Candlestick Patterns: The Complete Guide (2023)

Do you ever feel like the financial markets are a mysterious beast you can’t quite decipher? That’s fine. No need to panic. Today we will explore candlestick patterns and how they can give you a leg up in the game.

But first, what’s the deal with candlestick patterns anyway?

To experienced traders, these patterns are not just random drawings on a price chart; they are the footprints of the “smart money”—capital controlled by central banks, funds, market mavens, and other institutional investors.

It’s no secret that smart money is setting the rules of the game when it comes to trading. And for retail traders, recognizing those footprints and learning how to play the game is key to creating an edge in the markets.

Whether you decide to use technical or fundamental analysis in your trading decisions, knowing how market prices are moving is crucial.

The beauty of candlestick patterns is that each candlestick tells a story about the flow of market forces. A candle is like a visual contest on the price chart between buyers and sellers. Bullish patterns indicate that buyers are in control and bearish patterns signal that sellers are dominant.

At the end of the day, you want to use any possible tool and information that can help you make smarter trading decisions. And candlestick patterns are an invaluable tool in a trader’s toolbox. They repeat themselves in the markets time and time again and can be used to predict price movements accurately.

If you’re considering trading for a living or as an additional source of income, mastering the art of trading with candlestick patterns is a must. This extensive guide will give you the knowledge and skills you need to succeed. And it starts with understanding how candlesticks form and how to interpret candlestick patterns.

So let’s dive in!

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 the candlestick 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 that trading 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. Different platforms display different colors, but the most common color for bullish candles is a green tone.

Conversely, if the opening price is lower than the closing price, the body color is red.

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. 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.

Shadows can offer very valuable information about the current situation of a market.

That’s all regarding the anatomy of candlesticks. Understanding how candlesticks form and what information they hold is essential in mastering candlestick patterns.

Now let’s dive into the patterns and see how they can be used to make consistent profits.

Bullish and Bearish Candlestick Patterns

Most Reliable Candlestick Patterns

Before you start investing your hard earned money on trading with candlestick patterns let’s set some expectations straight. While candlestick charts 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 luck – it takes a combination of trial and error, disciplined execution, and a profound understanding of market cycles. Oh, and you also need a reliable trading platform that’s not charging insane fees and lets you trade with complete freedom. Like Morpher.

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 is longer in height than the candle’s body. 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 is for a good reason. This pattern is used by traders to identify possible trend reversals or continuations after a pullback. Its accuracy is 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) is at least two-thirds of the entire length of the candlestick.

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.

Engulfing

An engulfing candlestick pattern is a reversal pattern valid when a small candlestick is followed by a larger candlestick that completely engulfs the previous one.

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. This pattern indicates buyers have taken control, and the price will likely rise.

A bearish engulfing pattern is valid when a green candlestick is followed by a larger red candlestick. 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 probable decline in price in the near future, so you should 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. So it’s more accurate when it forms at the end of a downtrend. This pattern consists of three candlesticks:

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

The second candlestick has a small body and short shadows.

The third candlestick is a long bullish candle that indicates strong buying pressure and a potential trend reversal. The body of this candlestick is 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 candlesticks are characterized as follow:

The first candlestick has a long bullish candle with small shadows.

The second candlestick has a small body and short shadows.

The third candlestick is a long 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 long bullish (green) candlesticks. This pattern is more reliable when it forms in a downtrend that has been developing for a longer period of time and indicates that buyers are gaining control.

The three white soldiers pattern is easy to spot on a chart, as it consists of three consecutive long bullish candlesticks with little to no shadows. For this pattern to be valid, each candlestick has to open near the previous candle’s close price.

Three Black Crows

The three black crows pattern is a bearish reversal pattern that forms after an uptrend. Think of it as an upside down three white soldiers pattern.

This pattern is formed by three consecutive long red candlesticks. The opening of each candlestick occurs at the previous candlestick’s closing price, and the closing price is lower than the opening price.

Dark Cloud Cover

The Dark Cloud Cover “phenomenon” signals a 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 high of the previous day’s candle but closes below the midpoint of the first day’s candlestick.

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. This pattern consists of one candle and appears at the end of an uptrend, indicating a possible trend reversal to the downside. The hanging man candlestick has a small body 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 buyers nor sellers are in control and that the market is in a state of equilibrium. Traders interpret it as a signal to wait for more information before buying or selling.

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, while a pin bar has a small body. In general, pin bars are more reliable than 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 is a large candle with 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.

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 candlesticks 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 usually called Tweezer Bottom, and requires two consecutive candlesticks 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 require two consecutive candlesticks to have the same highs to be considered valid.

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 candlestick patterns in combination with other technical indicators such as moving averages, relative strength index, macd, or bollinger bands.

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Frequently Asked Questions

Do candlestick patterns work in all financial markets?

Candlestick 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?

Candlestick patterns appear 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

Since you made it all the way to the end of this article, I will say this: Congratulations! You are now one step closer to gaining an edge in the markets. Remember that mastering candlestick patterns takes time and practice, but don’t let that discourage you.

With dedication and a willingness to learn, you’ll be well on your way to becoming a skilled trader. So 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.