If you had just started to trade the stock market during/shortly after the COVID-19 crash, or at similar crashes…

You might be thinking to yourself that the market has gotten somewhat more difficult to trade.

Charts which looked promising somehow went “off-track”. The volatility increases, corrections look scary and you start to wonder if you were actually ready for this ride.

Well, there are means and tools to help with that predicament. After all, if what you know now isn’t working, then it’s time to look at how to help get it back on track.

One of these commonly overlooked aspects, is candlestick patterns!

It’s one of my favourite topics because there’s a levelling up to it. In the beginning, as most of us probably do, I started off by plain memorizing these patterns.

Which wasn’t all that fun because… Who likes memory work, right?

candlestick patters cheat sheet

Source: Reddit

As I looked at more and more charts and witnessed the dynamism of the market, it became clear to me that it was a matter of understanding what these price actions meant. (These price actions are reflected via the candlestick patterns.)

In the end, these “textbook” patterns that we learn will not always apply exactly in the live charts. Rather, there will be some variations, and it is up to you to be flexible about it.

Of course, if you would rather have the exact textbook patterns appear, that is perfectly fine. Do note, however, that you would have to exercise more patience in waiting for the set-up.

In my view, I would rather think that it is prudent to test out what actually works for you. This principle applies not just with candlestick patterns, but also with your trading style.

Before we dive into the various patterns, let’s first look at the basics of reading a candlestick.

 

Candlestick basics

There are 4 types of price information that we can gather from 1 candlestick:

  • Open
  • High
  • Low
  • Close

We have a visual representation of this price information from the respective “wicks” (also known as “shadows”) of the candle. The top wick shows the high, the bottom wick shows the low, and the candle’s “body” shows the open and close prices.

While the high and low is clearly indicated by the top and bottom of the wicks, the body will determine the open and close.

In which case, each candle is usually represented on the chart in black and white (i.e. filled and unfilled), or with colours such as red and green. In which case:

  • White/unfilled/green candle = price closed higher than the previous session.
  • Black/filled/red candle = price closed lower than the previous session.
candlestick basics ohlc

Source: Trading with Rayner

The “session” refers to the timeframe that you have selected for the chart. For instance, if it is a monthly chart, then each candlestick would reflect the open, high, low and close for 1 month. This applies for the respective charts on the weekly, daily, 4-hourly, hourly, 30-min, 15-min, 1-min, etc. Each candlestick would represent price on the respective timeframe.

By changing your timeframe, the information that is conveyed in the candlestick would reflect that accordingly.

We can largely categorize candlestick patterns into (1) bullish, (2) bearish, and (3) continuation patterns. Now that we’ve covered the candlestick basics, let’s get into some of the easier-to-digest patterns.

 

Engulfing

Engulfing patterns are either bullish or bearish. It is made up of 2 candles in which the body of the first candle is completely “engulfed” by the second candle.

Bullish engulfing candlestick pattern

Source: IG

In the bullish engulfing situation, the first candle should be bearish, and it is engulfed by a bullish candle.

In the bearish engulfing situation, the first candle should be bullish, and it is engulfed by a bearish candle.

To interpret this, let’s take the bullish engulfing situation as an example. Although the second candle opens lower than the first, buying pressure increased and price eventually closed above the previous candle. This shows that the buyers are now in control, and is a bullish sign that price may head upwards.

 

Doji

The doji resembles a cross or plus sign “+”, where the market’s open and close prices are almost the same. The body should be short or non-existent, and the wicks should be short and of about the same length for the top and bottom. It is therefore a continuation (also thought of as neutral) pattern, as it does not have any bullish or bearish indications.

This can be interpreted as a sign of indecision, as both buying and selling pressure are almost equal.

Nonetheless, the doji can be interpreted in combination with its neighbouring candles to derive bullish/bearish signals. In that context, the doji can be taken as a reversal pattern as well, as in the case of the (bullish) morning star and (bearish) evening star patterns.

In addition, slight variations to the cross-like doji will result in other patterns, which we will talk about next.

Doji candlestick pattern

Source: Investopedia

 

Dragonfly Doji & Gravestone Doji

The dragonfly doji appears like a “T” shape. The open, close and high prices are almost the same. The lower wick should also be long, and this overall represents a rejection of lower prices as the session not only opened, but maintained its close at the top.

The gravestone doji, on the other hand, appears like an “inverse T”. The open, close, and low prices are almost the same. The upper wick should be long, and this represents a rejection of higher prices. Despite buying activities, price eventually closed near or at the open, at the low of the candle.

 

Hammer & Shooting Star

The hammer candlestick is similar to the dragonfly doji where the close and high prices are the same, or almost the same such that there is little to no upper wick. There is a long lower wick as well. However, there are 2 main differences:

  • The opening price, despite the selling pressure, eventually closed higher, thereby giving the candle a short body.
  • Where the hammer is found at the bottom of a downtrend, it is a bullish reversal pattern. Prices are likely to head upwards as buyers took control and closed prices higher after the selling climax.
Hammer

Source: IG

Its bearish counterpart will be the “shooting star”. Again, you may take reference from the gravestone doji, or simply note the following differences:

  • The opening price, despite the buying pressure, eventually closed lower, thereby giving the candle a short body.
  • Where the shooting star is found at the top of an uptrend, it is a bearish reversal pattern. Prices are likely to head downwards as sellers took control and closed prices lower after the buying climax.
Shooting star

Source: IG

While there is another candlestick pattern known as the “inverse hammer”, the main difference with the shooting star is that the former is formed in a downtrend, whereas the latter is in an uptrend. In this case, the inverse hammer is actually a bullish pattern. This because sellers were unable to drive prices lower, and price eventually closed higher.

I hope you’re not confused by all these names at this point and seeing stars already. If you’re feeling all good, let’s carry on with the last 2 patterns (more stars)!

 

Morning Star & Evening Star

Remember that earlier on, I mentioned that the doji could be interpreted in combination with its neighbouring candles?

Well, that’s what the morning star and evening star encompass. They are both 3-candle patterns. The doji in the middle should not be overlapping between the 2 candles as price gaps on both the open and close prices.

So, here are the differences between the bullish morning star and bearish evening star.

Morning star

Source: IG

The morning star is a bullish candlestick pattern which appears after a decline in prices. The first candle is a down candle, followed by the doji which shows indecision in the markets. When the third candle being an upward candle with a long body appears, this indicates that selling pressure is subsiding.

On the other hand, the evening star is a bearish candlestick pattern which appears after price advances. The first candle is an up candle, followed by the doji which again shows indecision. Buying and selling are at an equilibrium. When the third candle which is a downward candle with a long body appears, this indicates that buying pressure is subsiding. The bears have won this time, and prices are likely to decline.

Evening star

Source: IG

 

Conclusion

Do note that candlestick patterns should NOT be used in isolation.

Instead, trade them together with technical indicators such as the moving average, and perhaps even in areas of support and resistance. It’s about stacking the odds in your favour, not recklessly entering based on a single piece of knowledge.

While there is a myriad of patterns (and their corresponding names), I hope you can see that it’s about understanding what the candles mean. How market psychology is reflected in these open, high, low and close prices, and what this means in consideration of the price trend.

If you’re now thinking to yourself: Which patterns are the most powerful or accurate?

Well, feel free to head over to this Investopedia article. While it makes for good reference, remember that there are no guarantees in the markets.

Understand it, test it out for yourself, and keep the strategies that work best for you.

By the way, we’re nearing the end of this series on the Beginner’s Guide, with just a few more topics to go. Nothing worthwhile is ever easy, so remember the reasons why its important to start!

 

Can anybody start trading and investing on their own? If you’ve read up to this point, the answer is a resounding yes. Stay tuned to the next parts of the series as we adopt a systematic approach in generating a step-by-step beginner’s guide.

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