67.90 % of retail investors lose their capital when trading CFDs with this provider.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67.90 % of retail investors lose their capital when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

Candlestick patterns in trading and how to trade them

Published: 11.01.2024

If you are new to trading, one of the first steps you should take is to learn how to trade candlestick patterns and how to recognize basic price formations on a chart. In this article, we will break down the basics and give you a tip for a complete trading strategy.

What are candlestick patterns

Candlestick patterns are graphical representations of price movements in financial markets that consist of individual candles on so-called candle charts. The history of candlestick charts is said to date back to 18th century Japan, where candlestick charts were used in commodity markets, mainly rice markets. The basic principles of the operation and use of candlestick charts were developed by Muneshimo Homma, a Japanese trader from the city of Sakata. It was not until the 20th century that candlestick charts were introduced to the world from Japan. Today, candlesticks are among the most widely used method of graphically depicting price charts in the financial markets.
 

Description of individual parts of the candle

The main advantage of a candlestick chart is the amount of information it can convey to traders at a glance. Each candle consists of a body and a wick and 4 prices (opening, closing, maximum and minimum). In addition, we can tell by the colour of the candle body whether the price was falling (red - bearish) or rising (green - bullish) during the time period we set.

Description of individual parts of the candle
 

Why are candlestick patterns important for trading?

Analyzing candlestick patterns is part of technical analysis - one of the most popular and widely used approaches in online trading. Based on the analysis of historical market data, it allows traders to gain a certain statistical advantage in determining the future price development of the asset they are trading. Simply put, if a candlestick pattern known as bullish engulfing appears on a chart, for example, a trader knows that there is a definite chance that the market will go up.

Thus, candlestick patterns are an indispensable tool when trading in any type of market and traders should be familiar with them. In this article, we will therefore introduce the most important of the candlestick patterns. We will show you the basic types of bullish (rising) candlestick patterns, bearish (falling) candlestick patterns and we will also show you the so-called continuous candlestick patterns, which signal the continuation of the market in the same direction. Of course, we will also teach you how to recognize all these on a chart.

Bullish and bearish candlestick patterns

Just as we divide the market into bullish (rising) and bearish (falling), we also divide the patterns on candlestick charts. Correct and timely identification of these candle patterns serves as one indication for traders to estimate the likely direction of the market. We deliberately choose words like "indication" and "likely" here because markets are erratic and their development can never be determined with 100% accuracy.

Thus, the candlestick patterns that we will show here should only serve as one of the indicators for you when trading using technical analysis. However, it is always better to back up your judgments with other analytical tools such as indicators. Purple indicators, which we have developed precisely to estimate the potential future direction of the market, may be a suitable choice.

 

Basic bullish candlestick patterns

These bullish candlestick patterns are often sought out by traders as indicators of possible future uptrends or reversals in the market.

Svíčková formace kladivo

Hammer

Candlestick pattern consisting of one candle. It has a small body and a long lower shadow, so it really resembles a hammer in shape. This pattern suggests that the bears may be losing strength and the bulls are beginning to take control. However, you should wait for the next candle to be drawn before acting on it.

Svíčková formace bullish engulfing

Bullish engulfing

This is a candlestick pattern consisting of two candles. Typical for a bullish engulfing pattern is that the second candle in the sequence completely "engulfs" the body of the first candle. This candlestick formation indicates a potential market reversal to an upward movement.

Svíčková formace Morning star

Morning star

This bullish candlestick pattern consists of three candles. It starts with a long bearish candle, followed by a small candle with an opening price close to the closing price of the first candle and finally comes a long bullish candle. The Morning Star formation indicates to us a possible reversal from a downtrend to an uptrend.

Svíčková formace Bullish Harami

Bullish Harami

This pattern consists of two candles. It starts with a long bearish candle followed by a small bullish candle which is completely inside the body of the first candle. The Bullish Harami indicates a possible reversal to the upside and is considered a signal that the bearish pressure is losing strength.

Boost your trading knowledge with Purple Academy!

Successful trader never stops learning. That is why we have created the Purple Academy where you can find interesting articles, knowledge-expanding ebooks and detailed trading turorials. So if you are interested, just dive in and start learning! (It’s free).

Basic bear candlestick patterns

Now that you have an idea of what the bullish versions of candlestick patterns look like in theory, let's show them together with the bearish ones on real charts from the market.

Inverted hammer

Like its bullish counterpart, the inverted hammer pattern has a small body. However, the long shadow is located above the body of the candle. This indicates a possible reversal from an uptrend to a downtrend.

Candlestick hammer pattern (A) and inverted hammer (B) on the DAX index in the cTrader trading platform

Candlestick hammer pattern (A) and inverted hammer (B) on the DAX index in the cTrader trading platform

Bearish engulfing

This pattern is similar to bullish engulfing but indicates a possible downward turn in the market. The second bearish candle engulfs the body of the first bullish candle, signaling that the bearish pressure may be gaining strength

Candlestick pattern bullish engulfing (C) and bearish engulfing (D) on the EURUSD currency pair in the cTrader trading platform

Candlestick pattern bullish engulfing (C) and bearish engulfing (D) on the EURUSD currency pair in the cTrader trading platform

Evening star

This is a bear candlestick pattern consisting of three candles. It starts with a long bullish candle, followed by a small candle with an opening price close to the closing price of the first candle and finally comes a long bearish candle. The evening star pattern indicates a possible reversal from an uptrend to a downtrend.

Candlestick pattern morning star (E) and evening star (F) on the Australian S&P/ASX 200 index in the cTrader trading platform.

Candlestick pattern morning star (E) and evening star (F) on the Australian S&P/ASX 200 index in the cTrader trading platform.

Bearish harami

This bearish candlestick pattern also consists of two candles. It starts with a long bullish candle followed by a small bearish candle which is completely inside the body of the first candle. The bearish harami indicates a possible reversal to the downside and is considered a signal that the bullish pressure is losing strength.

Candlestick pattern bearish harami (G) and bullish harami (H) on HK50 index in cTrader trading platform

Candlestick pattern bearish harami (G) and bullish harami (H) on HK50 index in cTrader trading platform

Candlestick pattern signaling market indecision

 

Doji candlestick pattern

Like the hammer pattern, the doji candlestick pattern is also made up of only one candle. In this case, however, it resembles a “+” sign rather than a candle. This is because the classic doji has the same closing and opening price and the same long lower and upper shadow. A doji pattern means indecision in the market, buyers and sellers are equally strong and so it is not clear which way the price will move next.
 

The Doji candlestick pattern appears in several forms on the markets

Long-legged Doji

This type of doji has long upper and lower wicks, indicating significant uncertainty and strong fluctuations between bulls and bears. Although the opening and closing prices are close together, the large range between the high and low indicates a struggle between buyers and sellers.
Dragonfly Doji
The dragonfly doji has a long lower wick and no upper wick, with the opening price, maximum and closing price almost the same. This formation may indicate a trend reversal, especially when it appears after a long decline.
Gravestone Doji
Opposite to the dragonfly doji, the gravestone doji has a long upper wick and almost no lower wick. The opening and closing price is at the lowest level of the trading range. This pattern often indicates a bullish failure and a possible reversal of the downtrend.
Price Doji
A price doji is a variation of the classic doji where the opening and closing prices are exactly the same or very close to each other, and the range between the high and low can vary. This type of doji shows a complete balance between buyers and sellers.


Různé variace na formaci doji na grafu indexu STOXX50
Different variations on the doji pattern on the STOXX50 index chart (CH - classic doji; I - long-legged doji; J - dragonfly doji; K - gravestone doji; L - 4 price doji)

Continuous candlestick patterns

We will now show two candlestick patterns that do not signal a reversal in the trend, but rather its continuation. Traders can use continuous candlestick patterns to confirm that the market is possibly going to be continuing in a given direction.

Svíčková formace Three white soldies

Three white soldies

This pattern consists of three long bullish candles. They follow each other and close near their highs. These candles have little or no shadows. If you find a three white soldier candlestick pattern in the chart, it means that the bulls have taken control of the market and it is very likely that the market will continue to rise.

Svíčková formace black crows

Three black crows

The opposite of the three white soldiers. If you see three black crows sitting on a downtrend, believe that there is a high probability that the trend will continue to decline. The formation is made up of three bearish candles that are characterized by a long body and little or no shadows. Thus, the candles are closing near their lows. This pattern clearly signals the predominance of sellers and trading against it is very risky.

Risks of candlestick patterns

Candlestick patterns must be understood in a broader context. Sometimes the formations are not exact as described by the theory, they may vary a little. Another problem is that they can give a false signal.

Candlestick patterns on the USDCAD currency pair
Candlestick patterns on the USDCAD currency pair


In Figure 11 we have a daily chart with the USDCAD currency pair. In the area marked with the letter A there is a chart that could be described as a morning star. However, unlike our pattern above, in this apparent morning star, the second candle did not form a gap at the open, nor did it form the lowest point of the formation. The formation is therefore not entirely accurate. Still, there has been a trend reversal as this bullish pattern often suggests.

In area B, on the other hand, we have the equivalent of an evening star. The formation in our case is even stronger because the second candle of the pattern has a long upper shadow, so we can consider this candle as a pin bar that signals the rejection of higher prices. Therefore, we might have thought that there would be a trend reversal, but instead the market continued on its strong uptrend.

In area C we have a clear three black crows candlestick pattern. The disadvantage of this formation is that with such a strong move, the price has travelled a long distance and there is a risk that the market will stall or reverse soon. This makes it clear that candlestick patterns need to be understood in a broader context and we need to look for so-called confluences with other methods of technical analysis that will increase their accuracy.

Key terms

Bar chart
Show answer
A graphical representation of the price of an instrument. Usually shows the opening, closing, high and low price within a specific time period.
Bearish / Bear market
Show answer
It is a designation for a falling market.
Bullish / Bull market
Show answer
It's a designation for a rising market.
Candlestick
Show answer
A graphical representation of the movement of the price change within the selected time frame. For example, a single candle on a daily time frame represents the price movement for one day. One candlestick on an hourly time frame represents the price movement over one hour. One candlestick shows open, close, high and low price within given time frame.
Candlestick patterns
Show answer
Candlestick patterns consist of one or more candles. Most candlestick formations consist of a maximum of five candles. They are used for short-term predictions of price movements or serve as confirmation for trade entry.
Continuous price patterns
Show answer
They are either price or candlestick patterns and they signal the continuation of an existing trend. These formations often occur when the main trend has slowed or formed a short-term pullback, i.e. the price has pulled back a bit. It should be said that formations are considered continuous if they follow the previous trend. Continuous price formations include flag, pennant, triangle and rectangle.
Doji
Show answer
A doji is a candle that is characterized by the opening and closing price being at or near the same level. In a chart it looks like a cross, an inverted cross or a plus sign. This candle indicates that there could be a change in movement.
Head and Shoulders
Show answer
The head of the shoulder is a price formation that signals a change in trend direction. It is made up of one higher peak and two lower peaks.
Morning star
Show answer
Morning star is a bullish candle formation that consists of three candles.
Price action
Show answer
Price action is a method of technical analysis that is based on observing a price chart without any indicators. It uses candle and price formations, market structure, horizontal supports and resistances and possibly trend lines.
Price patterns
Show answer
They are formed by many candles and take longer time to form.
Reverse price patterns
Show answer
Reverse formations signal a reversal of the current trend. The current trend will stop after some time, a consolidation will occur and then a new trend will start. A reverse formation that forms at the top of a move is called a distribution, where active selling of the instrument occurs. On the other hand, the formation that forms at the lower levels is accumulation, which is the area where active purchases will occur.
Technical analysis
Show answer
Technical analysis is a form of analysis where the trader examines the price. Charts are used for analysis to show the movement of the price. The assumption is that all the information is already contained in the price.
67.90 % of retail investors lose their capital when trading CFDs with this provider.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67.90 % of retail investors lose their capital when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.