Did you know it is possible to predict the market by reading the candlestick chart?
Of course, the global financial market can be very unpredictable, including crypto. But it is possible to understand how the market works when technical and fundamental analysis, asset management techniques are used correctly.
And of the most powerful technical tools is the candlestick chart.
This guide will reveal the ins and outs of candlestick patterns and some useful trading tips that will steer you in the right direction.
Let’s dive right in!
UNDERSTANDING CANDLESTICK CHARTS
Did you know candlestick charts appeared over three centuries ago?
The candlestick chart was invented in the 1700s by a Japanese rice trader — Munehisa Homma. He uses the candlestick elements (Open High and Close Low) to represent the price in the trading period.
Today, almost all financial markets rely on candlestick charts as a price representation.
But, do you really know how it works?
Read on as we decipher the ins and outs of candlestick charts.
What Is a Candlestick Chart?
A candlestick chart is a combination of multiple candles a trader uses to anticipate the price movement in any market. In other words, a candlestick chart is a technical tool that gives traders a complete visual representation of how the price has moved over a given period.
Candlestick is a crucial price action tool that shows detailed information about the price, including the open, close, high, and low for a particular time frame. Still, it’s confused with when it’s compared side-by-side with a bar chart.
Here’s an example of the bar chart and candlestick chart:
The bar chart and the candlestick chart may look similar, but there’s indeed a difference. In a candlestick chart, the relationship between open and close is represented by the color of the body. In contrast, the bars have a single vertical line and two horizontal lines on either side of the vertical line.
When an appropriate candlestick pattern forms on a price chart, crypto traders can anticipate price continuations or reversals. Therefore, a single candlestick and a group of candlesticks are essential to define a crypto trading asset’s upcoming price movement.
The Anatomy of a Candlestick
Firstly, let’s have a look at a visual look of a candlestick:
Here we can see a bullish and a bearish candlestick where the price is opened one direction and closed to the opposite direction.
The main body is the broader part of the candlestick that shows the opening and closing price. In a bullish candle, the opening price should be below the closing price. That indicates the price has risen over that period.
On the other hand, the opening price should be above the closing price in a bearish candle. That shows the price has decreased during that period.
The size of the body represents the market pressure. An extended length indicates a strong movement, while a short length represents a minor price movement.
Now, let’s learn how to read the red and green candlesticks in any crypto pair.
Typically, the green color or a buying pressure candle represents a bullish candlestick, and the red color represents the bearish candlestick. However, you can change the color at any time according to your choice and trading template.
The wick is the thicker part of a candlestick attached to the above and below the candle body. The wick above the candlestick’s real body indicates the highest price level during the timeframe. Similar to the wick below, the candlestick body represents the lowest level of that specific timeframe.
Opening High and Closing Low Price Explained
The OHCL is a candlestick chart type that shows the open, high, close, and low prices for a particular time.
The open price is the price level when the previous candle closes, and the current candle appears. Later on, the price will move up or down and will create a high or low. Lastly, when the candle closes at a price, it will point to a closing price. The future price of a candlestick stock depends on how these levels (OHCL) appeared.
Let’s have a look at an example.
Let’s say the Bitcoin price moved above the $50,000 level on a particular day and made a high above the $50,000 crucial level. However, the price moved lower and closed the daily candle below the $50,000 level by forming Doji or Pinbar.
What does this mean for you?
It means buyers tried to take the price above the $50,000 level but failed; thus, sellers took control over the price. It is a clear indication that the price failed to get stable above the $50,000 level, and it might be a good idea to sell now.
IDENTIFYING THE CANDLESTICK PATTERNS
Each candlestick form patterns that traders can use to recognize major support and resistance levels.
A great way to start is first to identify the candlestick patterns. Here’s what you need to know.
When Does a Candlestick Pattern Start to Show?
The candlestick pattern is a combination of some candlesticks representing a story about buyers and sellers for a particular time. However, the price movement in the financial market depends on supply and demand and traders’ emotions. As soon as the price reaches a resistance or support level, candlestick patterns will start emerging.
Therefore, when the price moves to a significant price zone, the candlestick pattern will become very important.
For example, the high psychological level of $60,000 has become a strong resistance level that attracted many buyers and sellers.
See the chart below to learn how to read candlestick chart:
Here Bitcoin made an indecision candle near the significant round number $60,000, indicating a starting point of the pullback.
The price fell with an impulsive bearish pressure towards the downside.
So, what will you do if you find an appropriate candlestick pattern at a critical support or resistance level?
You should closely track the buyers’ and sellers’ activity and enter a trade once the direction is set. The best solution is to wait for an appropriate candlestick pattern at support or resistance levels and enter the trade after a rejection.
Understanding Candlestick Chart Patterns and Trends
The trends usually are represented by the ups and downs of an asset’s price on the candlestick chart. The high and low points of several small trends are grouped to form a more significant trend.
These trends include:
READING THE CANDLESTICK CHARTS
Candlesticks charts are like a book where a trader can easily read the price from left to right.
While it’s not technical to read it but there is a learning curve to analyzing the chart.
Here is how to read the candlestick chart:
There are no specific rules for this, but it is preferred to start reading candlesticks from the far left until you see the first candlestick.
For example, if you are trading in a 15 minutes timeframe, you can see the last month’s data, but not before that.
You should focus on the speed of the trend and candlesticks formation at the end of the trend.
Let’s have a look at a practical example for a better understanding:
Here we can see the daily chart of Bitcoin, where the price started to move higher with a bullish engulfing pattern. Later on, the trend becomes corrective and moves lower. After that, the price forms another bullish engulfing, and the price moved higher and formed a new high.
To read the candlestick chart accurately, you should:
1. Use higher time frames
2. Focus on price action located at key support and resistance level
Trading Time Frames
Timeframes are an essential tool for traders. Although candlesticks patterns in all timeframes come from the price movement, there is technically no difference in higher or lower timeframes.
However, higher time frames always provide a more accurate price direction than the lower timeframe. Therefore, if you intra-trade any cryptocurrencies, you should see the price direction daily or H4 candles. When the lower timeframe and higher time frames match the direction, you can find profitable trades.
We have learned that a Hammer is a reversal candlestick but does it mean to sell immediately as soon as you see a Hammer candlestick in the chart?
The answer is no.
Candlestick patterns at a random place on your price chart do not provide highly accurate signals. However, a candlestick pattern within the trend and at a perfect location can provide high probability trades.
Therefore, you should always look out for the support and resistance level in the chart. Moreover, it would help if you considered the market context and the overall environment to increase success odds.
We can see a Bullish Engulfing pattern at the $10,000 level of BTCUSD in the above image. However, after the Bullish Engulfing Bar, a Bullish Shooting Star appeared, and it failed.
It’s because it is at a random place instead of a support or resistance zone. To add on, you should also consider:
- Impulse price movement: When the price moves with a solid bullish or bearish pressure, it creates new highs or lower lows aggressively.
- Correction movement: After an impulse, the price needs to correct, and the correction price becomes slow.
- Volatility: In the volatile market, the price breaks recent highs and lows but does not set any price direction.
- Non-volatility: In a non-volatile market behavior, the price aggressively moves higher or lower, indicating solid price dominance.
The price chart sample above shows that ETHUSD the four different nature of the trend is marked. If you can match the context with the candlestick formation, you can easily define the possible price movement in any asset.
How to Place a Stop-loss and Take Profit on a Pattern?
Having a stop-loss is an essential risk management tool for crypto trading to limit your losses on an open position that makes an unfavorable move. The key advantage of using a stop-loss order is to help you cut out losses without having to monitor your asset daily. And without a stop-loss, you are practically risking your investments.
The ideal place for setting a stop-loss is below or above the candles low/high with some buffer.
For example, we can see a Hanging Man formed at a critical support level, indicating a potential bullish movement in the price. The ideal stop-loss should be below the candlestick pattern with some buffer, and the take profit would be near the resistance level.
POPULAR CANDLESTICK PATTERNS
There’s no denying that candlestick patterns plays a significant role in technical trading. A candlestick pattern is especially useful for traders to determine the possible price movement and market trends based on the past patterns.
Of course, there is also a variety of candlestick patterns that signal bullish and bearish movements. But, what are the best candlesticks?
Here’s what you need to know:
Bullish and Bearish Engulfing
The bullish engulfing candle pattern is a combination of a red and green candlestick where the first candle is red (bearish). After closing the red candle, a green candle appears, engulfing the body of the previous candle, and it closes above the last candle’s high. On the other hand, the bearish engulfing candle is the opposite of the bullish body engulfing. Here, a green candle should appear first, and a red candle should engulf the body of the first candle.
Did you know?
Engulfing pattern indicates the price direction changes from bullish to bearish or bearish to bullish as soon as the candle closes above or below the previous candle’s closing price.
In the image above, we can see how an engulfing candlestick pattern forms in the market.
We can see that the engulfing pattern at a strong support level works as a vital price reversal zone in the following price chart:
The hammer candlestick has a long downside wick and a bullish or bearish small body to the upside. This type of candlestick usually indicates an asset’s exhaustion in the market, meaning there will be an upcoming trend reversal. That means sellers entered the market, pulling the price down but were countered by buyers who drive the price up.
The ideal price location of the hammer candlestick pattern is at the end of a downtrend.
If you want to open a trade based on the hammer candlestick, you should wait for the candle to close before entering a trade. But once the price break above, the candle’s high, then it’s time for you to enter.
Shooting star candlestick is the opposite of a hammer candlestick. The Shooting Star can be recognized by a log upside wick and a small downside body. If you find the bullish or bearish Shooting Start at any important resistance level, it is a potential selling opportunity you should consider.
The ideal price location of the shooting star pattern is at the end of an uptrend.
Hanging Man is like the Hammer candlestick, where the open, high, and close prices are almost the same. There should be a long shadow in the Hanging man candlestick, two times higher than the candle’s body.
In bullish Hanging Man, the closing price and high prices are the same. Whereas a bearish Hanging Man represents the opening price, and the high price is the same.
Triangle patterns happen when buyers and sellers become indecisive about the market. Hence, the price starts to squeeze due to the unavailability of supply and demand.
In triangle patterns, the price moves within two parallel trend lines that start to squeeze in a point. There are three types of triangle patterns in the financial market:
- Ascending triangle: A bullish formation of the pattern that indicates a potential upside breakout. The ascending triangle can be identified by a flat top and an ascending support trend line.
- Descending triangle: A bearish formation of the pattern that indicates a potential downside breakout. The descending triangle can be identified by a flat bottom and a descending resistance trend line.
- Symmetrical triangle: The price starts narrowing in a point and may move up or down after the symmetrical triangle breakout. The pattern can be identified by an ascending support trend line and a descending resistance trend line.
The chart above shows a real example of a symmetrical triangle in the Bitcoin daily chart. The price made lower highs and higher lows within the pattern.
Later on, the price breaks above the patterns and initiates a strong bullish movement.
THE PROS AND CONS
There are always ups and downs. While candlestick charts are excellent for traders to interpret the possible market trends and to make decisions strategically.
Still, there are limitations you should be aware of.
- A picture is worth a thousand words, and the candlestick chart offers a 360-degree view of the price
- Easy to understand, no need to be a finance graduate
- The price is easily predictable as buyer’s and seller’s activity is visible
- Shows potential buying and selling opportunities from solid price levels
Limitations of Candlestick Charts
- Although Candlestick charts show buyers and sellers activity in the price, it does not show the volume information
- Candlestick charts don’t take into account the fundamentals, but only the price reaction to the market fundamentals
- Candlestick patterns at a random place on the price chart often provide false directions.
- The chart can lead to analysis paralysis.
Did you know?
Analysis paralysis refers to a situation in which an individual or group has difficulties moving forward with a decision due to overanalyzing the data or overthinking a problem.
So that’s how you should start reading the candlestick chart. Which candlestick pattern can you identify? How can you translate these information into profits?
Let us know what you think and if it’s helpful!
Finally, we are at the end of this trading guide on the candlestick chart, and it’s time to summarize what we have learned about how to read a candlestick chart:
- A candlestick chart is a combination of multiple candles that a trader uses to anticipate the price movement.
- Popular candlestick patterns are Engulfing, Hammer, Shooting Star, Hanging Man, and Triangle patterns.
- You should consider the price trend and levels while projecting the price direction using candlesticks.
- The ideal stop-loss idea is to set it below or above the candlestick pattern with some buffer.
Candlesticks charts are very effective in the financial market, and almost all traders in the world focus on candlestick patterns. You can consider the candlestick trading system as an individual trading strategy, or you can use these tools in your strategy to increase your trading probability.