Candlestick patterns are one of the foundations in technical analysis. They can help predict the reversal or continuation of the trend, as well as provide a lot of other useful information. For example, to show how strong the uncertainty is at the moment and which of the market participants occupies a leading position, namely the superiority of buyers or sellers. There are a great many candlestick patterns, but all of them are based on similar principles that reflect the behavior of traders.
What it is
When it comes to what candlestick analysis patterns are, Japanese candles are most likely implied. This is a type of chart used in trading. They are used regardless of the asset and instrument, be it serious trading on the stock exchange, futures contracts or working on the Forex with a small deposit with some little-known broker.
Candlesticks are probably the most popular way to display prices in a graph. This is due to the high information content and at the same time the simplicity of this tool. In addition, many different indicators work on the basis of candles, which is part of the trading strategies of many traders around the world.
Candle structure
Before starting to describe what candlestick patterns are, it’s important to understand the tool in question. So, there are bullish candles - those that go up, and bearish ones - that go down. As a rule, they are painted in different colors. The most popular color schemes are green or white for bullish candles and red (often black) for bearish candles. However, many platforms allow the trader to customize the color scheme.
The Japanese candlestick has a body in the form of a vertical bar on the chart. It can be different, for example, short, long, square or very small. This is important information about the current price impulse, the size of the direction of the price will depend on the size.
It is also important to note that candles have the same shape and construction principle, regardless of which time period they have chosen. This is very convenient, for example, when analyzing trends and determining price levels. The rate of formation of one candle will depend on the selected timeframe (time period), which means that on M1 it will be equal to a minute, and on H1 - to an hour.
Shadows
This is a very important part of working with Japanese candles, in addition, from this moment you can begin to describe candle patterns. A shadow is a thin vertical strip that emerges from the body of a candle. It shows a small rollback of the price at the time of the opening of the candle, respectively, it can be both above and below. Such candles have separate names, for example, it can be a pinbar, doji, hammer and many others. Each carries certain information, for example, about the upcoming reversal, strong uncertainty or the continuation of the current trend. The most significant signals will be described below.
Models
Candlestick patterns can be divided into two types: bearish and bullish. As you know, the former are associated with a downward movement of prices, while the latter, on the contrary, predict an upward direction. They are also called candlestick trend reversal patterns. Despite the usefulness of such combinations, they do not guarantee a price change, and a trader should take into account many factors, for example, the current market situation, the chosen time frame (the situation on a minute or five minute chart can differ greatly from the situation on an hourly or daily). It is also recommended to use the lines of support and resistance, trend and follow the news. Below you will find the most popular and most effective candlestick analysis patterns.
Bullish Absorption
One of the most powerful and at the same time simple combinations. It is a short bearish candle and the next long bullish candle. Indicates the upcoming trend reversal up. However, it is important to monitor the behavior of the price, if this is consolidation (wave-like, lateral movement), then the effectiveness of this, and other patterns, will be quite doubtful.
Hammer
Candlestick reversal patterns can consist of only one candlestick, and this is an example. As a rule, it appears after the trend down, at the moment of weakening of the "bears". This candle really looks like a hammer due to its shadow below and a fairly short body at the top. Typically, this pattern predicts a subsequent uptrend.
Three stars
Very unusual candlestick pattern.
Represents three cruciform candles. It is a universal model, as it can denote a change in price both up and down. Apply depending on the previous trend. The effectiveness of this model will be slightly lower than that of the previous ones, if only because it is quite rare due to strong market noise, but it is quite suitable for use.
Bear absorption
The situation is the opposite of bullish. After the candlestick comes a longer bearish candlestick, indicating that sellers have strengthened in the market and a downtrend is expected. As in the case of the bullish takeover, it is important to monitor the price and not to rush, the appearance of the pattern does not give an absolute guarantee of a change in the situation.
Evening Star
Here we see two candles at the top, the second of which “hangs” with the help of its shadow, and after that the price reverses and changes direction. The model is very effective and indicates a market turn down. It is especially effective if the price reaches a certain level that has not been broken up to this point. There is also a variation called "morning star" - about the same principle, but the price goes up. A fairly effective pattern that often works.
Other combinations
In addition to these combinations, there are dozens of variations of candlestick patterns. For example, pinbars, which, as a rule, indicate uncertainty with one or another bias in relation to the direction of the trend. There are also variations of the "evening star" model, with similar principles and construction. Combinations often have fancy names, usually based on their appearance, for example, three soldiers (3 bullish candles of the same size) or a curtain of dark clouds (a variation of bearish absorption). By the way, it is not necessary to know all the models; it is better to hone the use of the most frequent and understandable ones for you. This will save time and increase the efficiency of your trading or training. Strong candle patterns are not a guaranteed key to success, but an important step on the way to it.
Signals
A very controversial question: "Is it worth it to install and use various auxiliary indicators?" It all depends on the experience, nature and style of the trader. Now we are not talking about generally accepted and popular indicators, such as the relative strength index or Bollinger Waves, but rather about specialized systems. These can be installed on the MetaTrader terminal - there are a lot of them on the Internet. For example, some indicator of candlestick patterns with an alert that will signal to the trader that a particular combination has appeared. They can be based on various principles, for example, on the size of a candle, on their quantity, value and many other factors.
Experienced traders create their own indicators that recognize candlestick patterns. Forex, stocks, futures or binary options - it does not matter, since the principle of constructing a price chart is the same everywhere.
If we return to the question regarding the use of indicators, we can conclude that someone will suffer losses and make fewer correct entries, while another trader will increase the percentage of profitable trades. This is primarily due to the basics of trading, because the signal about the appearance of a combination does not guarantee that it will work correctly.
Summary
It is very important to remember that candle combinations do not give any guarantee of successful transactions. The ability to define them will give the trader an additional advantage, but trading based on patterns only is not a good idea. Technical analysis is a cumbersome and complex system that includes many components, for example, determining a trend, support and resistance lines, working with various indicators, oscillators and volumes. In addition, trading psychology is important, understanding that the market is primarily a reflection of the actions of other people, and not just numbers and graphs.
If we return to candlestick patterns, then the ones described above are only a small part of what exists and can be used. There are specialized resources and literature related to candlestick analysis, where you can find a more detailed description of many other models.
It is important to note that it is better to practice on demo accounts or working with small amounts, honing the skills of entering the transaction based on the use of candlestick models. Do not once again risk a deposit, checking this or that model. Even if something worked qualitatively several times, it still does not give any guarantees in the future. Remember: trade is, first and foremost, risk management and competent management in relation to equity used in the work.