Candlestick Patterns: The Complete Guide (2023)

Candlestick patterns have long been recognized as a powerful tool in the world of financial markets. First used in Japan in the early 16th Century, candlestick charts provide valuable insights into market sentiment and price movement dynamics.

The purpose of this article is to serve as a comprehensive guide to candlestick patterns and to give you the knowledge and practical know-how to effectively identify, interpret, and utilize them in your trading strategy.

To begin, watch the video below ⬇️ to gain a high level understanding of the power behind candlestick formations and why professional traders use them in their strategies.

Now, let’s dive deeper into the different types of candlestick patterns, understand how they form, analyze their structure, and discuss their practical applications.

Let’s start!

The Anatomy of a Candlestick

Candlesticks are like the X-ray vision of a market. You can see what’s happening under the surface, like changes in a market’s strength and direction and how emotions shape the trends.

Each candlestick represents price information in a specific unit of time, such as one trading day in a daily chart, one hour in an hourly chart, and so on. By changing the time frame on a chart, the candlesticks will also change accordingly. Let’s look into the components of candlesticks next to understand how they form and what they represent.

Candlestick Components

The four components of a candlestick are the open, close, high, and low prices for a specific time period. Let’s look at an example of a daily candle:

• The open price is the first price at which the asset trades in one specific day.
• The close price is the last price at which the asset trades in one specific day.
• The high price is the highest price the asset reaches during the day.
• The low price is the lowest price reached during the day.

The Candlestick Body

The area between the opening and closing prices is called the body. The color of a candlestick body indicates a bullish or bearish price movement. If the opening price is lower than the closing price, the body color is green. Conversely, if the opening price is lower than the closing price, the body color is red. Different platforms display different colors, but these are the most common.

The size of the candlestick body itself offers valuable information to traders. The longer the body, the more bullish or bearish the candlestick is. A very long red body indicates aggressive selling (fear), and a long green body indicates strong adoption (optimism) in a market.

Upper Shadow and Lower Shadow

Almost every candle has so-called shadows (or wicks). The thin line between the top of the body and the high of the trading period is called the upper shadow. And the line between the bottom of the body and the low is called the lower shadow.

The length and positioning of the shadows provide key indications of market behavior. When the upper shadow is relatively long, it suggests that prices were driven higher during the session but encountered selling pressure or profit-taking near the peak. This could signify potential resistance levels or bearish sentiment coming into play. Conversely, a short upper shadow may imply that buyers remained dominant throughout the session, indicating a strong bullish sentiment.

That’s all regarding the anatomy of candlesticks. Understanding how candlesticks form and what information they hold is essential in mastering candlestick patterns. Now that we covered this part, let’s continue exploring the most common bullish and bearish patterns.

Bullish and Bearish Candlestick Patterns

Bullish candlestick patterns indicate a higher probability of upward price movement. It typically suggests that buyers are in control, driving prices even higher. Bullish patterns often exhibit characteristics such as larger green bodies, long lower shadows, and short upper shadows. These patterns can signify a potential trend reversal, continuation of an existing uptrend, or the formation of a support level.

On the other hand, bearish candlestick patterns indicate a higher likelihood of downward price movement. It implies that sellers are exerting influence and driving prices lower. Bearish patterns often feature larger red bodies, long upper shadows, and short lower shadows. These patterns can suggest a potential trend reversal, continuation of a downtrend, or the formation of a resistance level.

Most Reliable Candlestick Patterns

Before you start investing your hard earned money in candlestick patterns let’s set some expectations straight. While these candle formations can help analyze the markets and make informed trading decisions, they’re not a one-way ticket to easy profits.

Achieving success in trading requires more than just knowing how to spot chart patterns – it takes a combination of trial and error, disciplined execution, risk management, and a reliable trading platform that’s not charging insane fees and lets you trade with complete freedom. Like Morpher.

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Hammer and Inverted Hammer

A hammer candlestick pattern is a bullish reversal pattern that is most accurate at the bottom of a downtrend. It signals that sellers are losing power and are being outnumbered by buyers. Traders look for the hammer pattern as a signal to buy, as it suggests that the price will likely rise in the near future.

The candlestick has a small body, a long lower shadow, and no upper shadow. Also, the lower shadow has to be longer in height than the candlestick’s body for the pattern to be valid. The color of the body of a hammer candlestick can be either green or red.

The inverted hammer pattern looks the same as the hammer pattern. The only difference is that it’s upside down. Despite being called “inverted,” it’s still a bullish reversal pattern. It indicates the end of a downtrend and a possible trend reversal to the upside.

Pin Bar

The pin bar candlestick pattern is undoubtedly the most traded pattern out there, and it is for a good reason. This pattern is used by traders to identify possible trend reversals or continuations after a pullback. Its accuracy is significantly higher when it forms around key support and resistance levels, trendlines, and moving averages.

The bullish pin bar is characterized by a long lower shadow, with a small body and a relatively short shadow on the other end. The tail of the pin bar (the lower shadow) has to be at least two-thirds of the entire length of the candlestick for the pattern to be valid.

The bearish pin bar is the opposite of the bullish pin bar. It has a long upper shadow, a small body, and a short lower shadow. This rejection of higher prices signals that the market may be losing momentum and that a bearish reversal may come soon. Once a bearish pin bar is confirmed, traders look for short selling opportunities.

Engulfing

The engulfing candlestick pattern is one of the most common patterns used by traders to identify trend reversals and continuations after a pullback in the financial markets.

In a bullish engulfing pattern, the first candlestick is red, and the second one is green. The body of the green candlestick is much larger than the body of the red candlestick, with very little to no overlapping shadows. Also, the green candlestick has to open lower than the previous candlestick’s close and close higher than the previous candlestick’s high. The bullish engulfing pattern indicates that buyers have taken control, and the price will likely go up.

A bearish engulfing pattern is valid when a green candlestick is followed by a larger red candlestick. The exact opposite of a bullish engulfing pattern. The green candlestick must completely cover (or engulf) the previous candlestick. The pattern suggests that the bears have taken charge of the market and indicate a possible decline in price in the near future, so traders look for shorting opportunities.

The Morning Star

The morning star pattern essentially implies the bullish state of the market, as the appearance of the morning star is just before sunrise. It is more accurate when it forms at the end of a downtrend. The morning star is a three-candlestick pattern:

The first candlestick is a bearish candlestick with relatively small shadows.

The second candlestick has a small green or red body and short shadows. This candlestick forms at the lower end of the first candlestick.

The third candlestick is a bullish candlestick that indicates strong buying pressure and a potential trend reversal. The body of this candlestick has to be at least the same size as the first candlestick or bigger.

Traders look for the morning star pattern as a signal to buy, as it suggests that the price will likely rise soon.

The Evening Star

The evening star pattern is the upside-down version of the morning star pattern. It indicates the reversal of an uptrend into a downtrend. The three candlesticks are characterized as follow:

The first candlestick is a bullish candlestick with relatively small shadows.

The second candlestick has a small green or red body and short shadows.

The third candlestick is a bearish candle, and the body is bigger than the first one (or at least the same size).

Three White Soldiers

The three white soldiers pattern is a bullish reversal pattern consisting of three green candlesticks with small shadows. This pattern is more reliable when it forms in a downtrend that has been developing for a longer period of time.

For this pattern to be valid, each candlestick has to open near the previous candlestick’s close price.

Traders and analysts often interpret this pattern as a signal to enter long positions or add to existing ones, expecting further price gains.

Three Black Crows

The three black crows pattern is a bearish reversal pattern that is more accurate when it forms at the end of an uptrend. Think of it as an upside down three white soldiers pattern.

This pattern is formed by three consecutive bearish candlesticks. The opening of each candlestick occurs at the previous candlestick’s closing price, and the closing price is lower than the opening price. The three black crows pattern is particularly significant when it occurs at higher price levels or after a mature advance, indicating a potential decline in prices.

Dark Cloud Cover

The dark cloud cover “phenomenon” signals the potential end of an uptrend. It is a two-candle pattern where the first candle is a long green candlestick, followed by a long red candlestick that opens above the previous candlestick’s close. During its trading period, the price starts to decline significantly and the red candlestick closes below the midpoint of the first candlestick’s body.

This pattern suggests that the sunny days of the current uptrend are coming to an end. Bulls are losing control, and the bears are taking over.

Hanging Man

The hanging man pattern is a bearish signal. The shape of the Hanging Man candlestick resembles a person hanging by their feet, hence the name. It typically occurs after an uptrend in the market and suggests that the bullish momentum may be weakening or reversing. The hanging man candlestick has a small body positioned at the top of the candle and a long lower shadow. The lower shadow must be at least twice as long as the candle’s body, and there must be a small or no upper shadow.

Doji

The term “doji” in Japanese translates to “the same thing,” and it refers to the candlesticks with the open and close prices more or less the same. The length of the upper and lower shadows can vary.

A classic doji pattern is a candlestick pattern that indicates indecision and uncertainty in the market. The pattern indicates that neither the buyers nor sellers are in control and that the market is in a state of equilibrium. Traders interpret the presence of a doji pattern as a signal to exercise caution and await further confirmation or additional information before making any decisive buying or selling decisions.

There are different types of doji patterns, including the classic doji (which was described above), gravestone doji, and dragonfly doji. Each type of doji pattern has its own unique characteristics and interpretation.

Gravestone doji and dragonfly doji are very similar to the bearish and bullish pin bar patterns except for the size of the body. A doji candlestick has no body, meaning that the opening and closing prices are virtually the same, while a pin bar possesses a small body. In general, pin bars are more reliable than gravestone or dragonfly doji candlesticks.

Harami

The word “Harami” in Japanese means “pregnant.” The term represents the pattern’s appearance, which resembles a pregnant woman’s body with a small candlestick “inside it.” Don’t judge. I didn’t come up with this name.

The harami pattern is formed by two consecutive candlesticks. The first candlestick has a long body and small shadows. The second candlestick is a small candle with a body that is entirely inside the previous candlestick’s body.

In an uptrend, the harami pattern will have the first candlestick green and the second candlestick red. This indicates a possible trend reversal.

Likewise, in a downtrend the first candlestick is red, and the second one is green—a good time to look for buying opportunities.

Marubozu

The term marubozu means “bald head” or “shaved head” in Japanese. The Marubozu pattern is a candlestick with a long body with no shadows. It can either be bullish or bearish depending on its color and is the most accurate in trend continuations after pullbacks.

A bullish marubozu is a long green candlestick with no upper or lower shadow. This candlestick indicates that buyers controlled the market price from the open to the close, suggesting a strong bullish sentiment.

A bearish Marubozu is the opposite of a bullish Marubozu. The candlestick has a long red body with no upper or lower shadow, indicating that the price opened at its high and closed at its low. This suggests that the bears were in complete control of the market and that selling pressure remained strong throughout the session.

Tweezer Top and Bottom

The tweezer pattern is a short-term reversal pattern and it forms when two candlestick bodies have the same highs (in an uptrend) or lows (in a downtrend). This pattern indicates a struggle between buyers and sellers and can signal a potential trend reversal.

In a downtrend, the pattern is called tweezer bottom, and requires two consecutive candlestick bodies of either color to reach the same low point. This formation indicates that buyers are entering the market, as they were able to push the price back up from the low reached by the first candlestick.

When the market is in an uptrend, traders refer to the pattern as a tweezer top and it requires two consecutive candlesticks to have the same highs to be considered valid. This pattern signals a shift in market momentum and a potential trend reversal as bears begin to take control of the market.

Do Candlestick Patterns Really Work?

Yes, candlestick patterns are reliable for trading but you have to know their limitations and how to overcome them. And this can only be achieved through practice, practice, practice.

Learning to recognize a pattern doesn’t mean you’ll also be successful with it. There’s much more to trading than just patterns—such as knowing exactly when to enter and exit a trade after a chart pattern is completed or what risk-reward ratio is the most suited for your trading style.

By analyzing trading patterns on historical data, you will find out which patterns work the best with your strategy. Accuracy will differ based on which asset you want to trade, the indicators used in the analysis, and which time frame you use for analysis.

In general, trading patterns are more reliable on higher time frames such as 1-hour, 4-hours, or daily. This is because there is more market noise on lower time frames, and patterns tend to fail more often. One way to filter through the noise and increase accuracy is to use patterns in combination with other technical indicators such as moving averages, relative strength index, macd, or bollinger bands.

Frequently Asked Questions

Do chart patterns work in all financial markets?

Yes. Patterns can be identified in any financial market, but their reliability differs due to market players, volatility, timeframe, and trading strategy.

This is why it’s important to backtest your strategy on historical data and find out which markets are performing the best based on your trading rules.

For which type of trader candlestick patterns work the best?

Patterns form in every timeframe, so they can be profitable for all kinds of traders. Day traders usually trade patterns more aggressively with less confirmation as they prefer to get in and out of a trade as quickly as possible.

Position traders hold trades longer than a day and use patterns to identify the long-term direction, and they usually trade more conservatively, with more confirmation. If the trade goes wrong, they are out quickly. If it is profitable, they stay in the market and aim for a big winner.

Conclusion

Congratulations on reaching the end of this comprehensive guide! You’ve taken an important step towards gaining an edge in the markets. It’s important to remember that mastering candlestick patterns requires time, so don’t be discouraged if you don’t become an expert overnight. 

Practice Makes Perfect

As with any skill, practice is crucial in learning how to successfully trade any chart patterns. Take the time to study charts, identify patterns, and observe how they play out in real-time.

Integration with Risk Management

Remember that successful trading involves not only recognizing the patterns on the chart but also implementing robust risk management techniques. Establishing proper risk-reward ratios, setting stop-loss orders, and adhering to your trading plan are vital aspects of preserving capital and managing risk effectively. Always prioritize risk management alongside your candlestick analysis.

Learn from Mistakes

Trading involves risks, and it’s natural to make mistakes along the way. That’s why it’s important to trade with money you can afford to lose. Treat losses as opportunities for growth and learning. Analyze your trades, identify areas for improvement, and adjust your strategies accordingly. By learning from your mistakes, you can refine your trading approach and enhance your overall performance. I don’t know any trader who became rich overnight but I know rich traders who put a lot of effort into perfecting their trading strategies.

That being said… why not dive into those live candlestick charts and apply your newfound knowledge into action?

Happy trading!

Disclaimer: All investments involve risk, and the past performance of a security, industry, sector, market, financial product, trading strategy, or individual’s trading does not guarantee future results or returns. Investors are fully responsible for any investment decisions they make. Such decisions should be based solely on an evaluation of their financial circumstances, investment objectives, risk tolerance, and liquidity needs. This post does not constitute investment advice.