Candlestick patterns are used to predict the
future direction of price movement. Discover 16 of the most common candlestick
patterns and how you can use them to identify trading opportunities.
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What is a candlestick?
A candlestick is a way of displaying
information about an asset’s price movement. Candlestick charts are one of the
most popular components of technical analysis, enabling traders to interpret
price information quickly and from just a few price bars.
This article focuses on a daily chart, wherein
each candlestick details a single day’s trading. It has three basic features:
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The body, which represents the open-to-close range
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The wick, or shadow, that
indicates the intra-day high and low
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The colour,
which reveals the direction of market movement – a green (or white) body
indicates a price increase, while a red (or black) body shows a price decrease
Over time, individual candlesticks form
patterns that traders can use to recognise major support and resistance levels.
There are a great many candlestick patterns that indicate an opportunity within
a market – some provide insight into the balance between buying and selling
pressures, while others identify continuation patterns or market indecision.
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Before you start trading, it’s important to
familiarise yourself with the basics of candlestick patterns and how they can
inform your decisions.
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Practise reading candlestick patterns
The best way to learn to read candlestick
patterns is to practise entering and exiting trades from the signals they give.
You can develop your skills in a risk-free environment by opening an demo account, or if you feel confident enough to
start trading, you can open a live account today.
When using any candlestick pattern, it is
important to remember that although they are great for quickly predicting
trends, they should be used alongside other forms of technical analysis to
confirm the overall trend. You can learn more about candlesticks and technical
analysis with IG Academy’s online
courses.
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Six bullish candlestick patterns
Bullish patterns may form after a market
downtrend, and signal a reversal of price movement. They are an indicator for
traders to consider opening a long position to profit from any upward trajectory.
The hammer candlestick pattern is formed of a
short body with a long lower wick, and is found at the bottom of a downward
trend.
A hammer shows that although there were
selling pressures during the day, ultimately a strong buying pressure drove the
price back up. The colour of the body can vary, but green hammers indicate a
stronger bull market than red hammers.
Inverse hammer:
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A similarly bullish pattern is the inverted
hammer. The only difference being that the upper wick is long, while the lower
wick is short.
It indicates a buying pressure, followed by a
selling pressure that was not strong enough to drive the market price down. The
inverse hammer suggests that buyers will soon have control of the market.
The bullish engulfing pattern is formed of two
candlesticks. The first candle is a short red body that is completely engulfed
by a larger green candle.
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Though the second day opens lower than the
first, the bullish market pushes the price up, culminating in an obvious win
for buyers.
The piercing line is also a two-stick pattern,
made up of a long red candle, followed by a long green candle.
There is usually a significant gap down
between the first candlestick’s closing price, and the green candlestick’s
opening. It indicates a strong buying pressure, as the price is pushed up to or
above the mid-price of the previous day.
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The morning star candlestick pattern is
considered a sign of hope in a bleak market downtrend. It is a three-stick
pattern: one short-bodied candle between a long red and a long green.
Traditionally, the ‘star’ will have no overlap with the longer bodies, as the
market gaps both on open and close.
It signals that the selling pressure of the
first day is subsiding, and a bull market is on the horizon.
Three white soldiers
The three white soldiers pattern occurs over
three days. It consists of consecutive long green (or white) candles with small
wicks, which open and close progressively higher than the previous day.
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It is a very strong bullish signal that occurs
after a downtrend, and shows a steady advance of buying pressure.
Six bearish candlestick patterns
Bearish candlestick patterns usually form
after an uptrend, and signal a point of resistance. Heavy pessimism about the
market price often causes traders to close their long positions, and open a
short position to take advantage of the falling price.
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The hanging man is the bearish equivalent of a
hammer; it has the same shape but forms at the end of an uptrend.
It indicates that there was a significant
sell-off during the day, but that buyers were able to push the price up again.
The large sell-off is often seen as an indication that the bulls are losing
control of the market.
Shooting star
The shooting star is the same shape as the
inverted hammer, but is formed in an uptrend: it has a small lower body, and a
long upper wick.
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Usually, the market will gap slightly higher
on opening and rally to an intra-day high before closing at a price just above
the open – like a star falling to the ground.
A bearish engulfing pattern occurs at the end
of an uptrend. The first candle has a small green body that is engulfed by a
subsequent long red candle.
It signifies a peak or slowdown of price
movement, and is a sign of an impending market downturn. The lower the second
candle goes, the more significant the trend is likely to be.
The evening star is a three-candlestick
pattern that is the equivalent of the bullish morning star. It is formed of a
short candle sandwiched between a long green candle and a large red
candlestick.
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It indicates the reversal of an uptrend, and
is particularly strong when the third candlestick erases the gains of the first
candle.
The three black crows candlestick pattern
comprises of three consecutive long red candles with short or non-existent
wicks. Each session opens at a similar price to the previous day, but selling
pressures push the price lower and lower with each close.
Traders interpret this pattern as the start of
a bearish downtrend, as the sellers have overtaken the buyers during three
successive trading days.
The dark cloud cover candlestick pattern
indicates a bearish reversal – a black cloud over the previous day’s optimism.
It comprises two candlesticks: a red candlestick which opens above the previous
green body, and closes below its midpoint.
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It signals that the bears have taken over the
session, pushing the price sharply lower. If the wicks of the candles are short
it suggests that the downtrend was extremely decisive.
Four continuation candlestick patterns
If a candlestick pattern doesn’t indicate a
change in market direction, it is what is known as a continuation pattern.
These can help traders to identify a period of rest in the market, when there
is market indecision or neutral price movement.
When a market’s open and close are almost at
the same price point, the candlestick resembles a cross or plus sign – traders
should look out for a short to non-existent body, with wicks of varying length.
This doji’s pattern conveys a struggle between
buyers and sellers that results in no net gain for either side. Alone a doji is
neutral signal, but it can be found in reversal patterns such as the bullish
morning star and bearish evening star.
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The spinning top candlestick pattern has a
short body centred between wicks of equal length. The pattern indicates
indecision in the market, resulting in no meaningful change in price: the bulls
sent the price higher, while the bears pushed it low again. Spinning tops are
often interpreted as a period of consolidation, or rest, following a
significant uptrend or downtrend.
On its own the spinning top is a relatively
benign signal, but they can be interpreted as a sign of things to come as it
signifies that the current market pressure is losing control.
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Three-method formation patterns are used to
predict the continuation of a current trend, be it bearish or bullish.
The bearish pattern is called the ‘falling
three methods’. It is formed of a long red body, followed by three small green
bodies, and another red body – the green candles are all contained within the
range of the bearish bodies. It shows traders that the bulls do not have enough
strength to reverse the trend.
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The opposite is true for the bullish pattern,
called the ‘rising three methods’ candlestick pattern. It comprises of three
short reds sandwiched within the range of two long greens. The pattern shows
traders that, despite some selling pressure, buyers are retaining control of
the market.
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