August 11, 2022

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What are Candlestick Patterns in Trading?

So you’ve just started trading in Forex: good for you! Forex trading is something that you can do from the comfort of your own home: thankfully there is no need to go down to a physical stock exchange and scream your lungs out with all the other traders. Trading alone, however, might leave you with no one to ask when you’re confused by how a trade went down or what a certain term means; that’s why we’re here! Though the brokers at  www.oanda.com are always ready to explain anything that confuses you, it’s best to have an understanding of as much as possible going in. Today, we’re going to take a look at the term “candlestick pattern”, what it means and what a few key candlestick patterns would look like in trading.

What Is a Candlestick Pattern?

First introduced to the Western world in 1991 by Steve Nilson, a candlestick chart or pattern is a diagram in which data for a number of time frames is packed into single price bars. This amount of data packed into one bar makes the chart a lot more useful than some other trading chart options, like low-close or pen-high bars or even line charts that show data by connecting dots on a graph. The chart is color-coded and builds up a pattern that predicts what the price direction will be once they are filled in. This form of the chart was used in the Eastern world long before the west adopted it for forex trading: the candlestick pattern or chart dates all the way back to 18th century Japan when it was used by rice traders.

The features of a candlestick pattern are as follows:

  1. The body symbolises the open to close range.
  2. The shadow or wick. This represents the intra-day highs and lows.
  3. The color. This represents the direction that the market is moving in: green or white indicates an increase and red or black shows a decrease.

Is a Candlestick Pattern a Reliable Predictor?

Not all of these patterns are created equally. They have been very popular since the 90s, but this level of popularity has actually worked against the reliability of the charts themselves since hedge funds and their algorithms came into the picture. These hedge funds use their software to trap traders looking for either bearish (a pessimistic outcome: a drop in the stock price leads this investor to hope they can profit) or a bullish (an optimistic outcome: this trader believes they can profit from a rise in value) outcomes. Reliable patterns can still appear and can be used best in short or long-term opportunities.

Different Forms of Candlestick Pattern

Bullish Patterns

  1. The Hammer. This pattern is formed from a short body with a long and low wick and shows up at the bottom of a downward trend. This pattern shows that there were selling pressures over the course of the day but in the end, a forceful buying pressure drove the price up. The hammer will either be green or red, green indicating a stronger bull market.
  2. Bullish Engulfing. This pattern uses two candlesticks and depicts one being completely engulfed by the other. The shorter, red one will be engulfed by a larger green one. Prices are pushed up on the second day creating a favorable situation for buyers.
  3. Morning Star. If you see this form of the pattern after a period of considerable downtrending, you’re in luck! The morning star pattern is a beacon of hope in a bad situation. There are three sticks present in the pattern: a short-bodied candle sandwiched between one long red and one long green one. The short candle (the star) won’t overlap with either long candle. This pattern signifies that a bull market is coming your way.

Bearish Patterns

  1. Hanging Man. This is the inverse, bearish version of The Hammer. The shape looks the same but it signals the end of an uptrend instead of a downtrend. What this means is that there was a large sell during the day but buyers pushed the price up before closing. A large sell-off often indicated that the market is trending in a bearish direction.
  2. Three Black Crows. Here we see three long red candles with almost nonexistent wicks. This indicates that every session opens similarly to the previous day but prices are pushed lower with every close. This pattern heralds a downtrend since sellers have overtaken buyers for three days in a row.
  3. Dark Cloud Cover. A reversal is on the cards if this pattern appears. As the name indicates, this pattern is a dark cloud over yesterday’s blue skies. Two candlesticks appear, one red and one green. The red opens above the green’s body and closes below its halfway mark. This means that the bears have taken over and the price is pushed sharply downward.

Wrap Up

A quick search on the internet will reveal all known candlestick patterns in great detail. Remember while you are learning the details of these patterns that there’s no rush! Give yourself a solid grounding in the basics and you’ll soon understand the complexities as well.

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