Candlestick chart patterns are one of the many methods that stock market analysts and traders use to make informed investment decisions. Candlestick charting has been in existence since the 18th century, making it one of the most effective methods to understand price movements in the stock market.
Whether you are just a beginner looking to invest in the stock market or an experienced trader, having a good understanding of candlestick chart patterns can help you analyze stocks and make the right decisions at the right time.
What are Candlestick Chart Patterns?
Candlestick chart patterns provide a visual representation of price fluctuations over a given time period. They give insights into the size of price fluctuations, opening and closing prices, and the lowest and highest price points over a selected time period, which can be a day, week, or a month. Technical analysts use candlestick charts to identify patterns and predict future price movements in the stock market.
A candlestick chart pattern is made of three components, including:
- The Body
- Upper Shadow
- Lower Shadow
How To Read Candlestick Charts?
The body of a candlestick chart pattern shows the range between opening and closing prices. The highest point of the upper shadow shows the highest price during the selected period, whereas the lowest point of the lower shadow denotes the lowest price.
Now, to understand how to read a candlestick chart, you should know that these candlestick patterns can be either green/white or red. A green or white candlestick denotes that the closing price is higher than the opening price. On the other hand, a red candlestick denotes that the closing price is lower than the opening price.
A candlestick typically shows four data points related to the stock prices, which include:
- Open Price: The price at which the first trade took place during the selected period of time.
- Close Price: The price at which the last trade took place during the selected period, i.e. period specified by the chart.
- Highest price: The highest price at which trade took place during the selected period.
- Lowest Price: The lowest price at which trade took place during the selected period.
The color of a candlestick’s body tells a lot about the price movements. When there are more consecutive reds in a candlestick chart, it indicates that the price is falling. However, if there are more greens, then the price rises. The size of the shadow (also known as the wick) tells about the highs and lows during the selected period.
- If the upper wick of a green candlestick is short, it means that the trade closed near the high of the day.
- If the upper wick of a red candlestick is short, it means that the candle opened near the high of the day.
That’s how you can analyze candlestick patterns to understand the relationship between the highest, lowest, open, and close prices of a stock during a specified period of time.
A candlestick chart includes a combination of these candlesticks displaying price movements of a particular stock. For example, a candlestick chart pattern for a month may include numerous red and green candlesticks, with each denoting one day of trade.
20 Candlestick Chart Patterns For Smart Trading Decisions
Based on the price movements and market sentiment, candlestick chart patterns can be majorly divided into bullish patterns and bearish patterns. Bullish patterns indicate that it might be the right time to invest in the stock market, while bearish patterns indicate a downward price movement. Let’s discuss some proven candlestick patterns that stock traders can identify and consider when making investment decisions:
1. Hammer Pattern – Bullish
This is a candlestick chart pattern where a candle with a short body and long lower shadow is located at the bottom of a downward trend. In short, it’s a single candlestick pattern that marks the end of a downward trend.
It has a very little or no upper shadow, which indicates that the closing price is near or equal to the highest price. It indicates a positive buying behavior despite a high number of sell orders, resulting in the formation of a bullish pattern.
2. Piercing Pattern – Bullish
This is a two-body candlestick pattern located at the end of a downward trend. It involves a red candlestick followed by a green one, where the closing price of the green candle is halfway up the first (red candle).
Here, the first candle is a bearish candle and shows the continuation of a downward trend, whereas the second candle is bullish, which breaks the downward trend and shows that buyers are back in the market. It indicates a strong buying pressure, forming a bullish pattern.
3. Bullish Engulfing Pattern
This candlestick chart pattern is made of two candles, where the first one is a short red candle and the second one is a long green candle. The second (green) candle completely engulfs the first (red) candle, ending the downward trend and showing that bulls are back in the market. This indicates a bullish pattern and rising prices despite the marketing opening at a lower price than the previous day.
4. The Morning Star Pattern – Bullish
The morning star pattern is a three-candle pattern, where the first candle is a long red candle, the second is a short body (Doji) candle, and the third one is a long green candle. The red candle indicates the continuation of a bearish trend.
The second candle denotes an indecisive market, and the third green candle shows that bulls are back and a potential upward trend can be expected. Here, the second candle can be red or green, but should have no overlaps with the other two candles.
5. Three White Soldiers Pattern – Bullish
This pattern is made of three consecutive green candles with small shadows. Each candle in this pattern opens and closes higher than the previous day, i.e. the candles should open within the body of the previous candle. This indicates a potential upward price movement.
6. Bullish Harami Pattern
This is another bullish candlestick chart pattern with one large red candle and one shorter green candle. The first candle is a red(bearish) candl,e and the second one is a shorter green (bullish) candle entirely within the range of the first candle.
The closing price of the second candle is higher than that of the first one, while its opening price is lower, indicating that bulls have entered the stock market and an upward trend is expected.
7. Three Inside Up Pattern – Bullish
This is a three-candle pattern with the first two candles being the same as the ones in the bullish harami pattern, along with a third green candle that confirms a bullish trend.
The first candle isa long red candle, the second one is a small green candle entirely within the first candle’s range, and the third one is a long green candlestick. Stock traders can keep an eye on a stock after noticing the harami pattern and make a final decision after the completion of this three inside up pattern.
8. White Marubozu Pattern – Bullish
This is a single candlestick pattern with a long green body and no upper or lower shadows. It means that the open price is equal to the lowest trade price, and the close price is equal to the highest, indicating a strong buying pressure and a potential upward price movement.
9. Tweezer Bottom – Bullish
This is a two-candlestick chart pattern with one red candle followed by a green one. Both the candles have almost or exactly the same low. The lowest point of the red candle denotes its closing pric,e and the lowest point of the green candle denotes its opening price, which are almost the same.
The market starts the same, but the price goes up and closes higher, indicating that the downward trend may end, encouraging bulls to enter and push the prices up.
10. Inverse Hammer Pattern – Bullish
This pattern is quite the opposite of the hammer pattern. It is also located at the bottom of a downward trend. However, it has a long upper shadow and a short body. It also forms a bullish pattern and indicates that things will be under control for buyers.
11. Hanging Man Pattern – Bearish
This is a single-candlestick pattern formed at the bottom of an upward trend. It’s a red-body candlestick with a small body, a long lower shadow (almost twice the length of the body), and little to no upper shadow. It indicates a bearish reversal and the potential end of a bullish trend.
12. Dark Cloud Cover Pattern – Bearish
The dark cloud cover pattern is formed with two candlesticks, where a green candle is followed by a green one. The red candle opens at a higher price than the previous day’s close, but closes at a much lower price. The red candle’s body should overlap with more than half of the previous green candle’s body. This indicates that the bullish trend may end as bears are entering the market.
13. Bearish Engulfing Pattern
The bearish engulfing pattern is the opposite of the bullish engulfing. This is a two-candlestick chart pattern with a short green candle followed by a long red one. Here, the green candle should be completely engulfed by the red candle, marking a potential end to the bullish trend and indicating a bearish market.
14. The Evening Star Pattern – Bearish
This is a three-candlestick pattern formed after an uptrend, indicating a potential bearish reversal. In this pattern, the first candle is a green (bullish) candle, the second one is a small red/green candle indicating indecision, and the third one is a long red (bearish) candle, indicating a bearish trend. The middle candle should be small and must have no overlaps with the other two candles.
Read Also: Stock Market Basics for Beginners: Everything You Need to Know
15. Three Black Crows Pattern – Bearish
The three black crows pattern is formed after an uptrend, indicating a bearish reversal. It has three consecutive red candles, each opening within the real body of the previous candle. These candles have long bodies and little to no upper/lower shadows, which show that the highs are constantly decreasing and everyday lows going even lower, promoting a bearish trend.
16. Black Marubozu Pattern – Bearish
This is a single candlestick pattern having one red candle formed after an uptrend. It’s a candlestick chart with one red candle having a long body and no upper or lower shadows. It indicates that there is high selling pressure and bears have come back to the market. When this pattern is formed, buyers should be cautious and close their buying position.
17. Three Inside Down – Bearish
The three inside down pattern is another three-candlestick chart pattern indicating a potential bearish trend. The first candle is a long green (bullish) candle, sthe econd one is a red (bearish) one with its body entirely within the first candle’s body, and the third one is a long red candle, confirming the bearish trend.
18. Bearish Harami Pattern
The bearish harami pattern is the exact opposite of the bullish harami. This involves two candlesticks, including one green candle followed by a red one. The green candle is large, showing the continuation of a bullish trend, whereas the red one is short and indicates that bears are back in the market.
19. Shooting Star Pattern – Bearish
The shooting star is a single candlestick pattern formed at the end of an uptrend. It is a single red candle with a small body and a large upper shadow. This can be considered the opposite of the hanging man pattern; however, both indicate a bearish trend.
20. Tweezer Top Pattern – Bearish
The tweezer top pattern is two-candlestick pattern formed after an upward trend. This has two candles, the first one being green and the second one being red, having the same highs. The first candle, which is green, has a shorter body than the second candle, which is red, indicating the potential end of the uptrend and the start of a bearish trend.
Read Also: Stock Market vs Share Market: Key Differences Explained
Learn More at Strategic Alpha & Make the Right Investment Decisions
These were some of the most important candlestick chart patterns for stock traders; however, there are many more of them. If you want to gain in-depth knowledge of stock market investing from experienced investors having decades of experience, Strategic Alpha is the right platform for you.
You can attend the live weekly webinar to learn the basics of techno value investing or join the Conviction Club, where you get access to premium learning modules and a chance to attend one-to-one sessions with mentors and investment experts like Suyog Dhavan.
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FAQs
1. What are candlestick chart patterns in trading?
Ans. Candlestick chart patterns are a type of financial instrument used to analyze price movements in the stock market and predict potential future movements to make the right trading decisions. These look like candles with a body, along with upper and lower shadows, each of which indicates important data points.
2. Why are candlestick patterns important for traders?
Ans. Candlestick patterns can help analyze the market trends, sentiment, and price movements to make the right trading decisions at the right time.
3. How can candlestick patterns help stock traders make better decisions?
Ans. By looking at a candlestick chart, stock traders can understand how a stock has been performing and whether it’s showing a bullish or a bearish trend. A green candle is bearish and a red one is bullish. By understanding the data points associated with these candles, investors can predict possible future price movements of a stock.
4. Are candlestick patterns reliable for long-term stock market investors?
Ans. Yes, candlestick patterns are reliable for both long-term and short-term stock market investors.
5. Can candlestick patterns predict the right time to invest in the stock market?
Ans. Candlestick patterns do not provide a direct insight into the right time to invest, but they help you analyze previous patterns, market sentiment, and other factors, based on which you can predict potential (but not guaranteed) trend changes.
