How to read candlestick charts & candlestick patterns

Education / 11 Min Read
Desmond Leong / 09 Jul 2021

Candlestick charts are one of the most popular types of financial charts and ways to conduct technical analysis. The candlestick chart has a rich history dating back to 18th century Japan, which is why they are also known as Japanese candlesticks 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. Candlestick charts show the opening, closing and high-low range of each period's trading prices.

In this article, we will discuss:

  • What is a candlestick chart?
  • History of the candlestick chart
  • How to read candlestick charts
  • Candlestick components
  • Bar charts vs candlestick charts
  • Line charts vs candlestick charts
  • Candlestick patterns
  • Bullish candlestick patterns
  • Bearish candlestick patterns
  • Continuation candlestick patterns
  • 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 for price. 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 tell 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. You can also deduce more information from a candlestick chart as compared to other charts.

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?

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 90's by Steve Nison, one of the leading authorities on candlesticks and trading strategies who wrote the book 'Japanese Candlestick Charting Techniques'.

How to read candlestick charts

Candlestick charts tend to be in line with the previous day’s close, unless over the weekend. A candlestick chart can be used as a guide to understand traders’ decisions and activity from the previous day.

If the body of the candle is very narrow, traders were indecisive on that trading day, especially if the open and closing prices are at the same level. If you compare this with a bar chart, it's tough to determine if the open and close are at the same level.

The body and the shadows (wicks) also tell you a lot about prices and can have a myriad of meanings too. It’s important to consider the context of the chart before making a decision. A long wick at a key support may indicate a lot more than at another time in the day.

Further reading: Best technical indicators to use in trading

Candlestick components

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 currency pair 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.

Example of line chart.

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.

Wick (or shadow)

An important element of the candle is the wick or sometimes referred to as the shadow. It's purpose is to show the extremes in price for a specific period. The wick is visually thinner than the body of it 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 will 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 is moving 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 then traditional bar and simple line charts, and once a trader understands how to read them the information shown becomes quick and easy to digest.

Bar chart vs candlestick charts

Bar charts and candlestick charts have a similar layout but the candlestick offers a clear advantage o rpart. With the candles being a lot more visual then the bars, the formation and price patterns are much easier to analyse and under what direction the price is heading.

Bar chart in MetaTrader 4

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 price for the 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.

Line chart in MetaTrader 4

Further reading: Trading exit strategies professional traders use

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 is representing a difference between open and close prices, and the wick is highlighting the high and low prices of the time period.

Hammer candlestick pattern

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, it's shape is upside down, and is identified with a long upper shadow, short lower shadow and a tiny candle body.

Inverse hammer candlestick pattern

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 is showing 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 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.

Piercing line candlestick pattern

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 a tall white candle. The opposite to this pattern is the evening star, which is the bearish version signalling an uptrend into a downtrend.

Morning star candlestick pattern

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 candles body and a close that is higher than the previous candles highest price.

The opposite to this pattern is the three black crows, which is the bearish version indicating a reversal of an uptrend.

Three white soldiers candlestick pattern

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.

Bullish harami and harami cross candlestick pattern

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, 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.

Evening star candlestick pattern

Bearish engulfing pattern

As the name suggests, the bearish engulfing pattern is the opposite to 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 downtrending candle that engulfs the previous up candlestick.

Bearish engulfing candlestick pattern

Three black crows pattern

The opposite to 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.

Three black crows candlestick pattern

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.

Dark cloud cover candlestick 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 up candlestick that is followed by a doji that must be contained within the body of the previous candle.

Bearish harami and harami cross candlestick pattern

Falling three methods pattern

The falling three method can be contrasted with the rising three method, and is 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.

Falling three method candlestick pattern

Continuation candlestick pattern

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.

Doji candlestick pattern

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.

Dragonfly doji candlestick pattern

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).

Dragonfly doji example on chart

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.

Gravestone doji candlestick pattern

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.

Gravestone doji example on chart

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 price 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.

Spinning top candlestick pattern

Further reading: Forex trading for beginners

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, indices, commodities, cryptocurrency and most other financial markets by investors.

Conclusion

Candlestick patterns are very useful - and they get stronger when combined with various other technical studies. For example, combining candlestick patterns with support/resistance, oscillators or Fibonacci can lead to really good setups.

Importantly, you need to learn how to read candlestick patterns properly to improve your trading skills and find your edge in the markets.

 

The 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. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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