What Are Candlestick Patterns?
Candlestick patterns are visual formations created by one or more price bars on a chart. Each candlestick records the open, high, low and close of a given time period. The body represents the range between the open and close, while the wicks show the extremes reached during that period.
Traders use these patterns to gauge market sentiment. Candlestick analysis originated in 18th century Japan and was popularised in Western markets by Steve Nison. Today it remains one of the most accessible forms of technical analysis available to forex traders.
How to Read a Single Candlestick
- Body size. A large body shows strong momentum. A small body suggests indecision.
- Wick length. A long upper wick means price was pushed higher but sellers drove it back down. A long lower wick shows buyers stepped in after a decline.
- Colour. A green candle closes above the open, indicating net buying. A red candle closes below the open, indicating net selling.
- Position in context. The same candle shape can mean different things depending on where it appears within a trend.
Key Single Candlestick Patterns
Doji
A doji forms when the open and close are virtually identical, creating a very small body. It reflects indecision in the market. When a doji appears after a sustained trend, it can signal that momentum is fading.
Hammer
The hammer has a small body near the top and a long lower wick, at least twice the length of the body. It appears at the end of a downtrend and suggests that sellers pushed price lower but buyers recovered most of the losses.
Shooting Star
The shooting star is the inverse of the hammer. It has a small body near the bottom and a long upper wick. It forms at the top of an uptrend and indicates that buyers were overwhelmed by selling pressure.
Spinning Top
A spinning top has a small body with roughly equal upper and lower wicks. It signals uncertainty. Neither buyers nor sellers gained control during the session.
Key Multi-Candlestick Patterns
Bullish Engulfing
A bullish engulfing pattern consists of a small bearish candle followed by a larger bullish candle whose body completely engulfs the previous body. This suggests a shift from selling pressure to buying pressure.
Bearish Engulfing
The bearish engulfing is the opposite. A small bullish candle is followed by a larger bearish candle that engulfs it. This pattern appears at the top of an uptrend.
Morning Star
The morning star is a three-candle reversal pattern. The first candle is a long bearish candle, the second is a small-bodied candle, and the third is a long bullish candle that closes well into the body of the first candle.
Evening Star
The evening star is the bearish counterpart of the morning star. It forms at the top of an uptrend with a long bullish candle, a small-bodied candle, and a long bearish candle.
Three White Soldiers and Three Black Crows
Three white soldiers consist of three consecutive long bullish candles, each closing higher than the previous one. Three black crows are the reverse: three consecutive long bearish candles.
How to Use Candlestick Patterns in Forex Trading
- Identify the prevailing trend. Candlestick patterns are more reliable when traded in the context of the broader trend.
- Wait for confirmation. Most patterns require at least one follow-up candle to confirm the signal.
- Combine with other tools. Use candlestick patterns alongside chart patterns, support and resistance levels, and technical indicators.
- Consider the timeframe. Patterns on higher timeframes tend to carry more weight than those on very short timeframes.
- Define your risk before entering. Set a stop loss based on the pattern structure. Calculate your position size to keep risk within your tolerance.
Where to Place a Stop Loss
Stop loss placement depends on the specific pattern. For a hammer or bullish engulfing, a common approach is to place the stop below the low of the signal candle. Add a small buffer to account for spreads and normal market noise.
Risk Management Considerations
- Limit risk to 1% to 2% of your trading account per position.
- Use a reward to risk ratio of at least 1.5:1 where possible.
- Candlestick patterns do not guarantee a particular outcome. Even high-probability setups fail regularly.
- Avoid over-trading by acting only on the clearest signals.
Common Mistakes Traders Make
- Trading every pattern without considering the broader context.
- Ignoring confirmation.
- Relying on candlestick patterns alone.
- Applying patterns from one timeframe without checking alignment on higher timeframes.
- Overcomplicating analysis by trying to memorise dozens of obscure patterns.
Example Scenario Using a Forex Pair
Suppose EUR/GBP has been declining for two weeks and approaches the 0.8300 support level. On the daily chart, a hammer candle forms with a close at 0.8315 and a low of 0.8295. The following day, a bullish candle closes at 0.8340, confirming the hammer.
A trader might enter long at 0.8342 with a stop loss at 0.8290. The distance from entry to stop is 52 pips. A target at the recent swing high of 0.8420 provides 78 pips of potential reward, giving a reward to risk ratio of approximately 1.5:1.
This is a hypothetical example for educational purposes only. It does not represent a trade recommendation.
Final Thoughts
Candlestick patterns offer a practical way to read market sentiment on any timeframe. No single candle or pattern provides certainty. The value of candlestick analysis lies in combining it with sound risk management and a disciplined approach. Practise identifying patterns on a demo account before committing real capital.
Ready to Practise Reading Candlesticks?
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