WHAT IS A CANDLE?
Quite simply, a candlestick is a plot of price over time. This can be any time frame. For example, a one-minute candlestick is a plot of every traded price of a security or asset during that one-minute interval. Similarly, a 5-minute candlestick is a chart of all the prices that stocks are traded in 5 minutes of time.
This is all basic information until you realize that candlesticks are telling a story of buyers and sellers during that time period.
HOW TO READ CANDLESTICK PATTERNS IN TRADING
The value of candlesticks, which have existed for centuries, is in the story they tell. As you can see from the image above, a single candlestick shows the opening, high, low, and closing of the price action during that time frame.
To the naked eye, this might seem irrelevant. However, for the trained candlestick chart reader, all this information is very, very useful in decision-making. That’s why.
Imagine that a stock opens at $1 on a 1-minute candlestick, but is hit by a lot of selling pressure during the first quarter of the time interval. During the first 15 seconds, it trades below the opening price. This forms the lower wick of the candle.
Then, for the next 30 seconds, demand comes in and the stock price moves toward rising to $1.50. It is safe to assume that the bulls were able to surpass the sellers in that period.
However, with 15 seconds remaining in the formation of the candle, the sale of pressure returns. This pushes the share price to $1.25 and forms the top wick of the candle. Maybe the bulls took the profits and the bears re-entered the scene.
What remains is a candle of indecision, which we will talk about later. It is a graphical pattern that occurs over and over again.
There can be many implications for this type of candle. It tells you that neither bears nor bulls are in full control. Regardless of the type of candle or implication, the point is that every candle has a story to tell. It is also important that these graphic patterns are repeated, over and over again. It reveals a struggle between both market forces and where the stock might be headed next.
After all, it’s the “hard right edge” of the chart that we always try to anticipate. Graphic models help us with this.
TYPES OF CANDLE MODELS
In general, there are only three broad categories of candlestick patterns: bullish patterns, bearish patterns, or indecision. Most of these models require the formation of more than one candlestick to create a pattern – and there are many such patterns.
In fact, entire books have been written about all sorts of candle models that can be seen on the market. And while they are very informative and can add value to your trading decisions, the average trader can find the myriad patterns daunting. For this reason, most educators try to condense the types of candle models into the most popular ones.
Here are some examples of the most popular bullish and bearish candlestick combinations you might see. Maybe you already know some of them?
Bullish candlestick chart patterns
A bullish candlestick pattern is one that implies a bullish character – quite simple, right? This could be a downward trend reversal or a continuation of an uptrend.
For a single candlestick,
however, suppose it is a bullish candlestick when it “closes green.” What you’re looking for is a candle that closes higher than it opens, essentially. The example we gave above is similar.
For example, a marubozu candle occurs when the price opens at lows (no/small wick) and closes at highs (no/small wick). We usually consider these candlesticks to be very bullish as the bulls were in control during the entire time interval.
Notice how strong the green and bullish reversal candle is on this chart. It was enough to get past the entire red candle that preceded it – and the wicks are super small. This tells us that demand was strong during the formation of the candle.
Bearish candlestick chart patterns
Contrary to bullish candlesticks, bearish candlestick patterns are just what you would assume. They reveal that the bears were in control during the time interval in which the candle pattern was formed. Similarly, they can represent a reversal pattern after a strong uptrend or a continuation pattern during a downtrend.
For bearish candlesticks, suppose the price opens higher than it closes. In other words, the bears took control at some point after the candle opened and pushed the price lower as the candle formed.
In addition to just candlesticks, there are many models of combination of bearish candlesticks. These create a series of candles that produce a bearish “event”, per se.
Shooting Star Candelabrum Chart Models
Continuing with some of the most popular candlestick chart templates, let’s take a look at the shooting star candelabrum model.
For good reason, most traders assume this is a bearish candlestick pattern. When taken in the context of an uptrend, the presence of a shooting star often signals a reversal. Many contrarian traders like to see them on top of a parabolic race.
As the price rises, what you want to see is a large volume candle that starts at the bottom, goes up, and then goes back down to where it started. Leaves a nice long cover tail. This tells us that gravity, just like with a real shooting star, is bringing the price of the stock back to earth.
Traders look for them so that they can then take a short position and risk the maximum candle, assuming it doesn’t go higher.
Just as you would expect, the shooting star occurs at the end of an uptrend, giving you the opportunity to shorten stocks, expecting a reversal. After the formation of the candle of the shooting star, a short position is initiated on the lower pause, risking the top of the candle of the shooting star.
Models of hammer candlesticks
Hammer candle patterns are somewhat similar to shooting stars in that they often signal reversals. In fact, they can be bullish or bearish depending on the context.
A hammer candle pattern often signals a reversal of a downtrend, just as a shooting star at the opposite end of a trend does. Both the hammers and candles of shooting stars look the same, don’t they?
In the example of the Hammer candlestick model, we have sellers capitulating to stronger hands buying their shares. This leaves a long bottom wick and signals a reversal. To take this trade, you simply buy the breakout over the hammer candle after it has formed, risking up to the bottom of the wick.
Inverted hammer patterns can also signal reversal in a downtrend. It simply means that sellers have not been able to keep pushing the stock price down. Once they realize this, they give up and start hedging their positions, pushing the price higher.
Doji candlestick models
are often referred to as candles of indecision. They may appear red or green on a chart, but they are not exactly considered bullish or bearish. They typically indicate a stalemate between the two forces.
Like the example above, what is typically found in a doji candlestick is a very narrow body with wicks on both ends. Similar to what was discussed above, this informs the graph reader that both bears and bulls created a tug-of-war while this candle was forming, and neither really won, despite the candle closing green or red.
However, if you spot the doji candlestick motif in certain contexts, it may signal a reversal. We discuss this in our doji tutorial.
Comparatively, doji candles are narrow-bodied with long wicks. Ideally, you’ll want to wait for the next candle to form after a doji to make a decision about who has the upper hand – bull or bears. This will keep you safe in your trading decisions.
Cheat Sheet Candlestick Models
To avoid being overwhelmed, we have created for you a cheat sheet of the most popular candle models. Ideally, you’ll keep it handy while trading to train your graphic eye.
Over time, you should expect to recognize these patterns instead of having to refer to the cheat sheet of the candlestick pattern. As you see a title getting more and more extensive, it will become second nature for you to start spotting these patterns.
We have broken down the most popular patterns into bullish and bearish candlestick patterns in this cheat sheet. We recommend that you take the following approach to learn them:
- Choose a side (bullish or bearish)
- candle models for 2-3 months
- Identify all the examples you can find of these templates
- Document what makes the model work or fail
- Create a list of policies you can use to stay disciplined as you trade configurations
Focus on 2-3