Financial market analysis falls broadly under two categories, technical and fundamental. While fundamental analysis relies on macroeconomic conditions, quarterly earnings, and the prevalent interest rates among other factors to predict future price moves, technical analysis uses charts where the patterns formed by securities in the past are used.
Here we will talk about the Candlestick patterns and know how to read patterns in candlestick charts.
A candlestick pattern is formed as a result of the rising and falling price of an asset. While the technical charts may show random patterns, some specific patterns are used by traders as a buy or sell signal. It must be mentioned that these patterns are indications and not guarantees.
The patterns can be broadly divided into bullish and bearish. Bullish patterns are an indication that the price is likely to move up while bearish patterns might precede a fall in price.
Similar to a bar chart, a candlestick shows if the markets are open, close, high or low during the trading session. A candlestick has a wide portion, known as the “ real body”. It is described as the price range between the open and close of the trading session.
When the real body is black in colour, it means that the closing price is less than the opening price quoted by the security. The opposite of it is the empty body, which means that the closing price was higher than the opening price.
Traders have the option to alter the colour in their respective trading platforms. For instance, a down candle is usually shaded red (instead of black as described earlier). The up candle can be given a green colour (instead of white).
How to read candlestick patterns
There are several basic forms of candlestick patterns such as bearish engulfing pattern, bearish engulfing pattern, bullish engulfing pattern, bearish engulfing pattern. Let us now see how to interpret candlesticks.
- Bearish Engulfing Pattern: This pattern is formed when sellers of a security are more than that of buyers. You may ascertain this pattern when you witness a long red real body engulfing a small green real body. The bearish engulfing pattern is an indication that the bears are in control and the price of the security is likely to drop lower.
- Bullish Engulfing Pattern: As opposed to the bearish engulfing pattern, this pattern is formed when buyers outnumber sellers. This pattern looks like a long green real body engulfing a small red real body. Traders interpret this pattern as a buy indication. The prices are expected to move up when a bullish engulfing pattern is formed.
- Bearish Evening Star: An evening star is a pattern formed when the price of a security has topped. When the last candle in the pattern opens below the previous day’s small real body, the pattern formed is called a bearish evening star. The appearance of this pattern means that the security might witness a selling pressure in the future.
- Bearish Harami: This pattern signals that the traders are indecisive. A small red body fully inside the previous day’s real body is called a bearish harami. If the price momentum continues to be upward after such a pattern is formed, the up move may continue. But if the price begins to slide, it is likely to slide further.
- Bullish Harami: When a small real body, green in colour, forms inside the large real body of the previous day, the pattern is called bullish harami. The pattern is an indication that a trend is pausing and an upside movement may follow soon.
- Bearish Harami Cross: This pattern forms during an uptrend. When a doji follows an up candle — where the candlestick is nearly an equal open and close — the pattern is called bearish harami cross. Besides, the doji is within the real body of the previous session. Traders interpret such a pattern the same as a bearish harami.
- Bullish Harami Cross: This candlestick pattern is formed during a downtrend. The formation happens when a doji follows a down candle. The doji is within the real body of the previous session.The pattern, similar to bullish harami, is indicative of a trend pausing, followed by an upside movement.
Conclusion: Candlestick patterns help traders to predict future price moves. Candlesticks help traders gauge the sentiments around the security and other asset classes.While these patterns do indicate future price moves, experts suggest they are not a guarantee of the indications always being true.