Mastering Candlestick Patterns

Candlestick patterns are the basis of technical analysis in trading and offer traders a visual representation of price movement in financial markets in real-time. These patterns originally came from Japanese rice trading around the 18th century and now have become an indispensable tool for traders to understand the market sentiment and predict future asset price movements. By interpreting these patterns, traders can gain valuable insights into the ongoing battle between the buyers and the sellers and anticipate the shifts or reversals in price movements. 

In the ever-changing world of speculative trading, candlestick patterns play a crucial role, and understanding how they work is key to profit. In Contracts for Difference (CFDs), these patterns are very useful, as this type of training allows traders to leverage both upward and downward trends in the market. By understanding the workings of these patterns, traders can make informed decisions and potentially enhance their ability to capitalise on opportunities while making sure that their risk is positively managed. In this article, we will take you through the steps and knowledge that you need to master the candlestick patterns. 

What Are Candlestick Patterns?

Candlestick patterns are a type of financial chart used to represent an asset’s price movements over a specific period. Each candlestick provides four key pieces of information:

• The opening price
• The closing price 
• The highest price
• The lowest price for the given time frame. 

These patterns are visually distinctive and are very useful in identifying trends, reversals, and market sentiments. 

The origins of candlestick patterns date back to the 18th century in Japan when Munehisa Homma discovered them by observing patterns in rice prices. He discovered that he could gain valuable insights into market sentiments and psychology through fluctuations in rice prices. Over time, these discoveries evolved and were adapted to modern financial markets, which we use excessively today. 

Traders use candlestick patterns in speculative trading. They help traders assess whether a trend is developing bearishly or bullishly and whether the trends are likely to continue as they are or a reversal is expected. By carefully interpreting these trends, traders can gain profits, make informed decisions, and carefully enter or exit markets where they fit. 

How to Read a Candlestick Chart

To effectively read a candlestick chart, one should understand the key components of a candlestick. Generally, a candlestick has three key components: the body, the wick or the shadows, and the colours. We know that the candlestick represents four key pieces of information, and this information is based on how you interpret the different combinations of the three components of the candlestick. Here, we look at each component in detail:

The Body 

The body is the rectangular part of the candlestick. It reflects the difference between the opening and the closing prices during the specified periods of time. A long body indicates significant price movement, while a short boy suggests minimal movement or an indecisive market. 

The Wicks or the Shadows 

The thin lines that extend above and below the body are known as wicks or shadows. The top of the upper wick shows the highest price reached during the time frame, whereas the bottom of the lower wick represents the lowest price. Longer wicks can signal potential reversals or rejection of certain price levels. 

The Colours

Traditionally, the candlesticks come in only two colours: green or white and red or black. 

• Green or White Candlestick 

This type of candlestick indicates that the closing price was higher than the opening price, potentially signalling a bullish sentiment. 

• Red or Black Candlestick 

This type of candlestick indicates that the closing price was lower than the opening price, signalling a bearish sentiment in the market. 

While the wicks and colours can help identify trends and market sentiments, it is essential to note that they do not guarantee outcomes. Many factors play a role in market developments; depending on the candlesticks alone, they can bear potential risks. It is, therefore, wise to use the information gathered from the candlestick in conjunction with economic events, market psychology, and external news to ensure potential gains. 

Bullish Candlestick Patterns

A bullish candlestick patterns signal a potential upward movement in price. Traders often use this signal to identify entering positions for long-term positions. These patterns hold the most significance when they appear at the end of a downtrend, suggesting that there is a possibility for a trend reversal. There are two main types of bullish candlestick patterns to look out for:

The Hammer 

The hammer is a single candlestick pattern with a small body near the top and a long lower wick, which is often at least twice the size of the body. Hence the name, as it resembles a hammer. The long lower wick holds significance here as it indicates that initially, the sellers pushed the prices down significantly during the trading period. Still, the buyers are now pushing back and regaining control, which is driving the price back up to near its opening level. If it continues, a potential price reversal can be seen. The important thing to remember is that while the hammer candlestick suggests a bullish sentiment in the market, confirmation of the trend reversal from other technical analysis tools is necessary. 

The Bullish Engulfing Pattern

This bullish pattern consists of two candlesticks. The first candlestick is a small bearish candle, which may be red or black, followed by a larger bullish candle in green or white that engulfs the body of the first candlestick. This bullish engulfing pattern signals a shift from selling to buying sentiment in the market. This indicates that the buyers have potentially taken control, and an upward price movement may be imminent. With this pattern, additional confirmation is still required. 

Both patterns provide valuable insights into market sentiment and potential price reversals, but it is important to remember that they are just signals and not confirmations of reversals. To make an informed decision, you will need to consider many factors, such as world news, technical indicators, and market analysis. 

Reversal Candlestick Patterns

Reversal candlestick patterns indicate a potential change in the direction of a price trend, which is known as reversals. These patterns can signal a shift from an upward trend to a downward trend or vice versa. Traders can thus use such patterns, along with other indicators, to plan their next move. The key here is to use them as one part of the key as they only signal a potential reversal and do not necessarily confirm them. This is why it is always best to use them with other technical indicators to boost your reversal confirmation. 

There are quite a few types of reversal candlestick patterns. Most reversal candlestick patterns are named on the basis of the shape that they make when signalling the respective bearish or bullish reversal. Here we mention a few of the most famous ones:

Morning Star (Bullish Reversal)

The morning star is a bullish reversal pattern made of three candlesticks that appear at the end of a downtrend. It begins with a long, bearish candlestick, followed by a small, indecisive candlestick, which can be either bearish or bullish and ends with a long, bullish candlestick. Such a pattern suggests that the selling pressure is slowly weakening and the buying pressure is building, which can lead to upward price movements. 

Evening Star (Bearish Reversal)

The evening star candlestick pattern is the opposite of the morning star. It appears at the end of an uptrend and comprises three candlesticks: a long candlestick, followed by a small indecisive candlestick, and alongwith a bearish candlestick. This pattern signals that buying pressure is lowly fading and selling pressure is dominating, which could lead to a downward price movement. 

The Shooting Star (Bearish Reversal)

The shooting start candlestick pattern is a single candlestick with a small body near the bottom and a long upper wick that is at least twice the size of the body. This pattern typically appears at the top of an uptrend and signals that buyers tried to push the price but failed, allowing sellers to take control. Thus, a bearish trend may be developing or a potential downward reversal. 

The Inverted Hammer (Bullish Reversal)

The inverted hammer candlestick is very similar to the shooting start pattern and typically occurs at the bottom of a downtrend. It has a small body at the bottom and a long upper wick. This pattern signals a bullish reversal by indicating that the selling pressure may be weakening where the buyers are beginning to take control back. 

It is crucial to mention again that these patterns are not guarantees of a trend reversal but are only signals that need further confirmation using other technical analysis indicators. So, before you make any decisions based on them, factor in other important supporting indicators like geopolitical events, company news, the duration of the trend, and many more. This will help you make a strong and profitable decision and avoid losses. Reversal patterns are, therefore, an important part of trading and understanding them is beneficial for traders. 

Using Candlestick Patterns in Speculation

Candlestick patterns are potent tools for traders who want to speculate on price movements in financial markets, especially when trading Contracts for Difference (CFDs). By leveraging these patterns, traders can make informed financial decisions about entering or exiting trades at the optimum time, benefit from potential trends, and identify potential reversals. As explained before, traders still need additional contributing and supporting factors like technical indicators because candlestick patterns alone do not confirm any bullish or bearish signal. 

Here are a few ways that the traders use the candlestick patterns:

Identifying Entry and Exit Points

This is the most important use of candlestick patterns. Traders use bullish patterns like the inverted hammer or bullish engulfing pattern to spot potential buying opportunities. Similarly, potential bearish patterns like shooting stars or evening stars are used to spot potential selling opportunities. If used right, traders can determine when to open or close positions based on speculative price movements, making a profit and avoiding loss. 

Assessing Market Sentiment 

Candlestick patterns offer a visual representation of market psychology and sentiment, which, when used correctly, can be very beneficial for traders. For example, a series of green or white candlesticks represents a bullish pattern and indicates strong buying momentum. In contrast, a series of red or black candlesticks represents a bearish pattern and indicates a string of selling momentum in the market. Traders can use these sentiments to buy or sell positions to make profits and curb their losses. 

Combining Other Technical Indicators 

Experienced traders often combine these candlestick patterns with technical indicators like moving averages, relative strength index, or support and resistance levels. These combinations are very important as they help validate patterns and increase the likelihood of beneficial trading decisions. 

Speculating on Both Upward and Downward Movements 

CFDs allow traders to speculate on an asset’s rising or falling prices. A trader can use a bullish or a bearish candlestick pattern to speculate whether the price will go up or down and potentially make a profit in a short or long position.

Brokers and CFD Trading 

It is essential to understand that brokers facilitate the trading process and do not provide strategies or guarantees of success in CFD trading. Brokers can offer platforms and tools that traders can use to analyse candlestick patterns and execute trades. Still, in the end, the trader will be responsible for interpreting patterns, managing risks effectively, and developing and implementing strategies that lie entirely with the trader. 

To conclude, candlestick patterns are valuable tools for analysing price movements and for traders to identify speculative opportunities in CFD trading. However, in addition to the patterns, additional indicators are required to ensure outcomes and additional technical analysis is required to confirm the opportunities. 

FAQs About Candlestick Patterns

What Are the Most Reliable Candlestick Patterns for Predicting Market Trends?

There is no set-in-stone list of the most reliable candlestick patterns, as additional indicators are required to confirm their trends. However,  once confirmed, patterns like the inverted hammer candlestick, bullish engulfing candlestick, and morning star are used to spot potential bullish trends. In contrast, the shooting star, bearish engulfing pattern, and evening star pattern are most commonly used to spot bearish trends. 

What Is the Difference Between a Strong and a False Signal in Candlestick Patterns?

The main difference between a strong signal and a false signal is confirmation. Any signal can be strong or false in time, but what sets them apart is the confirmation of the trend using various technical indicators, such as volume analysis, support and resistance levels, or momentum indicators like RSI. 

Are Candlestick Patterns for Beginners in Trading?

Yes, beginners can effectively use a candlestick pattern to anticipate a potential entry or exit point in the trade, but only after careful confirmation. Candlestick patterns are a great entryway into technical analysis for beginners, and they can start by identifying such patterns on historical charts and demo accounts for experience before using them in real-life trading. 

Conclusion

In summary, candlestick patterns are valuable tools in speculative trading. They offer traders a visual representation of market psychology, sentiment, and price movements. Such patterns can help traders identify potential entry and exit points, upward and downward trends, and potential reversals so they can make informed decisions and rectify their strategies. In CFDs, candlesticks are used to analyse price movements, allowing traders to speculate on upward and downward trends. However, keep in mind that they are only signals and do not confirm any trends. 

For beginners, it is crucial to practice reading charts and consistently keep themselves updated on the matter. Use demo accounts to practice the identification of such patterns and then practice how to react in situations where potential profits can be made. In this way, you will be able to master the candlestick patterns in no time.