Candlestick Charts Explained – Trading the Patterns

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Contents

Forex candlestick patterns

Forex candlestick patterns are a popular tool to analyse price charts and confirm existing trade setups. They have been used for hundreds of years by Japanese rice traders and have made their way to the West through Steve Nison’s books. In this article, we’ll cover what Forex candlestick patterns are, how they’re formed, and how to trade on them.

Forex candle formations

Before we dig deeper into candlestick patterns, it’s important to understand how Forex candles are formed. Forex candles, or the candlestick chart, are OHLC charts, which means that each candle shows the open, high, low, and close price of a trading period. This is represented by the following picture.

The solid body of a candlestick shows the open and close prices of a trading period, while the upper and lower wicks of the candle represent the high and low prices of that trading period.

What are Forex trading candlestick patterns?

Forex Japanese candlestick patterns are specific candlestick patterns that can signal a continuation of the underlying trend, or a trend reversal. These patterns can be single candlestick patterns, which means that they’re formed by a single candlestick, or multiple candlestick patterns which are formed by two or more candlesticks.

Candlestick formations in Forex truly represent the psychology and sentiment of the market. They represent pure price action, and show the fight between buyers and sellers in a graphically appealing format.

While Forex candle patterns are a great way to confirm an existing trade setup, traders should be cautious when trading solely on candlestick patterns as there can be a significant number of false signals.

The most important candlestick patterns

  • Bullish and bearish engulfing patterns

Bullish and bearish engulfing patterns are one of the best Forex candlestick patterns to confirm a trade setup. A bullish engulfing pattern forms when a green candlestick’s body completely engulfs the previous red candlestick, signalling strong buying momentum which breaks above the previous candlestick’s high. Bullish and bearish engulfing patterns are reversal patterns which include two candlesticks.

A bullish engulfing pattern is shown on the following chart.

Similar to bullish engulfing patterns, bearish engulfing patterns form when a large bearish candlestick completely engulfs the previous bullish candlestick’s body, signalling large selling momentum which goes beyond the previous candlestick’s low. A bearish engulfing pattern is shown on the following chart.

  • Hammer and hanging man patterns

Hammer and hanging man patterns are also reversal patterns which form at the tops and bottoms of uptrends and downtrends. A hammer pattern forms at the bottom of a downtrend, with a small solid body and long lower wick, signalling that buyers had enough power to push the price back close to the opening price, hence the long lower wick. A hammer pattern is shown on the following chart.

A hanging man pattern looks similar to a hammer pattern, with the only difference being that it forms at the top of an uptrend. In this case, a hanging man pattern shows that selling pressure is growing – represented by the long lower wick – despite the uptrend. A hanging man pattern is shown on the following chart.

  • Three inside up and three inside down patterns

Three inside up and down patterns are triple candlestick patterns, which means that they’re formed by three candlesticks. A three inside up pattern begins with a bearish candlestick, followed by a bullish candlestick which forms inside the first candlestick, and followed by a third bullish candlestick which closes well above the high of the first candlestick. A three inside up pattern is shown on the following chart.

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Similarly, a three inside down pattern begins with a bullish candlestick, followed by a bearish candlestick which lies inside the first candlestick, followed by a second bearish candlestick which closes well below the first candlestick’s low. A three inside down pattern is shown on the following chart.

The final candlestick pattern which we are going to cover, and also one of the most important Forex chart candlestick patterns, is the doji pattern. The doji pattern is a specific candlestick pattern formed by a single candlestick, with its opening and closing prices at the same, or almost the same level.

A doji pattern signals market indecision. Neither buyers nor sellers managed to move the price far away from the opening price, signaling that a price reversal may be around the corner. A doji pattern is shown on the following chart.

As you can see, a doji pattern can form both during an uptrend and downtrend.

How to trade Forex based on candlestick patterns

Candlestick patterns are a great tool used by many Forex traders to confirm a trade setup. They should not be used to trade on their own, as they can produce a large number of false signals along the way. That’s why you need a trade setup already in place, based on tools such as chart patterns, channels, or Fibo levels, which is then only confirmed with a candlestick pattern, such as an engulfing pattern or hanging man pattern.

Forex candlestick strategy

As we’ve previously stated, the best Forex trading candlestick strategy is to use candlestick patterns for trade setup confirmations. Let’s take a look at the following charts, which show how to use candlestick patterns for day trading Forex the correct way.

1) Trading bullish pennants with engulfing patterns

The chart above shows a bullish pennant pattern which is confirmed by a bullish engulfing pattern. Once the engulfing pattern forms, a trade could enter in the direction of the pennant breakout.

2) Trading double bottoms with engulfing and hanging man patterns

The next chart shows a common double top pattern, followed by a pullback signalled by a hanging man pattern. Once the pullback is completed, a bullish engulfing pattern confirms the opening of a trade in the direction of the breakout. Bear in mind that these are only two examples of how to use candlestick patterns. You can combine them with all types of chart patterns and trading strategies.

Final words

Candlestick patterns are a great tool for trade confirmations. They represent the psychology of the market and the psychology of buyers and sellers who fight to move the price up and down. As such, candlestick patterns shouldn’t be used to trade on their own, but only to confirm existing trade setups.

Forex Candlestick Patterns Guide

Candlesticks chart highlights

The Japanese candlestick chart is considered to be quite related to the bar chart as it also shows the four main price levels for a given time period. So, what makes them the favorite chart form among most Forex traders? The answer is that candles have a lot of qualities which make it easier to understand what price is up to, leading traders to quicker and more profitable trading decisions. Japanese candlestick charts are believed to be one of the oldest types of charts in the world. It was originally developed in Japan, several centuries ago, for the purpose of price prediction in one of the world’s first futures markets. Below you will find a dissection of 12 major signals to learn how to use Japanese candlesticks.

Live Candlestick Patterns

Trading Candlestick Patterns

Summary

2.7. Harami

HOW TO USE CANDLESTICKS?

Learning candle patterns in groups is much like recognizing family members. If a large number of relatives were disbursed in a crowd of strangers it would be easy to miss them.

However, if the relatives were all brought forward and arranged by family units it would become rather easy to spot them, even if they were dispersed back into the crowd again.

Candlesticks, like relatives, can be grouped together and learned in family groups. They can be directly related or cousins. As in any family some of the cousins can be a bit odd, but in perspective they still fit and are much easier to remember if they can be placed into a family.

Candlestick patterns have very strict definitions, but there are many variations to the named patterns, and the Japanese did not give names to patterns that were ‘really close’.

Experience and common sense allow traders to read the message even if it does not exactly match the picture or definition in the book.

News, Analysis and Education Reports on Candlesticks

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Candlesticks Video

Candlestick Trading Strategies

All about Candlesticks: Analytical Tools

A chart is primarily a graphical display of price information over time. Technical indicators and trendlines can be added to it in order to decide on entrance and exit points, and at what prices to place stops. All these charts can also be displayed on an arithmetic or logarithmic scale. The types of charts and the scale used depends on what information the technical analyst considers to be the most important, and which charts and which scale best shows that information.

If your interest is a qualitative view of the market, because you want to display data that have had a large percentage of increase or decrease in price, usually longer-term charts, then it is more appropriate to use a logarithmic chart. While the arithmetic shows price changes in time, the logarithmic displays the proportional change in price – very useful to observe market sentiment. You can know the percentage change of price over a period of time and compare it to past changes in price, in order to assess how bullish or bearish market participants feel.

However, in the Forex market, the arithmetic scale is the most appropriate chart to use because the market doesn’t show large percentage increases or decreases in the exchange rates. On an arithmetic chart equal vertical distances represent equal price ranges – seen usually by means of a grid in the background of a chart. The arithmetic scale is also the most appropriate to apply technical analysis tools and detect chartist patterns because of its quantitative nature. Besides the arithmetic scale, the Forex world has also adopted the Japanese candlestick charts as a medium to access a quantitative as well as a qualitative view of the market. They were chosen among other types of charts – the two most common being the “line chart” and the “bar chart” – because of their attributes as we shall see throughout this chapter.

1. A Way To Look At Prices

The line chart is the simplest form of depicting price changes over a period of time. The line is graphed by depicting a series of single points, usually closing prices of the time interval. This simple charting method makes easier the assessment of the direction of a trend, or the comparison of the prices of multiple instruments on the same graph.

The Japanese candlestick chart is considered to be quite related to the bar chart as it also shows the four main price levels for a given time period. Candles have a lot of qualities which make it easier to understand what price is up to, leading traders to quicker and more profitable trading decisions. Japanese candlestick charts are believed to be one of the oldest types of charts, developed in Japan several centuries ago for the purpose of price prediction in one of the world’s first futures markets. In the 18th century, Munehisa Homma become a legendary rice trader and gained a huge fortune using candlestick analysis. He discovered that although supply and demand influenced the price of rice, markets were also strongly influenced by the emotions of participating buyers and sellers. Homma realized that he could capitalize on the understanding of the market’s emotional state. Even today, this aspect is something difficult to grasp for most aspiring traders. Homma’s edge, so to say what helped him predict the future prices, was his understanding that there is a vast difference between the value of something and its price. The same difference between price and value is valid today with currencies, as it was with rice in Japan centuries ago. Compared to the line and bar charts, candlesticks show an easier to understand illustration of the ongoing imbalances of supply and demand. They also speak volumes about the psychological and emotional state of traders, which is an extremely important aspect we shall cover in this chapter.

One advantage is that in Forex candlestick charts, candles are colored accordingly to the direction of price movement: when the open rate is higher than the closing rate the candlestick is colored with a “filled-in” body, and when the candlestick shows a “hollow” body, that means the closing rate exceeds the opening rate. The body of the candlestick, also called the “real” body, represents the range between the open and closing prices. In a quick view, you notice in which direction, if any, the price is heading. This is just one of the multiple conventions and the one we will use here, as each charting service may color the bullish and bearish candles differently. Below is an example of candlesticks and a definition for each candlestick component. The solid part is the body of the candlestick. The lines at the top and bottom are the upper and lower wicks, also called tails or shadows. The very peak of a candle’s wick is the highest price for that time period, while the bottom of the wick is the lowest price for that particular time period. Another advantage of using a candlestick chart is that you may combine them with conventional market indicators such as moving averages and trendlines. But the most outstanding advantage these charts offer are the early warning signs when changes in trends occur.

The Complete Guide to Candlestick Chart

Last Updated on March 30, 2020

The secret to reading candlestick chart is…

“Rayner, is this some kind of lame joke?”

When you learn a new language, what do you start with?

The words, right?

Because you can’t form a sentence without understanding the words.

And it’s the same for trading!

You can’t read a candlestick chart without understanding candlestick pattern.

So, the first thing you’ll learn is how to read candlestick patterns like a professional trader — even if you have zero trading experience.

(Or if you prefer, you can watch this training below…)

What is a candlestick pattern and how does it work?

Here’s the thing:

A series of candlestick patterns form a candlestick chart.

So, before I dive deep into candlestick chart, you must first know the basics of a candlestick pattern.

Let’s get started…

A candlestick pattern has 4 data points:

Open – The opening price

High – The highest price over a fixed time period

Low – The lowest price over a fixed time period

Close – The closing price

Here’s what I mean:

For a Bullish candle, the open is always BELOW the close.

For a Bearish candle, the open is always ABOVE the close.

Candlestick analysis: How to read and understand any candlestick pattern without memorizing a single one

There are hundreds of candlestick patterns out there.

And it’s silly to memorize every single candlestick pattern because you’ll “burn” yourself out.

Instead, I’ll teach you a trading hack that allows you to understand any candlestick pattern without memorizing a single one.

Every time you see a candlestick pattern, you want to ask yourself these 2 questions:

  1. Where did the price close relative to the range?
  2. What’s the size of the pattern relative to the other candlestick patterns?

1. Where did the price close relative to the range?

This question lets you know who’s in control momentarily.

Look at this candlestick pattern…

Who’s in control?

Well, the price closed the near highs of the range which tells you the buyers are in control.

Now, look at this candlestick pattern…

Who’s in control?

Although it’s a bullish candle the sellers are actually the ones in control.

Because the price closed near the lows of the range and it shows you rejection of higher prices.

So remember, if you want to know who’s in control, ask yourself…

Where did the price close relative to the range?

2. What’s the size of the pattern relative to the other candlestick patterns?

This question lets you know if there’s any strength (or conviction) behind the move.

What you want to do is compare the size of the current candle to the earlier candles.

If the current candle is much larger (like 2 times or more), it tells you there’s strength behind the move.

Here’s an example…

And if there’s no strength behind the move, the size of the current candle is about the same size as the earlier ones.

This is powerful stuff, right?

And we’re just getting warmed up.

How to analyse candlestick chart and read different market conditions (uptrend, downtrend, and range)

A candlestick chart is simply a series of candlestick patterns.

But how do you read a candlestick chart?

  1. Identify the major swing highs and lows on the chart.
  2. Then watch if the swing points are moving higher, lower, or at a similar level

And it’s likely to be in 1 of 3 situations:

  • The swing highs and lows are moving higher, an uptrend
  • The swing highs and lows are moving lower, a downtrend
  • The swing highs and lows are of similar height, a range

Here’s an example…

An uptrend in EUR/USD 4-hour:

A downtrend in USD/CAD Daily:

A range in XAU/USD Daily:

Pro Tip:

A major swing high/low will “stick out” in your face like a red bikini babe.

You’ll spot it easily.

If you’re struggling to find it, then it’s probably not a swing high/low (or you don’t like girls).

Candlestick chart analysis: How to identify strength and weakness in the markets so you don’t get caught on the wrong side of the move

Here’s the thing:

The market doesn’t move in one straight line.

Instead, it goes…

Up and down, up and down, up and down, right? (Something like that)

And you can classify this “up and down” pattern into:

  • Trending move
  • Retracement move

This is important, so let me explain…

A trending move is the “stronger” leg of the trend.

You’ll notice larger bodied candles that move in the direction of the trend.

Retracement move

A retracement move is the “weaker leg of the trend.

You’ll notice small bodied candles that move against the trend (otherwise known as counter-trend).

You might be wondering:

“Why is this important?”

Because in a healthy trend, you’ll expect to see a trending move followed by a retracement move.

But when the trend is getting weak, the retracement move no longer has small bodied candles, but larger ones.

This tells you opposing pressure is stepping in.

Here’s what I mean…

And when you combine this with another technique I’m about to show you, you can pinpoint market turning points with deadly accuracy.

Read on, I’ll tell you more…

How to “predict” market turning points with deadly accuracy

Would you like to be able to “predict” market turning points — and spot trading opportunities with low risk and huge returns?

Well, nothing works all the time.

But the technique I’m about to show you works well for me.

  1. Wait for the price to reach key market structure on the higher timeframe (like Support & Resistance, Trendline, etc.)
  2. Wait for the trending move to get “weak” by having smaller bodied candles
  3. Wait for the retracement move to get “strong” by having larger bodied candles
  4. Enter on the break of structure

Let me give you an example…

NZD/CAD Daily:

On the Daily timeframe, the price is at Resistance area and has a confluence of a downward Trendline.

The price could reverse lower so let’s look for a shorting opportunity on the lower timeframe.

NZD/CAD 8-hour:

On the 8-hour timeframe, the selling pressure is coming in as you notice the candles of the retracement moves getting bigger (a sign of strength from the sellers).

Also, the buying pressure is getting weak as the candles of the trending move get smaller.

One possible entry technique is to go short when the price breaks and close below Support.

I know this can be complex for new traders, so here’s another example…

NZD/USD Daily:

On the Daily timeframe, the price is at previous Support turned Resistance.

The price could reverse lower so let’s look for a shorting opportunity on the lower timeframe.

NZD/USD 4-hour:

On the 4-hour timeframe, the selling pressure is getting stronger as the candles of the retracement move get larger.

Also, the buying pressure is getting weak as the candles of the trending move get smaller.

If you want to trade this setup, you could go short on the break of Support.

This is powerful stuff, right?

Bonus: How to trade candlestick chart like a professional trader (3 powerful tips)

You’ve got what it takes to trade candlestick chart like a professional trader.

But I’m not done yet.

Because here are 3 powerful tips to help you improve your candlestick chart reading skill, fast.

#1: Higher lows into Resistance is a sign of strength

Old Rayner: “Oh look! The price is coming to Resistance, time to short this market.”

New Rayner: “Not so fast…”

Here’s the thing:

You don’t go short just because the price is at Resistance.

Because how the price approaches Resistance matters a lot.

For example, if you see higher lows coming into Resistance, it’s a sign of strength.

It tells you the buyers are willing to buy at higher prices and the sellers are unable to push price lower (than it did previously).

And this looks like an Ascending Triangle on your chart:

Can you see the higher lows approaching Resistance?

That is a sign of strength.

And more often than not, the price breaks out higher.

Pro Tip:

And the opposite is true.

Lower highs into Support is a sign of weakness (and it looks like a Descending Triangle).

#2: If you see a strong momentum coming into a level, it’s better to trade the reversal

When you get a strong momentum move lower, it’s because there isn’t enough buying pressure to hold up the prices — that’s why the price has to decline lower to attract buyers.

Now the entire “down move” is called a liquidity gap (a lack of interest) since not many transactions took place on the decline.

This means the market can easily reverse in the opposite direction due to a lack of interest around the price level.

That’s why you often see a strong move down into Support, and then BOOM, the price does a 180-degree reversal.

Here’s an example…

So remember, if you want to trade price reversals, always look for a strong momentum move into a level.

#3: Wait for the false break to profit from “trapped” traders

Has this ever happened to you?

You noticed the market broke out of the highs and you think to yourself…

“This breakout is real. Just look at the HUGE bullish green candle.”

So, you immediately go long… hoping to catch a BIG move.

But shortly after you entered the trade, the market reverses in the opposite direction!

And it doesn’t take long before you get stopped out of your trade.

Here’s what I mean…

So, what just happened?

Well, I call this a False Breakout.

It’s when you trade a breakout only to get “trapped” and have the market reverse against you.

Now you’re probably wondering:

“How can I profit from the False Breakout?”

Identify the key Support and Resistance where traders will look to trade the breakout

Wait for the breakout to fail when the price trades back into the range

Trade in the direction of the False Breakout

Let me show you an example:

This is powerful stuff, right?

Now if you want to discover more on how to profit from “trapped” traders, then check this out:

Frequently asked questions

#1: Can we apply all of these to other markets like bonds or cryptocurrencies?

Yes, you can apply these concepts to other markets like bonds or cryptocurrencies.

#2: Is there a way to know for sure that it will be a breakout instead of a false break?

There’s no way to know 100% that it will be a breakout instead of a false break.

But there are a few things to consider:

If the higher timeframe is in a downtrend and the breakout is to the upside, then chances are, the breakout will fail.

Alternatively, you want to see how the price approach a level. If it approaches a key support resistance with a huge momentum in a short period, then chances are, it’ll need to take a breather and the price would likely pullback (or reverse altogether).

Conclusion

So here’s what you’ve learned today:

  • If you want to read a candlestick pattern, ask yourself: 1) Where did the price close relative to the range? 2) What’s the size of the pattern relative to the other candlestick patterns?
  • Candlestick chart is made up of a series of candlestick patterns
  • Identify the swing highs/lows on your chart. This tells you whether the market is in a trend or range
  • A trending move is the “stronger” leg of the trend whereas the retracement move is the “weaker” leg of the trend
  • If the trending move is getting smaller and the retracement move is getting larger, it’s a sign the trend is weak (and might even reverse)

Now it’s your turn…

How do you trade with candlestick chart?

Leave a comment below and share your thoughts with me about this candlestick chart guide.

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