators such as volume.

• Bearish Harami:

Compared to the Bullish Harami, the Bearish Harami pattern has the opposite formation and behavior. Typically, a Bearish Harami signals a potential reversal at the end of an upward trend.  The Bearish Harami pattern consists of two candlesticks; the first has a relatively large green body, followed by a much smaller baby red candle within the prior candle’s green body.

It shows that bears have taken control of the market and are now likely to apply sell pressure, causing prices to drop. The Bearish Harami indicates that momentum is beginning to change from bullish to bearish, which allows traders to make money with this change.

A close below the low of the preceding candle confirms this bearish trend and its validity as an early warning sign of a bearish movement in prices. Unlike the Bullish Harami, in the Bearish Harami, the lower the baby candle forms, the stronger the pattern gets. Other Bullish Harami facts also apply to the Bearish Harami.

• Tweezer Top/Bottom:

The Tweezer Top candlestick pattern is a trend reversal signal formed when two candlesticks have almost the same highest value. This pattern can signal a potential top in the market, as it represents an upward move towards resistance and suggests that bulls are losing their will to buy.

This pattern also signals a weak upward momentum. Sellers will often enter the market and beat the bulls, creating a strong downward price movement.

Traders should look to combine the Tweezer Top with other technical indicators, such as support/resistance lines and volume charts, to confirm the validity of this trend reversal signal. Tweezer Top comes in various shapes; it can be combined with the previously discussed patterns such as Shooting Star, Bearish Engulfing, Bearish Harami, etc.

The Tweezer bottom is not that different from the Tweezer top; it’s only inverted. Like the Tweezer Top, Tweezer Bottom can also be combined with previous patterns.

Triple Candle Patterns:

Triple candle patterns are a type of pattern with three following candles, each representing the opening, closing, and highs and lows of the asset over a given period. Although each battle tells a unique story, the combination of the three candles might have a different meaning. Let’s move the tour to the first trio pattern, the Morning Star.

• Morning Star:

In a downward market trend, the Morning Star candlestick pattern lives up to its name as a sign of hope.  The Morning Star candlestick pattern is a powerful reversal signal used by professional traders to trade upward reversals. It consists of three individual bars that identify and confirm a market bottom.

The first candle is a large bearish candle that shows a major price drop. The second candle is similar to a distant star, with a small body below the surrounding candles. The third candle, unlike the first, is a large green candle, showing bulls’ control over the market.

For the pattern to be valid, a gap down between the first and second candles is preferred. As for a gap up between the second and the third candles, it is recommended, but it is not a must. This gap up provides evidence that buyers are once again interested in pushing the price higher.

The closing price of the third candle should cover at least half of the first candle. You should keep an eye on the third candle; the higher the ending price, the better. Usually, the “star” won’t share a price range with two surrounding bodies because of the price gaps. It means that sellers aren’t selling as much as they were on the first day, and a bull market is coming.

This pattern is mostly used in the stock market, but it doesn’t mean that it is not used in other markets. It has many use cases in other markets, such as the Forex market (GBP/CAD) example here. In markets where gaps can hardly be found, you better validate the pattern based on the third candle’s closing price; the higher it goes from the first candle high, the stronger the pattern.

• Evening Star:

The evening star candlestick pattern is often viewed as a bearish pattern that has three candles. The first candle is bullish, while the second is a small distant body that gaps away from the first. Finally, the third candle must close at least below the first candle midpoint showing a bearish reversal in play. This pattern forms at market tops and suggests a big price drop.

As with any bullish or bearish formation, traders should use additional technical and fundamental analysis to confirm trades based on evening star patterns. Remember, the first gap up between the first and second candle is favored, while the gap down between the second and third is optional. All Morning Star points also apply to the Evening Star.

• Three White Soldiers:

The Three White Soldiers candlestick pattern is one of the most reliable and powerful technical analysis patterns.  It consists of a series of long green (or white) candles with small wicks. In the daily timeframe, each candle closes higher than the day before. These are understood as a sign of bulls’ strength, given that it takes much greater buying pressure to move the price up than down.

This pattern can work both as a bullish reversal and an upward continuation pattern. When it forms at the end of a downward trend, it highlights more buying pressure coming to the market and marks the beginning of an upward trend.

Additionally, when it forms mid trend (bullish trend), it’s a sign of the bulls’ decisive victory over bears, which brings the bulls a winning streak that might last for the next few following candles. It is a huge sign that the price will go up, showing that buying pressure is getting stronger over time.

• Three Black Crows:

The three black crows candlestick pattern is an important signal to watch for in trading. It signals a bearish reversal at the end of a bullish trend and occurs when three following long-bodied candles close lower than the day before with relatively short wicks.

This indicates strong selling pressure, as buyers cannot support the market near the previous day’s closing prices – suggesting that a downward trend may come. The Three Black Crows pattern can also act as a continuation pattern in the middle of a downward trend. When this pattern forms mid-trend, it signals a bear controlled market which is likely to continue downward.

Five Candle Patterns:

Five-candle candlestick patterns are commonly used by traders and investors to get a better understanding of how an asset price is moving.  By looking at the candle shapes, traders can understand which way prices may go next and make smarter investing decisions based on that information.

They can also use these patterns to predict future movements and whether a trend is likely to continue or reverse. The most well-known of these are the Falling/Rising Three Methods patterns, so let’s focus some special attention on those.

• Rising Three Methods:

The Rising Three Method pattern is the first five-candle pattern you will learn. It consists of an initial large green-bodied candle, usually followed by three smaller red candles with no lower closing price than the initial green candle, and a fifth final green candle that closes above the first green candle.

Even though there is some selling pressure, buyers still have the upper hand. While the three small bearish candles in the middle are common, the number of candles and their color might differ from the norm. If the number of middle candles is higher, forming a Master Candle pattern is possible.

Let’s imagine you want to be careful and open a stronger position. In that case, you should wait for the last candle to surpass the first, and after receiving the pattern’s confirmation, open your long position confidently. Although it might seem more difficult than the previous patterns, based on my experience, you’ll have no problem making considerable gains once you learn it.

• Falling Three Methods:

The falling three method candle chart pattern has five candles, with the first candle being quite large, normally followed by three smaller candles that form lower highs than the first candle, and then a final downward candle that closes below the first candle. This pattern mainly shows that the bull army does not have enough power to form an upward reversal.

As you can see in the picture, bulls start a minor rally upward after the first red candle but fail to beat the bears upward. This failure allows traders to open new short positions or add to existing ones and prepare for the coming downward trend.

Careful traders would wait for the fifth candle to close below the first candle, confirming the pattern validity before opening a short position or adding to an existing one. You can combine the volume or other indicators with the falling three methods pattern for higher chances of a successful trade.

All the mentioned information about the rising three method also applies to the falling three method. Make sure not to mix up the rising/falling three methods with classic patterns of three falling peaks and three rising valleys.

FAQ

What is a Candlestick chart?

A candlestick chart is the most common type of chart used in technical analysis. The candlestick chart is a price-time chart that uses Japanese candlesticks to show price action over time. In the daily time frame, each candle shows the market’s open, high, low, and close price on that day.

How does a Candlestick chart work?

Candlestick charts show the opening, closing, high and low prices for a given period. A red or green body usually indicates a bearish or bullish trend, respectively — the longer the body is, the more intense the sentiment.

Shadows help to indicate whether buyers or sellers have been dominant throughout the period; long upper shadows indicate strong resistance, and long lower shadows indicate buying pressure pushing prices back up.

How can we analyze a Candlestick chart?

The most popular method involves looking at the length and type of each candle, or what is known as candlestick patterns. Generally, long bullish candles indicate strong buying pressure, while long bearish candles indicate strong selling pressure. You can also leverage reversal or continuation candlestick patterns to open more calculated trades.

How to read Candlestick charts for day trading?

To use candlesticks for day trading, you must first know how to read candles. Generally, candles consist of three parts, the body, which shows the open-to-close price of the day (if the daily time frame is selected) the upper and lower wick, which shows how high or low the price has gone, respectively.

After familiarizing yourself with what data candles convey, I recommend learning candlestick patterns.

Where to see Candlestick charts?

Many platforms offer candlestick charts of various markets, such as stocks, commodities, cryptocurrencies, forex, etc. The most well-known of them all is TradingView. TradingView is an advanced trading platform that offers many charts, indicators, and other trading tools which can assist in your analysis.

Conclusion

Another tour has come to an end. In this article, you learned about how small battles and fights can affect the overall direction of the market trend. You learned that based on the patterns these candles make, you can predict the outcome of the future battle with a 2-to-1 success rate.

You learned all sorts of candlestick patterns, from single candle patterns such as Hammer, Inverted Hammer, Shooting Star, and Hanging man to double candle patterns like Engulfing, Harami, and Tweezers, triple candle patterns like Three White Soldiers and Three Black Crows, Morning and Evening Star, and even five candle patterns such as Rising/Falling Three.

It is important to consider key elements such as support/resistance levels, volume indicators, and additional technical analysis tools and strategies. While candlestick patterns have enjoyed widespread use among traders for many years, it is essential to remember that these visual representations do not guarantee results and should be used in combination with other strategies.

Ultimately, traders need to consider their own objectives and risk tolerance when deciding how to employ these charting techniques. In the following articles, I will discuss support/resistance levels, trade triggers, and how to use various candlestick patterns to open winning trade positions.