Once you delve into forex trading, you’ll observe that professional traders and brokers frequently utilize a variety of diagrams, analytical tools, graphs, and stock charts to highlight trends and make projections in day trading.
A widely used tool in this realm is the candlestick chart. These charts are favoured in day trading for two reasons: they provide a comprehensive range of trading information and their design is straightforward, making them easy to read and interpret.
Understanding how to read candlestick charts and the different components of a candle is crucial. If you want to incorporate candlestick chart analysis into your trading strategy, this article covers all the basics to help you get started.
What is a Candlestick Chart?
A candlestick chart consists of individual candles, which traders use to analyse price action. This involves identifying the opening and closing prices for a given period, as well as the highest and lowest prices within that period.
Price action provides traders across all financial markets with insights into trends and potential reversals. For instance, clusters of candlesticks can form patterns that appear consistently on forex charts, suggesting possible trend reversals or continuations. Additionally, individual candlestick formations can signal potential buy or sell opportunities.
The duration each candle represents is determined by the trader’s selected time frame. A commonly used time frame is the daily one, where each candle illustrates the open, close, high, and low prices for the day. Understanding the various components of a candle can help predict future price movements. For example, if a candle closes significantly below its opening price, it might indicate a further price decline.
How to read a Candlestick Chart?
There are multiple methods to utilize and interpret a candlestick chart, which can be adjusted according to your trading strategy and preferred time frame. Some forex traders might focus on leveraging candle formations, while others aim to identify price patterns.
The candle’s body represents the opening and closing prices within the specified period. This is crucial for candlestick trading, as it allows traders to quickly gauge the price range of a pair during that period.
Additionally, the colour of the body indicates whether the pair price is rising or falling. For example, if a monthly candlestick chart shows consecutive red candles, traders can infer that the price is declining.
The vertical lines above and below the body, known as wicks or shadows, indicate the highest and lowest traded prices of the pair. Consider these scenarios:
– If a red candle has a short upper wick, it suggests that the pair opened near the day’s high.
– Conversely, if a green candle has a short upper wick, it implies that the pair closed near the day’s high.
Thus, a candlestick chart illustrates the relationship between a pair’s high, low, opening, and closing prices. The body can vary in length and colour (red or green), and the shadows can be long or short.
This combination of factors reflects the market sentiment towards the pair. Understanding these details is essential for effectively reading a candlestick chart.
Candlestick Chart Patterns
Candle chart patterns offer valuable insights into investor sentiment and the dynamics between demand and supply, bears and bulls, and emotions such as greed and fear.
While a single candle can provide significant information, understanding patterns requires comparing one candle with the preceding and succeeding ones. Recognizing these patterns is crucial for traders to benefit from candlestick charts.
To enhance comprehension, let’s categorize the patterns into two main sections:
- Bullish Patterns
- Bearish Patterns
Both types of patterns are vital for effective candlestick chart analysis.
Bullish Pattern
Hammer Pattern
The hammer pattern features a candle with a short body and a long lower wick, typically found at the bottom of a downward trend. It signals that despite selling pressures, a strong buying surge has pushed prices upward. If the candle body is green, it suggests a stronger bullish market compared to a red body.
Inverse Hammer Pattern
The inverse hammer pattern also has a short body but with a long upper wick, and it appears at the bottom of a downward trend. This pattern indicates initial buying pressure followed by selling pressure, hinting that buyers are likely to gain control soon.
Bullish Engulfing Pattern
The bullish engulfing pattern consists of two candlesticks. The first is a short red candle, followed by a larger green candle that completely engulfs the red one. This pattern indicates a bullish market sentiment, with prices pushed up despite opening lower than the previous day.
Piercing Line Pattern
The piercing line pattern involves two candles: a long red candle followed by a long green candle. The closing price of the second candle must be more than halfway up the body of the first candle. This formation indicates strong buying pressure.
Morning Star Pattern
The morning star pattern is a three-candle formation with a short-bodied candle situated between a long red candle and a long green candle. There is typically no overlap between the short and long candles. This pattern signifies a reduction in selling pressure and the onset of a bullish market.
Three White Soldiers Pattern
The three white soldiers’ pattern features three consecutive green candles with small wicks. Each candle opens and closes higher than the previous day’s candle. Following a downtrend, this pattern strongly indicates an upcoming bullish trend.
Bearish Pattern
Hanging Man Pattern
The hanging man pattern features a candle with a short body and a long lower wick, typically found at the top of an upward trend. This pattern indicates that selling pressures were stronger than the buying thrust, suggesting that bears are beginning to gain control of the market.
Shooting Star Pattern
The shooting star pattern also has a short body and a long upper wick, appearing at the top of an upward trend. It indicates that the market opened higher than the previous day, rallied slightly, and then fell, resembling a shooting star. This pattern signals that selling pressure is taking over the market.
Bearish Engulfing Pattern
The bearish engulfing pattern consists of two candlesticks: the first is a short green candle, followed by a larger red candle that engulfs the green one. This pattern usually occurs at the top of an upward trend and indicates a slowdown in the market rise and a forthcoming downtrend. A lower red candle typically signifies a more significant downtrend.
Evening Star Pattern
The evening star pattern is a three-candle formation featuring a short-bodied candle between a long green candle and a long red candle. There is usually no overlap between the short and long candles. This pattern indicates a reversal of an upward trend, with its significance heightened if the third candle surpasses the gains of the first candle.
Three Black Crows Pattern
The three black crows pattern consists of three consecutive red candles with short wicks, each opening and closing lower than the previous day’s candle. Following an upward trend, this pattern strongly indicates an upcoming bear market.
Chart patterns play a crucial role in reading a candlestick chart. There are numerous other patterns that traders can follow to understand market trends and sentiment. Consider this blog as a starting point for analysing candlestick charts and delving deeper into these patterns to comprehend market movements more effectively.