How do candlestick patterns work?
Understanding candlestick formations
Candlestick formations are visual depictions of price fluctuations that can be observed on stock charts.
They provide crucial information about the opening, closing, high, and low prices for a specific period, as well as the general sentiment surrounding a stock.
These patterns are easy to identify and can serve as templates for spotting potential trading opportunities.
There are several types of candlestick formations, including bullish, bearish, continuation, and reversal patterns.
Bullish candlestick formations
Bullish candlestick formations can indicate a reversal after a bearish trend or a continuation of an established bullish trend.
Bearish candlestick formations
Bearish candlestick formations suggest lower prices ahead and can either confirm an existing trend or signal a reversal after a bullish rally.
Japanese candlestick formations
They were initially used by Japanese rice traders in the 1700s and introduced to the Western world in the late 1980s. Today, they are the go-to charting method for many traders.
Bullish Reversal Patterns
Hammer
A Hammer candlestick pattern is formed when a security's low significantly surpasses its opening price, but the security rallies to close near the opening price.
This pattern's long lower shadow indicates that sellers initially pushed the price down, but buyers regained control and pushed the price back up, suggesting a potential bullish reversal.
2.Bullish Engulfing
The Bullish Engulfing pattern emerges when a small red candle is succeeded by a more substantial green candle, which entirely encompasses the candle from the prior day.
The pattern suggests that buying pressure has overcome selling pressure, creating a shift in market sentiment that could lead to an upward price trend.
3.Morning Star
A Morning Star pattern consists of three candlesticks: a long red candle, a small-bodied candle (either red or green) that gaps lower, and a long green candle that closes within the range of the first candle.
The pattern indicates a weakening downtrend, as the small-bodied candle represents indecision in the market, followed by a strong green candle that suggests a bullish reversal.
The Piercing Line pattern is a two-candle pattern with a long red candle followed by a long green candle that opens lower than the previous day's low but closes more than halfway above the midpoint of the first candle.
The second candle's strong close indicates a shift in market sentiment and suggests that the bulls are gaining control.
This pattern predominantly appears in stocks due to their potential for overnight gaps, as opposed to currencies or other round-the-clock trading instruments. Nevertheless, this pattern can materialize in any asset class on a weekly chart.
5.Inverted Hammer
The Inverted Hammer is a single candle pattern with a small body, long upper shadow, and little or no lower shadow.
This pattern occurs after a downtrend, and its long upper shadow represents buyers attempting to push the price higher.
The small body indicates a potential trend reversal as buying pressure increases.
6.Doji
A Doji candlestick pattern is formed when a security's opening and closing prices are nearly equal, resulting in a candlestick with a small or non-existent body and potentially long shadows.
This pattern represents market indecision, as neither buyers nor sellers could gain control, and may signal a potential trend reversal or continuation, depending on the context of the preceding candles and overall market trend.
7.Bearish Engulfing
The Bearish Engulfing pattern occurs when a small green candle is followed by a larger red candle that completely engulfs the previous day's candle.
This pattern suggests that selling pressure has increased, and the market sentiment has shifted toward bearishness, potentially leading to a downward price movement.
An Evening Star pattern consists of three candlesticks: a long green candle, a small-bodied candle (either green or red) that gaps higher, and a long red candle that closes within the range of the first candle.
The pattern indicates a weakening uptrend, with the small-bodied candle representing market indecision, followed by a strong red candle that suggests a bearish reversal.
9.Shooting Star
The Shooting Star is a single candle pattern with a small body, long upper shadow, and little or no lower shadow.
This pattern occurs after an uptrend, and its long upper shadow represents sellers attempting to push the price lower.
The small body indicates a potential trend reversal as selling pressure increases.
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