How Do You Read a Candlestick Pattern?

Candlestick charts are a type of financial chart that visualizes price movements over time. They originated in Japan and have been used by traders for more than 100 years.

Candlestick charting is now the standard for most traders and investors. There are certain patterns that tend to occur regularly in the market, and experienced traders use these patterns to help predict where prices might be headed in the short term.

This information is displayed on a candlestick chart, which is used by traders to make decisions about when to buy or sell.

How Do You Read a Candlestick Pattern?
How Do You Read a Candlestick Pattern?

Candlestick Components

The candlestick pattern is formed using the open, high, low, and closed prices of security each day. Each candle or bar on the chart typically shows one day, though sometimes an intraday chart may be used to show several different periods such as minutes, hours, or weeks.

The patterns are often divided into two categories: continuation patterns and reversal patterns.

Continuation patterns occur when the price is expected to continue in its current trend, while reversal patterns indicate that the price is likely to reverse its direction. The most common candlestick patterns are:

  • Doji – A pattern consisting of a single candle with an open and close at nearly the same level. Although not common, a Doji candlestick usually signals to analysts that there may be a price reversal. More specifically, candlestick charts can show details about the market’s direction, investor sentiment, energy/momentum, and risk.
  • Hammer/Hanging Man – A pattern characterized by a small real body and a long lower shadow. The pattern indicates that the market is in a downtrend, but buyers are trying to push prices higher.
  • Evening Star/Morning Star – A pattern that usually consists of three candles where the second candle is larger than the first or third. This pattern typically indicates a price reversal, with the second candle being particularly important.
  • Engulfing – A pattern that occurs when one candle completely engulfs another candle, indicating a reversal in trend. A black candlestick followed by a large white candlestick the next day indicates a bullish trend.
  • Shooting Star/Inverted Hammer – A pattern characterized by a long upper shadow and a small real body. The message it sends to traders is that the bulls are now ready to buy the stock at lower prices. Market prices are under pressure from buyers to increase following a downtrend.

Reading the Patterns

The key to reading candlestick patterns is to look at the open, high, low, and close prices for each candle and use them to determine which type of pattern it forms.

Traders should also pay attention to any other technical indicators that may be present, such as volume or trend lines.

Once the pattern has been identified, traders can then use it to make informed decisions about when to buy or sell a security.

Keep in mind that candlestick patterns alone cannot predict future price movements, but they can provide valuable insight into short-term trends and help traders make better decisions.

Experienced traders are also able to combine candlestick patterns with other technical indicators such as moving averages or support and resistance levels to help them form a more complete picture of the market. 

Candlestick Pattern
Candlestick Pattern

Two-Day Candlestick Trading Patterns

One of the most common candlestick patterns used by traders is the two-day candlestick pattern. This pattern consists of two candles that appear one day after each other and form a continuation or reversal signal depending on the characteristics of the individual candles.

The first candle typically signals either a continuation or reversal, while the second candle confirms this signal. By combining the two candles, traders can gain insight into not only short-term market direction but also identify longer-term trends. 

Candlestick vs. Bar Charts

The main difference between candlesticks and bar charts is that candlesticks provide more visual information than bar charts.

They are more visually stimulating and therefore easier to interpret, making them a popular choice among traders.

Candlestick patterns can also be used in conjunction with other technical indicators to gain more insight into market trends. Bar charts, on the other hand, provide less visual information and can be difficult to interpret. 

Ultimately, which type of chart is better will depend on the individual trader and the trading style they prefer.

Candlestick patterns are an invaluable tool for traders looking to gain more insight into short-term price movements. 

The Bottom Line

Japanese rice traders discovered centuries ago that investor emotions have a major impact on asset movements.

By looking at the open, high, low, and close prices for each candle on a chart and combining them with other technical indicators, traders are able to gain an understanding of how market sentiment may be shifting and use this knowledge to make better trading decisions.