Do candlestick patterns work?
Candlestick patterns are a technical analysis that originated in Japan around the 18th century. Japanese rice trader Munehisa Homma invented the technique, but it was popularised in the early 1990s through Steve Nilson’s book, Japanese Candlestick Charting Techniques.
But do they still work today? Let us investigate.
What Is a Candlestick Pattern?
Candlestick charts are a technical tool that combines information from several periods into a single price bar. This makes them more useful than the traditional open, high, low, and close (OHLC) bars or simple lines that connect the dots of closing prices. Candlesticks make patterns that can be used to figure out where prices are going. This colorful technical tool, used by Japanese rice traders in the 18th century, is made more interesting with the right color coding.
Traditionally, candlesticks are best used once a day because each candle represents a full day’s worth of news, data, and price action. This suggests that candles are more useful for long-term or swing traders.
The most important thing is that each candle has a story. The best way to look at a candle is as a battle between buyers and sellers. A light candle (typically green or white) shows that the buyers have won, while a dark candle (red or black) shows that the sellers have won. But the battle between buyers and sellers between the open and the close makes candlesticks useful as a charting tool.
Types of candle stick patterns
Hammer: A bullish reversal is indicated by forming a single candlestick pattern known as the “hammer” at the end of a downtrend.
This candle’s real body, which is little and near the top, has a lower shadow that ought to be twice as large. There is minimal to no top shadow in this candlestick chart pattern.
The psychological explanation for this candle formation is that sellers pushed them to lower as soon as prices opened.
As soon as buyers entered the market, prices shot up, and the trading session ended with prices higher than they had started.
Piercing pattern: A two-day candlestick price pattern known as a “piercing pattern” denotes a likely short-term change from upward to downward. The design contains a trading range of average or greater size on the first day, with the opening around the high and the closing near the low. Additionally, there is a gap after the first day of trade, with the second day’s opening and closing prices being close to one another. Additionally, the close should be a candlestick that spans at least half of the upward length of the red candlestick body from the previous day.
Bullish engulfing pattern: A white candlestick that opens lower than the previous day’s finish and closes higher than the last day’s opening is known as a bullish engulfing pattern. It can be recognized when a little black candlestick that represents a bearish trend is followed the next day by a large white candlestick that represents a bullish trend, with the body of the last candlestick completely engulfing or overlapping the former.
An illustration of a bearish engulfing pattern would be in contrast to a bullish one.
Morning Star: After a slump, the Morning Star multiple candlestick chart pattern forms, signaling a bullish reversal.
It consists of three candlesticks:
- A bearish candle in the first
- A Doji in the second
- A bullish candle in the third
The first candle indicates that the downward trend is still in effect. A Doji on the second candle suggests market uncertainty. According to the third bullish candle, the market’s bulls are back, and a reversal will occur.
The true bodies of the first and third candles should be entirely clear of the second candle.
Three white soldiers: The bullish candlestick pattern known as “three white soldiers” is used to forecast the reversal of the present decline in a price chart. The design consists of three long-bodied candlesticks that open within the natural body of the preceding candle and close above the high of the previous candle. These candlesticks should open within the body of the candle in front of them in the design, and their shadows should be a manageable length.
Marubozu: Japanese for “bald head” or “shaved head” is marubozu. This is because such a candle lacks at least one shadow, which suggests that either the opening or closing price will equal one of the candle’s maximum prices. A Marubozu that lacks both shadows signifies that the market opened and closed at the candle’s extreme levels.
The Long White Candle and White Marubozu, which appear as a long line, have significant meanings. It reflects the market’s strength, particularly if it is developing amid heavy trade volumes. It could be a continuation candle or a reversal candle, depending on how it shows on the chart.
Three Inside Up: A multiple candlestick pattern called the Three Inside Up is formed after a decline and indicates a bullish reversal.
Three candlesticks make up the formation; the first is a long bearish candle, and the second is a modest bullish candle that should fall within the first candlestick’s range.
The third candlestick, which will confirm the bullish reversal, should be a long bullish candlestick.
Hanging Man: The inverse of the hammer pattern is the hanging man. A green or red candlestick with a short body and a lengthy lower shadow creates it. It appears at the peak of an upward trend. It predicts a significant sell-off during a specific period, but bulls might briefly drive prices upward before losing control.
Evening star: Technical analysts utilize the evening star pattern on stock price charts to determine when a trend is ready to change direction. Three candles make up the bearish candlestick pattern: a red candle, a small-bodied candle, and a huge white candlestick.
A price uptrend’s peak and the appearance of evening star patterns indicate that the uptrend is about to terminate. The morning star pattern, seen as a bullish indication, is the opposite of the evening star pattern.
Three Black Crows: The term “three black crows” refers to a bearish candlestick pattern that may indicate the conclusion of an upswing. Candlestick graphs display a security’s opening, high, low, and closing prices for the day. The candlestick is white or green for stocks that are rising. They are either black or crimson as they descend.
Three consecutive long-bodied candlesticks that opened within the previous candle’s body and closed lower than the last candle make up the black crow pattern. Traders frequently use this indicator with other technical indicators or chart patterns to confirm reversals.
Dark Cloud Cover.: A down candle (usually black or red) begins above the close of the preceding up candle (often white or green) and subsequently closes below the middle of the up candle, forming the bearish reversal candlestick pattern known as Dark Cloud Cover.
The pattern is notable because it demonstrates a change in momentum from upward to downward. An up candle and a down candle combine to form the design. Traders anticipate prices dropping even more on the following (third) candle. It is known as confirmation.
Doji: The body of the Doji candlestick is remarkably small, and its shadows are very long. Even though it is typically seen as a trend continuation pattern, traders should exercise caution because it might potentially result in a reversal. When the situation is obvious, a few candles following the Doji, you should open a position to avoid confusion.
Falling Three Methods: Five candles make up the falling three-method pattern, which denotes the continuance of a downward trend. It has a long red body, three little green bodies that follow one another, then another long red body. The bearish red candles completely engulf the green candles, showing that the bulls lack the strength necessary to buck the downward trend.
Rising Three Methods: The rising three-technique pattern can be seen during uptrends. Three small red candles, a long green candle, and another long green candle make up the pattern.
How to read a candlestick?
After some practice, candlestick charts are simple to understand since they are packed with information about past price history. There are chart patterns made up of many candlesticks arranged in a specific way in addition to the candlestick patterns we previously examined. Double tops and bottoms, flags and pennants, and more are a few examples.
By observing the broad trend visually, traders of any experience level can understand how to interpret a candlestick chart. Typically, these images include information traders can use to spot specific candlestick forms and patterns, particularly around resistance and support levels.
The use of candlesticks in day trading is crucial. Whether you are trading or investing, candlestick analysis is vital since analyzing price action is quite difficult without it.
There are many candlesticks, but one must comprehend their intricate details.
Every candle has a unique significance; if you use them correctly, you can eventually forecast the future price action’s direction.