Candlestick patterns are critical for traders to decide the trading strategy. Still, before we go into candlestick patterns, we will go over the gist of what precisely a candlestick chart is. The Candlestick chart originated in 17th century Japan and is an essential charting tool to understand the price trends in the market quickly. Four different values in a candlestick chart form the candle and the wicks or shadows.
Open:The opening price of a stock at the start of the given time (forms the actual body of the candle)
High:The highest price of the stock in a given time (forms the upper wick)
Low:The lowest price of the stock in a given times period (forms the lower wick)
Close:The closing price of a stock at the end of the given time (forms the actual body of the candle)
They can be daily, weekly, monthly candle charts, or even charts for 1 minute, 5 minutes, 15 minutes time intervals on a given day.
The candlestick chart gives an excellent idea of the price fluctuation in a given period, much better than simply plotting the price at different times on the chart's x-axis.
About Candlestick Patterns
Various candlestick patterns form interesting shapes that signal the beginning or end of the previous bearish or bullish trend. Depending on the pattern, market sentiments, and trend analysis, traders can decide on the price at which to buy or sell and when to make the trade.
Here are the top 5 candlestick patterns that traders must know:
The Doji pattern is formed when the Open Price and Close Price are the same or almost the same, and there is Low and High Price, so the candle has nearly nobody with a lower and upper wick. After the start at the Open price, there is a price rise, but there is also a dip in the price within the same interval before settling down at around the opening price itself. (bulls and bears fighting but neither winning)
The Hanging Man is also an important candlestick pattern that occurs only in an extended uptrend. It is called so because it resembles the line figure executed with legs swinging beneath. The pattern is formed with the open price either higher or lower than the close price, but there is very little or no price increase and the low price is much lower than the candle body, or the lower wick is at least twice the size of the body. Here, the traders sense a sell-off jump to get a bargain price; thus, the selling continues after this candlestick pattern.
The Hammer pattern looks the same as the Hanging Man pattern as such, but it occurs after an extended downtrend, with the low price much lower than the open price and close price, but with the close price rallying higher, like the phrase "hammering out the bottom ." After this pattern, there is a significant uptrend and buying of the shares.
This is one of the best candlestick patterns and involves two adjacent candles. Here, the next candle engulfs or completely covers the previous candle signaling a change in trend.There are two types of Engulfing Patterns
Bullish Engulfing Pattern
There is a definite downtrend in the Bullish candlestick pattern in the stock price in the Bullish candlestick pattern. Still, the next candlestick or the candle to the right shows a marked upward trend – a bullish trend, with the price opening lower than the close price of the previous candle. Still, the price rallies, and the closing price are higher than the previous candle's opening price.
Bearish Engulfing Pattern
In the bearish engulfing pattern, there is an uptrend, but immediately, there is a bearish rally, and a downtrend is shown in the next candle that engulfs the first candle. Here, the price is on the rise. Still, in the next trading time period, even though the opening price is higher than the close of the previous candle, bearish sentiments set in, and the closing price is much lower than the opening price of the previous candle.
Although we cannot be sure which candlestick is most reliable, we can safely say that the Engulfing Pattern signals a switch in trend.
Morning Star and Evening Star
There are other candlestick patterns that we can see with three candles next to each other. In the morning star Pattern, there is a bearish candle (large dark candle) which shows a marked decrease in price; this is immediately followed by a star doji or a doji with a very small body, visible lower and upper shadows implying a slight change in trend towards a price increase. The third candle that completes the pattern shows a marked recovery and increase in price with a bullish candle that closes somewhere lower than the opening of the first candle. It shows rising prices like the rising Sun emerging out of the dark night, hence the Morning star.
The Evening star is the opposite of the Morning star pattern, with a bullish candle, a star doji near the high of the first candle, and then a bearish candle that signals the end of the price rise and the start of a fall in price. The body of the bearish third candle is still within the first candle's body. But this marks the trend reversal, like the Sun setting into the dark night and the dark candle or downward price trend starting, hence the name Evening Star.
Traders use several candlestick patterns, but these five are the top patterns used. We can use these patterns to understand and predict how the market will swing next and invest our money intelligently.