Candlestick Patterns Explained

Candlestick pattern is observed in technical analysis. It is basically a movement in prices which is shown graphically on a candlestick chart. Some investors believe that they can predict a specific market movement with this chart.

History of Candlestick Pattern

According to Steve Nison, candlestick pattern charts first came into appearance in somewhat after 1850. From his book, Japanese Candlestick Charting Techniques, Steve Nison brought the pattern of candlesticks to the world in 1991. Most of the development and charting credit of candlestick pattern goes to Homma, a legendary rich trader from the town of Sakata.

Reliability of Candlestick Pattern

Not all candlestick patterns perform equally well. Because of the huge popularity of candlestick patterns, the reliability of these candlestick patterns has been lowered down. These patterns have been destroyed by hedge funds and their algorithms. Hedge fund administrators use software programs to trap members searching for high-odds bullish and bearish results.

How to Read a Japanese Candlestick Chart

Every candlestick pattern has 4 data points:

• Open - This point shows the opening price

• High - At this point, price is highest for a fixed time period

• Low - It is the point where the price is lowest for a fixed time period

• Close - This point shows the closing price

Bullish Reversal Candlestick Patterns

In bullish reversal candlestick patterns, buyers are temporarily in control. However, it is not advised to jump immediately whenever you find such a pattern because this type of pattern does not provide you an edge in the markets.

There are 5 bullish reversal candlestick patterns which you should know:

1. Hammer

It is a single candle bullish reversal pattern which appears when the price goes down. It shows rejection of lower prices.

Ways to recognize hammer pattern:

• Little to no upside shadow.

• Closing of price at the top of one-fourth of the range.

• Length of lower shadow is twice or thrice the length of the body.

2. Piercing pattern

It is a double candle reversal candlestick pattern which appears after the downfall of price. This pattern closes inside the body of previous candle. In terms of strength, this pattern is not much strong.

Ways to recognize piercing pattern:

• In piercing pattern, the first candle has a bearish close.

• The body of second candle closes past the midway sign of the principal candle.

• The closing of second candle is bullish.

3. Morning Star

Morning star reversal candlestick pattern is a 3 candle pattern which forms when the price goes down.

Ways to recognize morning star pattern:

• Bearish closing of first candle.

• Small range of second candle.

• Aggressive closing of third candle (more than 50% of the initial candle).

4. Bullish Engulfing Pattern

Bullish engulfing pattern also forms after a decline in price. It is a 2 candle bullish reversal candlestick pattern.

Ways to recognize bullish engulfing pattern:

• Bearish close of first candle.

• Bullish close of second candle

• Second candle overlaps the first candle.

5. Tweezer Bottom

Tweezer bottom is a 2 candle bullish reversal candlestick pattern which appears after the price decline. This pattern signifies that the market faces difficulty trading lower and it can move to higher.

Ways to recognize tweezer bottom:

• Rejection of lower prices can be observed in the first candle.

• The low of first candle is re-tested by the second candle.

Bearish Reversal Candlestick Patterns

In bearish reversal candlestick patterns, sellers are temporarily in control.

Following are the 5 bearish reversal candlestick patterns:

1. Shooting Star

It is a single candle pattern which appears when the price goes up. It shows rejection of higher prices.

2. Tweezer Top

A double candle pattern which appears after the rise in price. It tells that market is facing difficulty in high trading and can shift towards lower side.

3. Evening Star

It is a triple candle pattern and forms after the rise in price. It tells the tiredness of buyers.

4. Dark Cloud Cover

It is a double candle pattern and forms after a rise in price. It is not much strong.

5. Bearish Engulfing Pattern

It also forms when the price rises. It is a 2 candle bearish reversal candlestick pattern. One can get the idea of sellers mind state through this pattern.

The Bottom Line

Though candlestick patterns are able to capture the attention of traders, many continuation and reversal signals emitted by these patterns are not reliable in the modern trade world where high-tech software are used. Luckily, insights by Thomas Bulkowski show unordinary exactness for a narrow selection of candlestick patterns, offering traders significant purchase and sell signals.