What Are Candlestick Patterns? Plus 5 Amazing Tips To Trade Patterns
When it comes to trading, there are a variety of different techniques that can be used to try and predict what the market will do next. One of these techniques is known as candlestick analysis.
Candlestick charts are used to show the price movement of an asset over time. They are one of the most popular tools that traders use to make decisions about when to go long or short.
So, What are Candlesticks?
In short, candlesticks comprise two main parts: the body and the wicks. The body is the part of the candlestick that represents the opening and closing prices for the period it covers. The wicks are the lines that extend above and below the body and show the highest and lowest prices reached during that period.
Several different candlestick patterns can be used to try and predict what the market will do next. These patterns are effective because they show the interaction between buyers and sellers of a particular asset.
With that said, let’s deep dive into the main candlestick patterns used in technical analysis.
The Bullish Engulfing Pattern
The bullish engulfing pattern is one of the most popular candlestick patterns traders use to make decisions. This pattern is formed when a bullish candle completely engulfs a bearish candle.
The psychology behind this pattern indicates that the bulls are in control of the market and that the bears have given up. As a result, traders will often use this pattern as a sign to buy an asset. For a bullish engulfing candle to be valid, it must engulf the body and wicks of the preceding bearish candle. Simple right?
How to trade this pattern
When you see a bullish engulfing pattern form, you can enter into a long position with a stop loss at the low of the bullish candle. You can also set your target at the previous high. You can also look for this pattern to form a fundamental support level and use it as a bullish reversal signal.
The bearish engulfing pattern is the opposite of the bullish engulfing pattern. It is another famous candlestick pattern traders use to decide when to buy or sell. This pattern is formed when a bearish candle completely engulfs a bullish candle.
It indicates that the bears are in control of the market and that the bulls have given up. As a result, traders will often use this pattern as a sign to sell or to take profits on a current long position.
How to trade this pattern
When you see a bearish engulfing pattern form, you can enter into a short position with a stop loss at the high of the bearish candle. You can also set your target at the previous low or the next support level.
Morning Star Pattern
The morning star pattern is a three-candlestick pattern that signals a bullish reversal. This pattern forms after a prolonged downtrend and comprises a bearish candle, a small bullish or bearish candle, and a bullish candle.
The first bearish candle in this pattern indicates that the bears are still in control of the market. However, the second candle is smaller and shows that the bulls are starting to take control and that the bears are losing strength. The third candle confirms this trend reversal and shows that the bulls are now in control of the market.
How to trade this pattern
You can enter into a long position when the third candlestick in this pattern forms. Your stop loss should be placed at the low of the second candle, and your target can be set at the previous high. If you’re not comfortable with this, you can create your own rules for taking profits. You can take profits at pivot points, Fibonacci levels, support levels, and other key price areas.
Evening Star Pattern
The evening star pattern is the opposite of the morning star pattern and is a three-candlestick pattern used to signal a bearish reversal. This pattern forms after a prolonged uptrend and comprises a bullish candle, a small bearish or bullish candle, and a large bearish candle.
The first candle in this pattern indicates that the bulls are still in control of the market. However, the second candle shows that the bears are starting to take control and that the bulls are losing strength. The third candle confirms this trend reversal and shows that the bears are now in control of the market.
It’s important to know that the second candle is the smallest of the three. Its small size shows indecision and the inability of bulls to move prices higher.
How to trade this pattern
You can enter into a short position when the third candlestick in this pattern forms. Your stop loss could be placed at the high of the second candle, and your target can be set at the previous low or a preceding key level.
Doji
The Doji is a special candlestick pattern found at the top or bottom of trends and can signal a potential trend reversal. This pattern forms when the open and close prices are equal or very close.
The doji candlestick pattern occurs when the market is in equilibrium, and neither the bulls nor the bears are in control. This indecision can often lead to a reversal in the current trend.
How to trade this pattern
If you see a doji form at the top of an uptrend, it could signal that the bullish trend is losing strength and that a bearish reversal may occur. You can enter a short position with a stop loss above the doji candlestick.
If you see a doji form at the bottom of a downtrend, it could signal that the bearish trend is losing strength and that a bullish reversal may occur. You can enter a long position with a stop loss below the doji candlestick.
Based on the market trend and candle presentation, Doji candlesticks are of two types;
1 Gravestone Doji
The gravestone doji is a unique doji pattern with a long upper shadow and small or no lower shadow. This pattern forms when the open and close prices are equal or very close to each other, and the highs are much higher than the lows.
The gravestone doji signals that the bears are in control of the market and that prices are likely to continue falling.
How to trade this pattern
If you see a gravestone doji form at the top of an uptrend, it could signal that the bullish trend is losing strength and that prices are about to fall. You can enter into a short position with a stop loss above the gravestone doji.
2 Dragonfly Doji
The dragonfly doji is the opposite of the gravestone doji and is a special type of doji pattern with a long lower shadow and small or no upper shadow. This pattern forms when the open and close prices are equal or very close to each other, and the lows are much lower than the highs.
The dragonfly doji signals that the bulls are in control of the market and that prices are likely to continue rising.
How to trade this pattern
If you see a dragonfly doji form at the bottom of a downtrend, it could signal that the bearish trend is losing strength and that prices are about to rise. You can enter a long position with a stop loss below the dragonfly doji.
Tweezer Tops
The tweezer top is a special candlestick pattern that signals a potential reversal from an uptrend to a downtrend. This pattern forms when there are two consecutive candlesticks with equal highs.
The first candle in this pattern shows that the bulls still control the market. However, the second candle shows that the bears are starting to take control and that the bulls are losing strength.
The nature of these candles suggests a reversal because the trading volume in the bullish candle is matched by that of the following bearish candle. This indicates an increase in the selling pressure.
How to trade this pattern
You can enter into a short position when the second candlestick in this pattern forms. Your stop loss should be placed at the high of the second candle, and your target can be set at the previous low.
Tweezer Bottoms
The tweezer bottom is a special candlestick pattern that signals a potential reversal from a downtrend to an uptrend. This pattern forms when there are two consecutive candlesticks with equal lows.
The first candle in this pattern shows that the bears still control the market. However, the second candle shows that the bulls are starting to take control and that the bears are losing strength.
How to trade this pattern
You can enter a long position when the second candlestick in this pattern forms. Your stop loss should be placed at the low of the second candle, and your target can be set at crucial levels.
Pinbar Candlestick Pattern
The pin bar candlestick pattern is a particular type of candlestick pattern that can signal a potential trend reversal. This pattern forms when the open and close prices are not equal, and one end of the candlestick is much longer than the other. As a result, a bullish Pinbar would have a long lower wick and a small upper body. A bearish Pinbar will have a long upper wick and a small lower body.
How to trade this pattern
If you see a pin bar candlestick pattern form at the top of an uptrend, it could signal that the bullish trend is about to reverse and that prices are about to start falling. You can enter a short position with a stop loss above the pin bar candlestick.
Conversely, if you see a pin bar candlestick pattern form at the bottom of a downtrend, it could signal that the bearish trend is about to reverse and that prices are about to start rising. You can enter a long position with a stop loss below the pin bar.
5 Tips for Trading Candlestick Patterns
If you want to trade candlestick patterns, there are a few things you should keep in mind:
1. Look for candlestick patterns that form at crucial levels of support and resistance
Trading candlestick patterns at support and resistance (key) levels is a great way to add confluence to your trades and improve your trading results. These critical levels are points where price has turned in the past—as a result, having a candlestick pattern at these levels can be a good confirmation that the price is likely to reverse. While doing this, also make sure to pay attention to the trend.
2. Pay attention to the size of the candlesticks
The size of the candlestick can give you essential clues about the market sentiment. For example, candlesticks with larger volumes are considered more reliable than smaller ones.
3. Use candlestick patterns in conjunction with other technical indicators
Candlestick patterns can be a great addition to your trading toolbox. However, it is essential to remember that no single indicator is perfect and that you should always use other technical indicators to confirm your trading decisions.
4. Be patient and wait for the pattern to complete
One familiar mistake traders make is trying to enter into a trade too early before the candlestick pattern has been completed. This can lead to getting false signals and can result in losses. Instead, be patient and wait for the pattern to complete before entering a trade.
5. Set realistic profit targets
When trading candlestick patterns, it is essential to set realistic profit targets. This means taking into account the size of the candlestick and the level of support or resistance. For example, if you are trading a bearish pin bar pattern, your profit target should be below the level of support.
Final Thoughts
Candlestick patterns can be a great way to improve your trading results. By following the tips above, you can avoid common mistakes and increase your chances of success. Remember to continuously manage your risk and use stop losses to protect your capital.