How to read candlestick patterns and charts when trading
There are dozens of different candlestick patterns that can be formed, each with its own meaning. In this blog post, we'll break down 20+ of the most common candlestick chart patterns and explain what they indicate.
Candlestick charts are one of the most popular types of financial charts and tools to learn how to perform technical analysis. The candlestick chart has a rich history dating back to 18th century Japan, which is why they are also known as Japanese candlestick charts.
To this day, candlestick patterns are used by most traders as an indication of market sentiment and price direction and have become a popular way for traders to view the markets because of how their patterns differ from other types of charts.
Table of contents
- What is a candlestick chart?
- How to read candlestick charts?
- Candlestick components
- List of candlestick patterns
- Bullish candlestick patterns
- Bearish candlestick patterns
- Continuation candlestick patterns
- History of the candlestick chart
- Bar chart vs candlestick charts
- Line chart vs candlestick charts
- Why are candlestick charts popular?
What is a candlestick chart?
A candlestick chart is a form of displaying all the important information a trader needs to try and predict price movement. The opening, high, low, and closing prices are visible and easily recognised during a specific time frame. They are usually preferred to the traditional bar chart because, from a visual perspective, they are much easier to interpret (especially when combining multiple candlesticks together to form candlestick patterns).
Conceptually candlesticks (through patterns) measure market sentiment in the form of bullish vs bearish strength. Each of these patterns tells us a different story about what we could expect from the price chart.
Candlestick chart analysis provides easily readable information. For example, when the close is higher than the open, you know immediately because the body is green. If this happens several days in a row, you can assume a short-term uptrend is in place. If you look at a bar chart, this information is not as easy to identify.
Understanding how continuation and reversal patterns work can help develop your knowledge of the many different candlestick chart patterns.
Example of candlestick chart
Example of line chart
These are the exact same charts. One shows you the candlestick chart while the other shows you a line chart.
Notice how much more information you can interpret and decipher from a candlestick chart vs a line chart?
How to read candlestick charts
Candlestick patterns are a way of interpreting a type of chart. For the candlestick to be complete, you need to wait for a session's closing price. This would show us the full picture - with the open, close, highest point, and low price of the asset in that given period. The area above the body is called the wick or the shadow. For this example, we use a green candle to signify a bullish candlestick and a red one to signify a bearish candlestick.
A candlestick bar has this name because it looks like a candle with a candle wick. Candlestick charts can show us several patterns, such as the doji, hammer, inverted hammer, shooting star, and morning star, which can be important information to help inform our trading strategies.
These patterns can be continuation patterns, reversal patterns, or consolidation patterns, and be made up of bullish candles and bearish candles.
Candlestick components
Wick (or shadow)
An important element of the candle is the wick sometimes referred to as the shadow. Its purpose is to show the extremes in price for a specific period. The wick is visually thinner than its body and is seen as an indicator for traders where there are extreme prices happening while also showing them what direction the price is going.
Open price
The open price is found at either the top or bottom of the candle body. We can determine what end the price opened at and whether prices went up or down during that period. If things trended upwards, then a green/white candlestick opening means its open price was found near the bottom while if they go downwards you'll find red and black candles with their openings being towards the top.
High price
The high price is found at the top of the shadow (or wick), this indicates the highest price during the period. When there is no upper shadow/wick, it means that the close price or the open price was the highest price traded.
Low price
The low price is found at the bottom of the shadow (or wick) below the body. If the open or close was the lowest point there would be no lower wick.
Close price
The close price is the last price traded during the specific time period and is indicated on the candlestick by either the top (green or white candle) or bottom (red or black candle) of the body.
When the candle forms at the start of a new trading period it is constantly changing as the price moves up and down. During this time the candlestick can change colours from green to red until the time period ends with the last price which is the close price. The candle will be completed and a new candle will begin forming at the start of the new trading period.
Price direction
The direction of the price can be found by looking at the colour of the candle. If the price is closing above the opening price of that candle then the colour will be green since it is moving upwards.
When the opposite happens and the price moves down from the opening price then the colour of the candle will be red. These two changes in colour make it easy to identify the price direction on a candlestick chart.
Price range
The price range is the difference between the highest and lowest price of a candle during its time period.
To calculate this, simply take the price of the upper wick and subtract the price of the bottom wick from it.
Price range = highest price - lowest price
Other charts used in forex and other financial markets include line charts containing only one point (open, high, low, or close) or a Bar Chart (which consists of an open price, high low, and close). Candlesticks charts are significantly more unique than traditional bar and simple line charts, and once a trader understands how to read them the information shown becomes quick and easy to digest.
List of candlestick patterns
There are several different types of candlestick patterns that you can use to trade the markets. In this article, we will focus on many different candlestick patterns, including bullish, bearish, and continuation candle patterns.
Bullish candlestick patterns
When you learn about bullish patterns you are discovering a wide range of trading information that can help you make a decision on a particular direction the market is moving. Find some common bullish patterns here:
Hammer pattern
The hammer pattern occurs on a candlestick chart when the trades are significantly lower than the opening, but will rally within that time period to close near the opening price.
A hammer-shaped candlestick forms when the lower shadow is around twice the size of the body, where the body of the candle represents the difference between open and close prices, and the wick highlights the high and low prices of the time period.
Inverse hammer pattern
The inverse hammer or inverted hammer candlestick pattern can appear on a chart at the bottom of a downtrend, which could signal a bullish reversal. Similar to the hammer pattern, its shape is upside down and is identified with a long upper shadow, a short lower shadow, and a tiny candle body.
Bullish engulfing pattern
The bullish engulfing can be discovered when a small black candle with a bearish trend is followed by a large white candle at the opening of the next day that shows a bullish trend. The main body of the new candle will engulf the body of the candle from the previous day.
This pattern is a two-candle reversal and is the opposite of the bearish engulfing candle pattern.
Piercing line pattern
The piercing pattern can mark a potential short-term reversal from a downward to an upward trend and is generally identified as a two-day pattern. On the first day, the candle opens near the high and closes near the low with an average-sized trading range. When the second day begins there is a gap down, where the opening will be near the low and close near the high.
Morning star pattern
The morning star is a bullish sign used in technical analysis and consists of three candles that form after a downward trend, indicating the start of a trend moving upward.
The first candle is tall and black, followed by a smaller black or white candle with a short body and long shadows, with the third is a tall white candle. The opposite of this pattern is the evening star, which is the bearish version signalling an uptrend into a downtrend.
Three white soldiers pattern
The three white soldiers are used to predict a reversal of the current downtrend on a candlestick chart. There are three consecutive long-body candles in the pattern, that begin within the previous candle's body and a close that is higher than the previous candle's highest price.
The opposite of this pattern is the three black crows, which is the bearish version indicating a reversal of an uptrend.
Bullish harami and harami cross pattern
The bullish harami is a chart indicator that can signal the reversal in a bear price movement. Traders can take this as a good sign to enter into a long position of an instrument.
A bullish harami is usually indicated by a white candle showing a small increase in price, that is contained in the downward price movement (shown by black candles) from the past few days.
The bullish harami cross is shown on the chart by a large down candle that is followed by a doji and will occur during a downward trend. It is confirmed when the price moves higher after the pattern has occurred.
Rising three pattern
The first candle is bullish with a large real body within a significant uptrend section, that is followed by three consecutive small-bodied bearish bars that are trading above the low and below the high of the first candle. The last candle is bullish, breaching the high and close of the first candle with a large body.
Bearish candlestick patterns
Now you have a basic understanding of bullish patterns, it is time to learn some bearish patterns you will find on the candle charts. Find some common bearish patterns here:
Hanging man pattern
The hanging man will occur during an uptrend and is the signal that prices could begin falling. The bearish reversal signal is composed of a small real body, a long lower wick, and little or no upper wick.
The pattern can be validated if the candle following the pattern is declining, which will see traders usually enter short trades or exit long trade positions.
Shooting star pattern
The shooting star is a bearish candlestick pattern, which can signal a potential price top and reversal. It often occurs after an uptrend and indicates the price may begin going back down.
The pattern will have a long upper wick, a small or no lower wick, and a small real body that is near the low of the day.
Evening star pattern
The evening star candlestick pattern is used by technical analysts on a stock price chart to determine if a trend is about to reverse. The pattern is bearish and consists of three candles including a large white candle, a small candle, and a red candle.
This pattern is considered by traders a strong indicator of price points in the future going to decline and is the opposite of the morning star pattern.
Bearish engulfing pattern
As the name suggests, the bearish engulfing pattern is the opposite of the bullish engulfing pattern. This bearish signal can occur at any time on the chart but is more likely to occur after a price advance.
The bearish reversal pattern consists of an up candle that is followed by a down-trending candle that engulfs the previous up candlestick.
Three black crows pattern
The opposite of the three white soldiers pattern, the three black crows is a bearish candlestick pattern used by technical analysts to predict the reversal of a current uptrend.
The pattern includes three consecutive long-bodied candles that opened in the real body of the previous candle and also closed lower than the previous candle too.
Dark cloud cover pattern
The bearish dark cloud cover is a reversal pattern that highlights a shift in momentum to a downtrend following a price going up. The pattern starts with an up candle followed by a down candle, with the third candle continuing lower confirming the pattern.
Bearish harami and harami cross pattern
The harami and harami cross can be both bullish and bearish candlestick chart patterns. The bearish version will suggest to traders that prices may reverse to a downward trend.
The bearish harami has an opposite identifier to the bullish reversal pattern, where it consists of a long white candle followed by a small black candle. The second candle has an opening and closing price that is contained within the body of the first up candle.
A bearish harami cross is a chart pattern that also forms after an uptrend. The starting candle is a large candlestick that is followed by a doji that must be contained within the body of the previous candle.
Falling three methods pattern
The falling three methods can be contrasted with the rising three methods and are the bearish alternative for a five-candle continuation pattern. This pattern signals to traders that bulls still don't have enough to be able to reverse the bearish trend.
The first candle is bearish with a large real body within a significant downtrend section, that is followed by three consecutive small-bodied bullish bars that are trading above the low and below the high of the first candle. The last candle is bearish, breaching the lows of the first candle with a large body.
Continuation candlestick patterns
To further improve your candlestick chart analysis, learn about the continuation patterns that are present on forex charts and many other assets. Find some common continuation patterns here:
Doji pattern
Doji candlestick patterns provide data but are often used as part of other practices since they generally represent indecision. A doji by itself is neutral as the open, and the close is at the same level. A doji with a long upper shadow, known as a gravestone doji, is different from a doji with a long lower shadow, known as a dragonfly doji.
The evaluation of a doji depends on the preceding candles or the trend of the market. When there is a doji after a rally, it tells you that positive momentum is beginning to weaken. When there is a doji after a decline, negative momentum is slowing. While a doji does not signify a reversal, it does tell you that supply and demand are becoming more evenly matched.
You will encounter both doji patterns with long shadows and short shadows. A doji with long shadows tells you that there has been a lot of market volatility but no clear direction. A doji with short shadows tells you there is very little volatility and market indecision.
The dragonfly and the gravestone doji patterns usually provide critical information after a rally or a decline.
Dragonfly doji pattern
The dragonfly doji is usually found at the bottom of bearish trends. It is a strong signal of a potential bullish bounce to come.
A dragonfly doji candle looks like a "T," and if this occurs after a decline, it is considered a reversal pattern. You might consider purchasing a currency pair after a dragonfly doji pattern and placing stop-loss below the lower shadows of the candlestick (low of that Doji shadow).
Gravestone doji pattern
The gravestone doji is usually found at the top of bullish trends. It is a strong signal of a potential bearish reversal to come.
A graveyard doji candle can also be viewed as a reversal pattern if found following a rally. The graveyard doji-pattern looks like an upside-down "T" as the open, and the close is the session's low. In this scenario, you might consider selling the currency pair and placing a stop loss above the graveyard goji high.
Long-legged doji pattern
A long-legged doji candle is a signal of indecision. It occurs when the opening price and closing price are very close together, but not necessarily at an equal level. It consists of a long upper and lower wick, with a small body due to the opening and closing prices being approximately the same.
The long-legged doji can also be viewed as a reversal candlestick pattern if it's found following an extended uptrend in prices.
Spinning top pattern
The spinning top candlestick pattern is a sign of neither bullish nor bearish sentiment. It's created when the price opens and closes near its high, with the real body generally being small. This means there is little to no difference between the two prices; this leads to indecision of the asset.
When a spinning top occurs near the top of an uptrend then there could be a sign the bulls are losing control and we may see a trend reversal. Whereas, if the spinning top is found at the bottom of a downtrend then the opposite can be signalled and it may be the bears that are losing control.
History of the candlestick chart
The candlestick chart is sometimes referred to as the 'Japanese candlestick chart', due to its history dating back to 18th century Japan. Munehisa Homma, a famous Japanese rice trader, used the first variation of the chart in the rice trading markets and his status and expertise became renowned.
The candlestick chart was introduced to the Western world in the early 90s by Steve Nison, one of the leading authorities on candlesticks and trading strategies who wrote the book 'Japanese Candlestick Charting Techniques'.
Bar chart vs candlestick charts
Bar charts and candlestick charts have a similar layout but the candlestick offers a clear advantage. With the candles being a lot more visual than the bars, the formation and price patterns are much easier to analyse, and under what direction the price is heading.
Line chart vs candlestick charts
The line chart is a closing price-only chart, whereas the bar and candlestick show price information including open, high, low, and closing prices for a specific amount of time. A timeframe is still chosen on the line chart but only the closing prices are required at the end of each period.
Why are candlestick charts popular?
Candlestick charts provide more information than other types of charts because they combine the open, high, low, and close prices into one graph. The variety of different chart patterns that can be analysed on candlestick charts is extensive and beneficial to learn.
If forex traders or any type of traders spend the time needed to understand the many candlestick patterns and different technical indicators available on these charts, then their predictions of future price movements will be so valuable to the progression of their trading careers.
These charts are the most commonly used in forex trading, stock trading, indices trading, commodities trading, and crypto trading, and most other financial markets by investors.
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This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.
