Introduction to Candlestick Patterns
Candlestick patterns, originating from 18th century Japanese rice traders, are powerful technical analysis tools that visually represent price action within specific time periods. Each candlestick displays opening, closing, high, and low prices, with patterns forming reliable signals for potential market reversals and continuations. Understanding these patterns helps traders identify market psychology and make more informed trading decisions across all financial markets.
Candlestick Anatomy
Basic Structure
- Body: Rectangle showing open-to-close price range
- Bullish candle: Green/white body (close higher than open)
- Bearish candle: Red/black body (close lower than open)
- Wicks/Shadows: Lines extending from body showing high/low extremes
- Upper shadow: Shows highest price reached in period
- Lower shadow: Shows lowest price reached in period
- Doji: Open and close at virtually same price (minimal/no body)
Price Action Interpretation
| Candle Element | Market Psychology |
|---|---|
| Long body | Strong conviction in direction |
| Short body | Indecision or weak momentum |
| Long upper shadow | Sellers rejected higher prices |
| Long lower shadow | Buyers rejected lower prices |
| No shadows | Price moved steadily in one direction |
| Equal shadows | Balance between buyers and sellers |
Reversal Patterns: Bullish
Hammer
- Formation: Small body at upper end with long lower shadow (2-3× body length)
- Context: Appears during downtrend
- Psychology: Sellers pushed price down but buyers regained control
- Confirmation: Bullish candle or gap up on following day
- Reliability: 60-70% when properly confirmed
Bullish Engulfing
- Formation: Bearish candle followed by larger bullish candle that completely engulfs previous candle
- Context: End of downtrend
- Psychology: Complete shift from seller to buyer control
- Confirmation: High volume and third confirming bullish candle
- Reliability: 75-80% when volume confirms
Morning Star
- Formation: Three-candle pattern: bearish candle, small-bodied middle candle with gap down, bullish candle with gap up
- Context: Bottom of downtrend
- Psychology: Shift from bearish to indecision to bullish
- Confirmation: High volume on third day, close above midpoint of first candle
- Reliability: 70-75% with confirmation
Piercing Line
- Formation: Bearish candle followed by bullish candle that opens below previous low but closes above midpoint of previous candle
- Context: Downtrend
- Psychology: Sellers exhausted, buyers taking control
- Confirmation: High volume on second candle, third bullish candle
- Reliability: 65-70% at strong support levels
Bullish Harami
- Formation: Large bearish candle followed by smaller bullish candle contained within previous candle’s body
- Context: Downtrend
- Psychology: Downward momentum pausing, potential reversal
- Confirmation: Third bullish candle breaking above pattern
- Reliability: 60% alone, 70% with confirmation
Three White Soldiers
- Formation: Three consecutive bullish candles, each opening within previous body and closing higher
- Context: After downtrend or consolidation
- Psychology: Sustained buying pressure and momentum
- Confirmation: High volume progression
- Reliability: 80% when all candles show similar size/strength
Tweezer Bottom
- Formation: Two or more candles with identical lows
- Context: Downtrend
- Psychology: Support level identified and held
- Confirmation: Third bullish candle after pattern
- Reliability: 60% alone, higher at major support levels
Reversal Patterns: Bearish
Shooting Star
- Formation: Small body at lower end with long upper shadow (2-3× body length)
- Context: Appears during uptrend
- Psychology: Buyers pushed price up but sellers regained control
- Confirmation: Bearish candle on following day
- Reliability: 65-70% at resistance levels
Bearish Engulfing
- Formation: Bullish candle followed by larger bearish candle that completely engulfs previous candle
- Context: End of uptrend
- Psychology: Complete shift from buyer to seller control
- Confirmation: High volume and third confirming bearish candle
- Reliability: 75-80% at major resistance levels
Evening Star
- Formation: Three-candle pattern: bullish candle, small-bodied middle candle with gap up, bearish candle with gap down
- Context: Top of uptrend
- Psychology: Shift from bullish to indecision to bearish
- Confirmation: High volume on third day, close below midpoint of first candle
- Reliability: 70-75% with volume confirmation
Dark Cloud Cover
- Formation: Bullish candle followed by bearish candle that opens above previous high but closes below midpoint of previous candle
- Context: Uptrend
- Psychology: Buyers exhausted, sellers taking control
- Confirmation: High volume on second candle, third bearish candle
- Reliability: 65-70% at significant resistance
Bearish Harami
- Formation: Large bullish candle followed by smaller bearish candle contained within previous candle’s body
- Context: Uptrend
- Psychology: Upward momentum pausing, potential reversal
- Confirmation: Third bearish candle breaking below pattern
- Reliability: 60% alone, 70% with confirmation
Three Black Crows
- Formation: Three consecutive bearish candles, each opening within previous body and closing lower
- Context: After uptrend
- Psychology: Sustained selling pressure and momentum
- Confirmation: High volume progression
- Reliability: 80% when all candles show similar size
Tweezer Top
- Formation: Two or more candles with identical highs
- Context: Uptrend
- Psychology: Resistance level identified and held
- Confirmation: Third bearish candle after pattern
- Reliability: 60% alone, higher at major resistance levels
Continuation Patterns
Doji
- Formation: Open and close at virtually same level (cross, dragonfly, gravestone variants)
- Context: Any trend or at support/resistance
- Psychology: Perfect equilibrium between buyers and sellers
- Interpretation: Indecision; continuation or reversal signal based on context
- Reliability: 50% alone, higher with confirmation candle
Spinning Top
- Formation: Small body with upper and lower shadows larger than body
- Context: Any trend
- Psychology: Indecision in the market
- Interpretation: Trend weakening but not necessarily reversing
- Reliability: Weak alone, better as component of larger patterns
Rising Three Methods (Bullish)
- Formation: Bullish candle followed by three small bearish candles contained within first candle’s range, then bullish candle making new high
- Context: Uptrend
- Psychology: Profit-taking before trend continuation
- Confirmation: Final candle closes above initial candle
- Reliability: 75% when volume decreases during middle candles
Falling Three Methods (Bearish)
- Formation: Bearish candle followed by three small bullish candles contained within first candle’s range, then bearish candle making new low
- Context: Downtrend
- Psychology: Short covering before trend continuation
- Confirmation: Final candle closes below initial candle
- Reliability: 75% when volume decreases during middle candles
Marubozu
- Formation: Candle with no or minimal shadows (open = high, close = low for bearish; open = low, close = high for bullish)
- Context: Any trend
- Psychology: Complete dominance by buyers or sellers
- Interpretation: Strong trend continuation signal
- Reliability: 70% for indicating strength of current trend
Indecision/Neutral Patterns
Doji Star
- Formation: Trend candle followed by doji that gaps in trend direction
- Context: During established trend
- Psychology: Exhaustion of current trend
- Confirmation: Candle in opposite direction of trend
- Reliability: 60% with confirmation
High Wave Candle
- Formation: Small body with very long upper and lower shadows
- Context: Any trend
- Psychology: Extreme indecision, volatility without direction
- Interpretation: Warning of potential reversal
- Reliability: 50-55%, better as cluster
Long-Legged Doji
- Formation: Doji with very long upper and lower shadows
- Context: Any trend
- Psychology: Extreme volatility and indecision
- Interpretation: Possible trend exhaustion
- Reliability: 50-55%, increases at major support/resistance
Multiple Candle Patterns
Three-Line Strike (Bullish)
- Formation: Three bearish candles followed by bullish candle opening below third candle but closing above first candle’s open
- Context: Downtrend
- Psychology: Final surge of selling overcome by strong buying
- Reliability: 80% for trend reversal
Three-Line Strike (Bearish)
- Formation: Three bullish candles followed by bearish candle opening above third candle but closing below first candle’s open
- Context: Uptrend
- Psychology: Final surge of buying overcome by strong selling
- Reliability: 80% for trend reversal
Abandoned Baby
- Formation: Trend candle, followed by doji gapping away, followed by opposite candle gapping in other direction
- Context: Any trend
- Psychology: Complete trend reversal with confirmation
- Reliability: 70-75% with proper gaps
Pattern Recognition Techniques
Context Factors
- Trend strength: Stronger existing trends require stronger reversal signals
- Support/resistance: Patterns at key levels increase reliability
- Volume: Increasing volume on reversal candles confirms pattern
- Timeframe: Higher timeframe patterns generally more reliable
- Multiple confirmations: Patterns coinciding with other indicators (RSI, MACD, etc.)
Confirmatory Signals
- Price breaking above/below pattern formation
- Follow-through candle in expected direction
- Increasing volume on breakout direction
- Oscillator confirmation (RSI, Stochastic)
- Multiple timeframe alignment
Pattern Reliability Table
| Pattern | Reliability (Alone) | Reliability (With Confirmation) | Best Market Conditions |
|---|---|---|---|
| Hammer | 55-60% | 70-75% | Downtrend at support |
| Bullish Engulfing | 65-70% | 80-85% | Downtrend with increased volume |
| Morning Star | 65-70% | 75-80% | End of downtrend at support |
| Shooting Star | 55-60% | 70-75% | Uptrend at resistance |
| Bearish Engulfing | 65-70% | 80-85% | Uptrend with increased volume |
| Evening Star | 65-70% | 75-80% | End of uptrend at resistance |
| Doji | 50% | 65-70% | At trend extremes |
| Three White Soldiers | 70-75% | 80-85% | After downtrend or base |
| Three Black Crows | 70-75% | 80-85% | After uptrend or top |
Trading Strategies Based on Patterns
Entry Techniques
- Conservative: Wait for confirmation candle after pattern
- Moderate: Enter on close of pattern completion
- Aggressive: Enter on pattern identification with other confirming factors
- Breakout: Enter on break of pattern’s high/low
Stop Loss Placement
- Below/above the pattern’s low/high
- Below/above the signal candle’s low/high
- Using ATR to determine appropriate distance
- At previous support/resistance level
Take Profit Methods
- Previous swing high/low
- Fibonacci extension levels (127.2%, 161.8%)
- Risk:reward ratios (1:2, 1:3)
- Trailing stop based on pattern size
Common Mistakes & Best Practices
Mistakes to Avoid
- Trading patterns in isolation without context
- Ignoring volume confirmation
- Overtrading minor patterns
- Misidentifying patterns in choppy markets
- Neglecting overall market conditions
- Using patterns on very low timeframes
Best Practices
- Combine patterns with other technical indicators
- Consider fundamentals alongside technical patterns
- Practice pattern recognition regularly
- Maintain trading journal of pattern performance
- Use multiple timeframe analysis
- Be patient waiting for high-probability setups
- Size positions according to pattern reliability
Resources for Further Learning
Books
- “Japanese Candlestick Charting Techniques” by Steve Nison
- “Encyclopedia of Candlestick Charts” by Thomas Bulkowski
- “The Complete Guide to Price Action Trading” by Rayner Teo
Websites & Tools
- TradingView (pattern recognition tools)
- Candlestick Pattern Indicator (MT4/MT5)
- Bulkowski’s ThePatternSite.com
- BabyPips.com (educational resources)
- ChartSchool by StockCharts.com
Practice Resources
- Historical chart analysis exercises
- Paper trading platforms
- Candlestick pattern quizzes
- Backtesting software
- Trading simulators
Remember: Candlestick patterns are probability-based signals, not guarantees. Always manage risk appropriately and consider patterns as one component of a complete trading strategy.