Traders use candlesticks to understand price action. Beyond their easy color code and shape on a chart, candlesticks summarize all the essential information traders need to know, so they can make better-informed decisions.
Below, you’ll learn more about the basics of candlesticks, the most common candlestick patterns, and how to read them.
Understanding Candlesticks Charts
Candlestick charts are useful tools for traders who want to understand how prices move in relation to market psychology and emotions.
Candlesticks can show various patterns and signals on a price chart, depending on their shape, size, and position relative to each other.
They consist of one or more candlesticks, each of which tells a story about the battle between buyers and sellers during a specific time period.
In essence, candlesticks show you these details:
- where the price opened for a period
- where the price closed for a period
- price highs and lows for a specific period
The parts of a candlestick chart include:
- Upper Shadow: the vertical line between the highest price reached during the trading day and either the closing price (in the case of a bullish candle) or the opening price (in the case of a bearish candle). It shows the highest point to which the price rose during the trading session.
- Real Body: the colored portion of the candlestick chart that shows the difference between the opening price and the closing price for a given trading period.
- A green (or white) body indicates that the asset's price moved higher over the course of the trading day
- A red (or black) body indicates that the prices ended lower than they were at the day's opening.
- Lower Shadow: the vertical line between the lowest price reached during the trading day and either the opening price (in the case of a bullish candle) or the closing price (in the case of a bearish candle). It shows the lowest point to which the price dropped during the trading session.
Long vs. short bodies
The longer the body is, the higher the buying or selling pressure will be. Conversely, short candlesticks indicate little price movement and market consolidation.
Long green (or white) candlesticks show strong buying pressure. The longer the white candlestick is, the further the close price is above the open.
Long vs. short shadows
Candlesticks with short shadows suggest that most of the trading action happened near the open and close. Candlesticks with long shadows show that prices go far beyond the open or close price.
Most Common Candlestick Patterns
A Bullish Engulfing pattern occurs when a smaller bearish candle is followed by a larger bullish candle, completely engulfing the previous one. This pattern usually translates as a potential trend reversal from bearish to bullish.
A Bearish Harami consists of a large bullish candle followed by a smaller bearish candle within the body of the first candle. It signals a potential bearish reversal.
A Doji candle has a small body, indicating indecision in the market, so neither the bulls nor the bears have taken control. Opening and closing prices are the same, displaying a small, horizontal line. The Dojj pattern often precedes a significant price movement and can signal a potential reversal.
A Hammer candlestick has a small body with a long lower wick and little to no upper wick. It comes after a period of selling pressure and shows potential bullish strength and a reversal from a downtrend.
Unlike the Hammer, the shooting star has a small body with a long upper wick and little to no lower shadow. This pattern suggests potential bearish pressure and a reversal from an uptrend.
A morning star pattern consists of three candles: a red candle followed by a small-bodied candle (either red or green) that gaps below it, and then a green candle that gaps above and closes above the midpoint of the first candle. This indicates that sellers were losing control and buyers were gaining strength. A morning star pattern can signal a bullish reversal after a downtrend.
The opposite of the morning star, an evening star pattern includes three candles: a green candle followed by a small-bodied candle (either green or red) that gaps above it, and then a red candle that gaps below and closes below the midpoint of the first candle. This indicates that buyers were losing control and sellers were gaining strength. An evening star pattern can signal a bearish reversal after an uptrend.
Candlestick Charts vs. Line Charts vs. Bar Charts
Apart from candlestick charts, line charts and bar charts provide different ways way to visualize the price.
Candlestick charts reveal the opening and closing prices of the asset within a given time frame (the body) and also show the highest and lowest prices reached during that period (the wick).
Overall, they provide a vivid snapshot of market sentiment.
Unlike candlestick charts, line charts focus solely on the closing prices of assets over time. They’re the simplest form of charting, as they connect closing prices with a continuous line. This minimalist approach can be advantageous for traders who prefer a clear and uncluttered view of price movements.
Bar charts, also known as OHLC (Open-High-Low-Close) charts, strike a balance between the richness of information provided by candlestick charts and the simplicity of line charts. Each bar on a bar chart represents a specific time frame and consists of four key price points: the opening price (left horizontal line), the closing price (right horizontal line), the highest price (upper vertical line), and the lowest price (lower vertical line).
Here’s a clearer view of the differences between candlestick, line, and bar charts:
|Candlestick Charts||Line Charts||Bar Charts|
|Ideal for short-term traders, day traders, and for understanding market sentiment||Ideal for long-term investors, trend-following traders||Ideal for traders seeking a balance between information and clarity|
|Offer detailed insights into price action and sentiment, ideal for identifying reversals and patterns||Offer a clean and simple view of price trends over time||Shows essential price points for informed decision-making|
|Easy to understand for beginners||Don’t provide detailed information about intra-day price fluctuations||Can appear complex to beginners|
How to Read Candlestick Patterns
Candlesticks convey a wealth of information about market sentiment and price dynamics. Here's what they reveal:
1. Market sentiment
Candlestick patterns reflect the collective emotions of traders. A bullish candle, for instance, signals optimism and buying pressure, while a bearish candle indicates pessimism and selling pressure. The size and shape of a candle provide further insights into the intensity of these sentiments.
2. Price trends
Candlesticks help identify the prevailing price trend. An uptrend is characterized by a series of ascending bullish candles, while a downtrend features descending bearish candles. Reversal patterns in candlestick charts can signal potential trend changes, offering valuable entry and exit points.
3. Support and resistance levels
Candlesticks assist in pinpointing critical support and resistance levels. These are price points where buying and selling activities are concentrated. Candlestick patterns, such as doji or hammer candles can indicate potential trend reversals or continuations.
Volatility can be your friend or your enemy, but candlesticks can help you translate its signs. Wide-ranging candles signify high volatility, while narrow candles suggest low volatility. Recognizing volatility patterns can aid traders in adjusting their strategies accordingly.
Understanding the basics of candlesticks is a crucial skill for anyone navigating the complex world of the financial realm, including cryptocurrency markets.
But successful trading doesn’t solely rely on identifying candlestick patterns. It involves a holistic approach, including risk management and combining these charts with technical indicators.
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