Words and Expression: Figures are like words. Thousands of word spoken may make them difficult to comprehend. Charting those figures is like expressions. A visual way to understand and grasp the movement in a more efficient way
Candlestick charting was developed as an effort to add market sentiments to the normal charts and to enhance the understanding of the market movement even more.
Market prices are not only governed by the facts. The market is not ONLY governed by the fundamentals or technicals (technical analysis). There is this third factor and which plays a very important role. This is market psychology or the general market sentiment. The market may go upside down in one day or even in one hour… but if you would really see, no economic fundamentals would have changed during that day or that hour. What really changed was the market sentiment. It’s Fear and Greed but many times just simple fear. Candlestick charts can give an understanding of those market sentiments.
It’s believed that Candlestick charts were developed in the 18th century by famous Japanese rice trader Homma Munehisa. The basic idea behind candlestick charting was to have an overview of open, high, low, and close market prices over a certain period. Candlestick charts make it very easy to read and understand the market sentiments hidden behind the price movement in trading be it Forex Trading or any stock and commodity trading. Since the conception there people have been putting great efforts to relate specific chart patterns to the likely future behavior of a market.
Around 1900 Charles Dow had picked up the candlestick charting and since then it has been commonly used by financial instruments’ traders. In this article we will mainly be talking in terms of Forex (currency) trading.
There are many candlestick patterns but we will be talking about the important ones.
Please also note that these patterns must be combined with other technical analysis indicators and not in isolation.
The following patterns are divided into two parts: Bullish patterns and bearish patterns. These are reversal patterns that show up after a downtrend or pullback (bullish patterns) or an uptrend (bearish patterns).
Candlestick Engulfing Pattern: A commonly observed and popular favorite candlestick pattern. Engulfing pattern consists of two candles. The first (red candle) is a narrow range candle that closes down for the period near the low of that period ("Day" on a "daily chart" or "Hour" on an "hourly chart"). The sellers currency pair is being sold and have a downward pressure but the narrow candle indicates that the downward pressure is not aggressive. The second period candle is a wide range (long) candle that “engulfs” the body of the first candle and closes over the top of the range. The currency pair is being bought more aggressively.
Candlestick Hammer Pattern: The rice of the currency pair opened for a particular period ("Day" on a "daily chart" or "Hour" on an "hourly chart"), then at some point there was a aggressive selling pressure and the price of the currency pair shot down. By the end of the period (closing), the downward pressure decreased and buying started and the price of the currency pair closed much above the low of that period.
Candlestick Harami Pattern: When you see this pattern the first thing that comes to mind is that the momentum preceding it has stopped. During the first period ("Day" on a "daily chart" or "Hour" on an "hourly chart") you see a wide range candle that closes near low of that period. The currency pair is still being sold. Then during the next period, there is only a narrow range candle that closes up for that period.
Candlestick Piercing: This is also a two-candle reversal pattern where on the first day you see a wide range candle that closes near the bottom of the range. The sellers are in control. On the second day you see a wide range candle that has to close at least halfway into the prior candle. Those that shorted the stock on first day are now sitting at a loss on the rally that happens on the second day. This can set up a powerful reversal.
Candlestick Doji Pattern: The doji is probably the most popular candlestick pattern. The stock opens up and goes nowhere throughout the day and closes right at or near the opening price. Quite simply, it represents indecision and causes traders to question the current trend. This can often trigger reversals in the opposite direction.
You’ll notice that all of these bearish patterns are the opposite of the bullish patterns. These patterns come after a rally and signify a possible reversal just like the bullish patterns.
Ok, now it’s your turn! I’ll let you figure out what is happening in each of the patterns above to cause these to be considered bearish. Look at each candle and try to get into the minds of the traders involved in the candle.
There is one more pattern worthy of mention. A "kicker" is sometimes referred to as the most powerful candlestick pattern of all.
You can see in the above graphic why this pattern is so explosive. Like most candle patterns there is a bullish and bearish version. In the bullish version, the stock is moving down and the last red candle closes at the bottom of the range.
Then, on the next day, the stock gaps open above the previous days high and close. This "shock event" forces short sellers to cover and brings in new traders on the long side.
This is reversed in the bearish version.