A Brief Introduction and Example to Candlestick Patterns
There are several types of charts that you can use in the financial market. What is not known well by new traders is on the importance of these charts.
A good example of this is on the chart below.
The chart shows a line graph of the USD/JPY pair and a candlestick chart of the EUR/USD pair. These two charts are necessary!
The line chart is a good one to show the trend of the pair. However, it does not tell traders what to do. As such, it is not a useful chart to use when trading.
This is unlike candlesticks, which are the most popular charts. Other types of charts you will encounter in the market are bar charts, step lines, histograms, circles, renko, and columns among others.
What is a Candlestick Chart?
Japanese candlestick patterns are some of the oldest types of charts. These charts were discovered hundreds of years ago in Japan, where they were used in the rice market. Today, these charts are the default when you open most trading software (Ppro8 too!).
They are popular because they give more indications to traders.
Parts of a Candlestick
In the first chart above, you can see that a line chart is pretty basic. It is just a line. Unlike a line chart, a candlestick has more parts that help traders know when to buy and when to sell.
This is shown in the image below.
The two images shows a bullish and a bearish candlestick. The black one is bearish candle while the one on the right is the bullish candle. The black and white parts of the candles are known as the body while the two lines are known as shadows.
Therefore, in a daily chart, a single candle usually represents a day. In a hourly chart, a single chart usually represents a hour. Candlestick patterns in day trading usually work with minute chart.
Benefits of using Candlestick Charts
There are many benefits of using candlesticks patterns when trading. Some of these benefits:
They tell us more – Unlike other types of charts, candlesticks tell us more about the financial asset. For example, they tell us when it opened and when it closed.
More accuracy – Candlestick patterns are usually relatively accurate in predicting the future price of an asset.
Used by most traders – These charts are used by most traders in the market. This means you are in good company.
Reversals and extensions – Candlesticks are excellent in helping you identify reversals and extensions.
Popular Candlestick Patterns
A good way to use candlesticks is to use the popular patterns. There are many patterns that have been identified that help to show reversals and new patterns.
Some of the common types of reversal candlestick patterns are:
- Hammer and inverted hammer
- Hanging man
- Bullish and bearish engulfing patterns
- Dark cloud cover
- Piercing patterns
among others. Other patterns are morning and evening star, shooting star, and Dojis.
Example of Candlestick Pattern at work
As you see, there are so many candlestick patterns that you can use in the market. In this article, we will look at just one and see how to use it when doing analysis.
When you look at the EUR/JPY pair shown below, there are several candlestick patterns that you can see.
A good one is the one we have labelled a bullish engulfing.
To spot a bullish engulfing pattern, you need to first identify when a chart is moving downward trend.
In this, you need to spot a chart with several consecutive bearish bars (in this case, we identified a chart with several red bars). The candlestick pattern is established when a long bearish candle is followed and a smaller bullish candle.
This candle must be completely engulfed by the bearish candle. When this happens, it is usually an indication that a new upward trend is starting.
External useful resources
Definition and simple Candlestick pattern – Wikipedia
Pattern Dictionary – StockCharts School