What are Candlesticks in Trading and How to Use Them?
Candlesticks or candlestick pattern charts are popular tools that many traders use. They form a part of technical analysis and are used by technical analysts. These types of charts are very good at representing price changes of assets. Not only do they provide a clear visualization of trends, but they do so quickly.
Charts with candlestick patterns are a lot more visually appealing than simple bar or line charts. This is because you can look at them and know in an instant in which direction a financial instrument or asset’s price should move during a time period.
Due to their importance in trading, we are going to discuss candlesticks in today’s article. Thus, we will talk about this useful charting technique and how you can use it to help you become a better trader.
Table of Contents
What are Candlesticks and Candlestick Charts?
A candlestick is a type of chart pattern. Technical analysis makes frequent use of it. In a chart, candlesticks represent the highest, lowest, opening, and closing prices of a financial instrument (stock, currency pair, commodity, option, CFD, etc.) within a time period.
The concept of candlesticks originated in Japan. Japanese traders and rice merchants tracked market prices and market psychology using this technique.
They realized that as much as the price of rice is dependent on supply and demand, it is also influenced by the emotions of traders. Consequently, they used candlestick charts to determine future price movement based on past price patterns.
The wide part of a candlestick is called the “real body”. This part tells us whether the closing price was higher or lower than the opening price. Additionally, there are different colors for the real body.
The color of the real body can be black or red if the financial instrument closes at a lower price. If it closes higher, then they are white or green. Keep in mind, though, these colors are subject to change by the trader. If you like to know more about this topic, you can find more examples in my book Trading for Success.
How Can You Use Candlesticks to Help You Trade?
You can use candlesticks to help you trade by following the up and down movement of the price. These price movements can sometimes be random. However, at other times, they can form patterns. We use these patterns to make trading decisions.
The candlestick patterns can be separated into two categories:
- Bullish patterns. These indicate that the price is likely to move up. They are usually indicated by the color green or white.
- Bearish patterns. These show that the price is likely to go down. They are usually indicated by the color red or black.
How Can You Use Candlesticks to Help You Trade?
To help you read candlestick charts and trade better, I have listed a few common candlestick patterns below. You will know what they look like and what they indicate when you see them.
Bullish Engulfing Pattern
The bullish engulfing pattern is when buyers (bulls) outnumber the sellers (bears). It is represented in the chart by a long real body that is green in color. So, this green body engulfs a much smaller red real body. Since the bulls outpace the bears, the price could go higher. The image below visually demonstrates this bullish engulfing pattern with much more clarity. You can view the behavior of the candlesticks and understand how to read them.
Bearish Engulfing Pattern
In a bearish engulfing pattern, you will see an uptrend developing as sellers outpace buyers. This chart shows a red long real body engulfing a green smaller real body. It is an indication that sellers are in control of the market. Consequently, that means the price could continue heading downwards.
Bearish Evening Star
The last candle opening under the previous day’s small real body in the pattern shows the bearish evening star. The small real body can either be red or green. This last candle closes deep into the candle of two days before.
Subsequently, this pattern sees sellers taking control of the market and more selling taking place.
The bearish harami consists of two candlesticks. First, it is a small red real body. This red real body is inside the previous day’s candle’s real body. It is a reversal pattern that appears on top of an uptrend. This pattern shows the uncertainty of the buyers’ situation. Therefore, it is an indication that the price may reverse and start moving down.
It is the opposite of the bearish harami. While bearish harami is preceded by an uptrend, here a downtrend follows. A large red body (of the previous day ) encloses a small green real body. By doing this, the candlestick indicates to the traders that the price is going to pause.
Bullish Harami Cross
As opposed to the bearish harami cross, this pattern occurs in a downtrend. Here, doji plays a part. Doji is a session where the opening and closing prices are almost equal. It represents the same things as the bullish harami.
Bearish Harami Cross
The bearish harami cross happens in an uptrend. The doji exists within the larger real body of the previous day. It represents the same things as the bearish harami.
How Do You Read Candlesticks for Beginners?
As mentioned earlier, in a candlestick chart, each candle represents the opening, closing, highest, and lowest prices. For instance, a trader set the time frame to 10 minutes. This would mean that a new candlestick will develop every 10 minutes. Similarly, if a trader sets the time frame to one hour, it means that the candlestick will close within one hour.
Candlestick charts show the following information:
- The current price
- The movement of a price within a given period of time
- The price range that an asset has covered in a given period of time
The top or bottom of a candlestick represents its opening price. Accordingly, if the price goes up, the opening price is represented by the bottom. Likewise, if the market closes at a lower price than it started with, the top represents the opening price.
This is the last price traded in a candlestick. Similar to the opening price, it is also represented by the top or the bottom of the real body.
The closing price is constantly changing as the candle develops. You may see the color go from green to red or vice versa. This happens when, for example, the price falls below the opening price and then moves above it later on.
The top of the upper wick of the candlestick indicates the highest price. Furthermore, if the financial instrument opens or closes at the highest price, there will be no upper shadow. In the case that the upper wick of the candle is long, or an upper shadow occurs, the high price is extremely strong. On the contrary, the closing price, in that case, is weak.
The bottom of the shadow or tail below the real body shows the low-price value. If the financial instrument closes or opens at the lowest price, then there will be no bottom shadow.
Now that you are familiar with the basic components of the candlestick chart, you can begin to look for different patterns. This way, you will be able to read what each pattern signifies.
Types of Candlestick Patterns
Single Candle Pattern
This candle pattern involves only a single candlestick. Some popular single candle patterns include:
- Spinning top
- Spinning bottom
- Hammers (inverted hammer, the hammer, hanging man)
Double Candle Pattern
A double candle pattern involves two candlesticks. A few familiar patterns in this category are:
- Bullish engulfing
- Bullish harami
- Bearish engulfing
- Bearish harami
Tripe Candle Pattern
This type of candle pattern is a combination of three candlesticks. A few popular tripe candle patterns are given below:
- Three black crows
- Three white soldiers
- Evening star
- Morning star
What Candle is the Best for Trading?
There are several candlestick patterns that exist to determine price direction. Not all of them have the same level of accuracy, though. For this reason, I have mentioned the ones with the greatest accuracy below. Of course, these patterns will not work for every scenario. However, they are the most reliable out of the ones in use.
- Three Line Strike (predicts higher prices with 83% accuracy)
- Three Black Crows (predicts lower prices with 78% accuracy)
- Evening Star (72% accuracy in predicting lower prices)
- Two Black Gapping (68% accuracy in predicting lower prices)
Candlestick patterns have been the interest of traders for decades, if not centuries. Even with the passage of time, many of these patterns have remained effective in predicting price movements.
Recognizing the different candlestick patterns and understanding how they work can help you analyze the emotions of a market. If you know what these patterns signal, you will be able to build an advanced trading strategy.
If the concept of candlesticks sounds too advanced for you, and you want to learn the basics of trading first, my book Trading for Success will be the perfect guide for you. It will help you lay the foundations of trading with the help of images and real-life examples to gain a deeper understanding of the different trading strategies that exist. In addition, the trading personality questionnaire in the book will help you understand yourself as a trader and the strategies you need to employ to be a successful moneymaker.
If you enjoyed this article on What are Candlesticks in Trading and How to Use Them? or have any questions for me, please feel free to leave them in the comment section below!
Recommended Resources: If you’re interested in learning more about online trading, check out my book “Trading for Success; 8 secrets why women are better forex traders” and take a deep dive into my blog.