Candlesticks Explained: A Comprehensive Guide for Traders and Investors 2023
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Trading crypto requires a lot of preparedness. These include market analysis, research, and developing an effective trading strategy. A candlestick is one of the technical analysis tools that crypto traders use to check a coin’s price action to determine the best times to open and close trades. Candlesticks basic charts are also explained in details in this piece.
However, reading candlesticks can be complicated for beginners. So, with candlesticks explained in this detailed guide, we demystify what a candlestick is and why it’s important in crypto trading to answer the question, “What do candlesticks tell you?” Keep reading.
Understanding the Basics of Candlestick Charts
Candlestick charts are market analysis tools used to analyze or read an asset’s price action at a particular time. They make up part of the technical analysis tools that digital asset traders use to form the opening prices, highs, lows, and closing prices of various financial instruments.
While candlesticks are popular with crypto trading, it’s important to note that the market analysis tool isn’t limited to only cryptocurrencies. Forex investors also use candlesticks on paper trading apps since the forex market involves buying and selling digital assets.
So, with crypto candlesticks explained, you can understand how to use various candlestick patterns.
Origins and Historical Context
Candlestick charts have become more popular recently due to more awareness about cryptocurrencies, but their history dates back to the 1700s in Japan. At the time, there were no bars with points and figure charts to track price movements for goods and services. So, a Japanese man called Homma found a way to connect traders’ emotions and the demand and supply of rice, which was commonly traded at the time.
With a distinct connection between market sentiment and the traditional demand and supply measures for rice, people could track the price movements of the product. Ultimately, with more observations, the initiative led to the development of the first candlestick charts and patterns.
As candlesticks do now, they’ve acted as highly-effective trading tools that traders from over a century ago used to get price insights based on market emotions. That is, the general market sentiment of an asset can cause price changes that candlesticks predict.
Interestingly, the price actions can be determined per time – hours, days, weeks, months, and years. So, candlestick users can select a trading pair and work with their latest or oldest price actions over a given period to make more informed trading decisions.
The Importance of Visual Representation in Trading
There’s a massive amount of data in the financial trading world. Analysts and investors go through high volumes of data every second, from stocks to bonds, market indices, crypto, and commodity trading apps. However, with data visualization, users can translate information into visual contexts like a graph or chart.
Candlesticks charts are crucial technical visual representations that give an overview of a market’s price movement to help traders determine if it’s positive or negative. As such, the visual representation of the data makes it easy for traders to analyze the snapshot and interpret its data. The information derived from the colorful data representation can then be used to support their decision-making process from time to time.
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Components of a Candlestick
To read and analyze price patterns using candlesticks, you must first understand a candlestick’s components and what each part says. As stated earlier, a candlestick shows the day market’s highs and lows compared to its open and close. So, a candlestick shape changes according to the relationship between the day’s high, low, opening, and closing prices.
With the various candlestick shapes giving an overview of the overall market sentiment, investors conducting technical analysis can determine the best time to enter and exit trades. Now let’s go into more detail about what a candlestick looks like and what its visual representations mean to technical analysts.
Body, Wick and Tail
A candlestick is divided into the body, wick, and tail. The body (or real body) is the most visible part of a candlestick, and it represents the price range between an asset’s opening and closing prices over a specific period – usually one day.
However, the body can also highlight a trading pair’s opening and closing price range in the long term. As such, you can see a candlestick representing price data for a month, depending on the trading chart settings.
So, how do you read the data the candlestick’s body represents?
When the real body is black or red, the close was lower than the open over the given period. Conversely, if the body is white or green, the close was higher than the open at the time.
With candlesticks explained, it’s clearer what the body and its colors stand for. However, these colors may vary depending on traders’ preferences and their charting platforms.
Besides the body, a candlestick has upper and lower wicks. These are two thin lines above and below the body, also called the “shadow.” the upper shadow is called the wick, and the lower shadow is the tail.
The top of the upper wick shows the highest price an asset reached during a selected period, while the bottom of the lower wick represents an asset’s lowest price during the same time frame. But if an asset’s open or close price is the same as the high and low, its candle will not have a wick.
So, the wicks indicate the difference between the opening and closing prices, while the body shows the entire price change of a trading pair.
Open, High, Low, and Close (OHLC)
As the name implies, the OHLC chart is used to visualize the open, high, low, and close prices for a given period. The OHLC chart shows a candlestick’s four significant data points, highlighting the increasing or decreasing price momentums from one period to another.
The OHLC chart has one vertical and two horizontal lines. The vertical line on an OHLC chart represents the high and low, the horizontal line to the left indicates the open price and the right horizontal line represents the closing price. Altogether, they combine to make a structure called a bar.
When the open and close lines are far apart, there’s a strong momentum, but when they are close, there’s a weak momentum or indecision. On the other hand, the high and low can be used to assess market volatility, as they represent the entire price range during the period.
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Why Candlesticks Matter in Technical Analysis
While candlesticks are not all there is to technical analysis, they are essential tools analysts and traders employ to make better trading decisions. We highlight why candlesticks are vital in technical analysis.
Visualization of Price Movements
Imagine a case where you had to sort out various price data and figures to determine specific trading pairs’ price movements. Doing so will have you spending hours plotting and combining extensive data. And this is where candlesticks come in. At their core, candlesticks help study the price movements of various assets within a given period.
However, instead of having extensive price data, a candlestick gives a snapshot of the data using colorful charts, making it easier for analysts to know whether a market’s price movement is positive or negative and the degree of either possibility. By taking a glance, you can see the highest and lowest price an asset reached during a specific period and its opening and closing prices simultaneously.
Identifying Patterns and Trends
Seasoned traders understand that candlesticks offer more than just periodic price movements. The candlestick data can also be used to determine price patterns and market trends to understand the general market sentiment and predict future market actions.
For instance, a green candle indicates a bullish sentiment, and a red candle suggests a bearish sentiment. Similarly, a long wick at the bottom of a candle’s body might show that traders are buying more of an asset as its price falls and may be a good sign that the asset’s price will rise soon. Conversely, a long wick at the top of the candle suggests that traders are selling their assets to take profits before a price dump.
Bullish and Bearish Candlesticks
Every candlestick pattern consists of a combination of candles indicating whether an asset’s price movement is bullish or bearish. We highlight the characteristics of each trend below.
Characteristics of Bullish Candlesticks
Bullish candlestick patterns indicate that an asset’s price will likely rise. So, when there are more buyers than sellers, a bullish candlestick chart will show a long real body (white or green) that either continues a pattern or reverses it.
For instance, in the image below, the price action moved from red to green and continued progressing, representing a bullish price movement.
Characteristics of Bearish Candlesticks
Bearish price action is the opposite of a bullish one. It indicates a downtrend in an asset’s price and is usually represented by a black or red candle that moves downward. As the image below shows, a new bearish movement reversed an initial bullish trend, resulting in a downward (red) candle movement.
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Common Single Candlestick Patterns
There are many candlestick patterns to know when conducting technical analysis. These patterns mean different things, and we highlight the most commonly used ones below.
Doji and Its Variations
A Doji is one of the most typical candlestick variations among traders. The single candlestick pattern looks like a cross or plus sign, representing virtually the same open and close price of an asset within the same period. In other words, a Doji pattern suggests market indecision. In this case, neither buyers nor sellers control the market, and an ongoing trend may be reversed.
There are different Doji candlesticks variations. These include;
- The Standard Doji
- The Long-legged Doji
- The Dragonfly Doji
- The 4-price Doji
- The Gravestone Doji
A Doji with a longer upper wick indicates a bearish trend, while a long lower tail suggests a bullish trend.
Hammer and Shooting Star
Other popularly used types of candlesticks are the hammer and shooting star candles. The hammer candlestick is a single candle with its wick pointing down. A hammer can be red or green, as its color depends on the candle after it. It usually appears when sellers enter the market during a bearish trend, signifying a bullish reversal.
On the other hand, the shooting star indicates the peak point of an ongoing upward trend after an asset has been in a bullish zone for a long period. The candle’s long wick represents a halt in a high price, and it often comes before a bearish reversal.
Basic Candlestick Patterns
To a typical trader, market price movements are not random. They are patterns traders can use for analysis and incorporate into their strategies. However, all candlestick patterns represent either a bullish or bearish pattern. We highlight the basic candlesticks explained patterns below.
Engulfing Patterns: Bullish and Bearish
The bullish engulfing patterns represent a market trend where buyers are more than sellers. The candlestick chart has a long (green or white) real body engulfing a small (red or black) body, indicating that bulls control the market at the time and an asset’s price may go higher.
On the other hand, a bearish engulfing pattern comes up during an uptrend after the sellers outnumber the buyers. The candle is usually a long (red or black) real body engulfing a small (white or green) body, indicating that sellers control the market and an asset’s price could start declining.
Harami Patterns: Bullish and Bearish
The Harami pattern indicates that the market is “pregnant” and forms both bullish and bearish signals, depending on the period. The candle has a small (green or white) real body inside a large real body of the previous day. The bullish Harami indicates that a downtrend is pausing, and an upside could be on the way if a trader waits another day.
The bearish Harami is the opposite. It indicates indecision among buyers, and traders can watch the pattern to make informed decisions. If the price of an asset goes higher after the pattern, the uptrend may continue – otherwise, a down candle coming after the bearish Harami indicates a downtrend.
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Continuation Candlestick Patterns
The continuation candlestick patterns are tools traders use to predict when an ongoing trend will resume after a slight pause. In other words, if sellers gain market control, a continuation pattern can indicate when buyers are likely to return stronger. The common continuation candle patterns are highlighted below.
Flag and Pennant Patterns
The flag and pennant patterns are short-term continuation patterns that indicate the resumption of a market trend. The flag is a short price trend experienced between a longer price trend on a chart, indicating the possible continuation of the previous trend. A trend resumption after a flag could result in a rapid price increase.
A pennant pattern is a continuation pattern that pops up when an asset experiences a massive upward or downward movement followed by a brief consolidation before continuing in the initial trend direction. The pattern looks like a small triangle and can be bullish or bearish.
Symmetrical Triangles
The symmetrical triangle is a continuation pattern indication a consolidation period before the market price breaks upward or downward. The triangle helps traders to determine entry and exit points. However, it holds a neutral pattern, with no ascending or descending line to show bullish or bearish trends.
Reversal Candlestick Patterns
From our Candlesticks explained so far, you can already tell that the market can either continue or reverse. When the market rebounds, the trend changes from its current flow to a new one – which can be an uptrend or downtrend.
Head and Shoulders Pattern
The head and shoulders pattern forms when an asset’s price rises to its highest and returns to the base price before the uptrends. In other words, the pattern predicts a bullish-to-bearish trend reversal, informing traders that an asset has already peaked.
Double Top and Double Bottom Patterns
A double top is an “M” shaped pattern that indicates a bearish market reversal after a bullish trend. Conversely, the double bottom pattern is “W” shaped, and it signals a bullish price movement after a period of downtrend.
Combination With Technical Indicators
While candlesticks are important technical indicators, they are only market prediction tools and offer no guarantees. However, for more effective analysis, candlesticks cannot stand alone. It’s advisable that analysts combine candlestick patterns with other technical analysis tools.
Using Moving Averages with Candlestick Patterns
A moving average (MA) chart is another popular analysis tool used to track the price movements of an asset. It defines the average price of an asset over a particular period. Combining moving averages and candlestick patterns will help define the starting point of your analysis.
When price action stays above the moving average, it indicates that the price is in a general uptrend. However, if price action remains below the moving average, it suggests a price downtrend. Combining both analysis tools will give traders a stronger idea of the market’s direction.
Incorporating RSI and MACD for Confirmation
Technical analysts, especially day traders, also use the relative strength index (RSI) and the moving average convergence divergence (MACD). The MACD identifies the overall direction of a trend, while the RSI identifies price swings. Both indicators provide signals to traders, and you can use them to confirm the predictions from your candlestick and moving average patterns.
By doing so, you can confirm price momentums using various indicators. For example, if one indicator signals momentum in one direction, check whether the other indicator agrees before entering a trade. Similarly, you can exit a position when the indicators diverge.
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Developing Candlestick-Based Trading Strategies
Since candlesticks offer deep market insights, traders around the world build their trading strategies around them. How can you build a trading strategy using candlestick patterns?
Trend Following with Bullish and Bearish Patterns
The common method is to follow the market trend highlighted by the candlestick patterns. Doing so will help identify bullish and bearish patterns of an asset or a trading pair, informing you of the best time to open and close positions.
Swing Trading with Reversal Patterns
Unlike day traders, swing traders hold positions for more than a day, hoping to profit from price swings. Such traders can read price actions using reversal patterns to determine when a price is likely to change direction and either enter or exit their positions.
Risk Management and Entry/Exit Points
No matter the solid candlestick-backed trading strategy you create, cryptocurrencies remain volatile, and trading is risky. However, you can mitigate these risks using the methods below.
Placing Stop-Loss Orders Based on Candlestick Patterns
A stop-loss order is a common risk management tool among traders. The order is an instruction from a trader to a broker to buy or sell an asset once it reaches a price. In other words, a stop-loss can help open or close your position if the market rises or falls.
To go short, set a stop-loss price above the candlestick pattern’s highest point, and to go long, set the stop-loss below the lowest pattern point.
Identifying Entry and Exit Signals
You must know your entry and exit points before trading. Interestingly, your candlestick patterns can give you entry and exit signals to identify when to long or short an asset. However, it’s best not to use the candlestick signals in isolation but to combine them with other technical analysis tools like MA, RSI, and MACD.
Importance of Backtesting
Backtesting is a method used to evaluate the effectiveness of a trading strategy. The backtesting results can also be used to optimize an existing trading strategy through the methods below.
Testing Candlestick Patterns on Historical Data
Traders can backtest to see how their strategy would have worked in the past. Doing so offers them more insights into the likelihood that the candlestick-backed strategy will work in the future. And if the performance isn’t so great, they can optimize the strategy.
Learning from Backtesting Results
As stated earlier, a backtesting result offers insights into the effectiveness of a developed trading strategy. After backtesting, the result informs you whether to trade in real-time with the strategy or improve it for more effectiveness.
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Continuous Learning and Improvement
Learning as a trader never ends. How do you continue to develop your skills and achieve desired results?
Staying Updated with New Patterns and Variations
Continuously evolve with the market by learning new trading patterns and ideas to improve your strategy. To do this, you can join an online community of traders to gain insights. You can also do your own research (DYOR) and find the latest trading patterns on day trading apps like etoro and variations.
Reflecting on Past Trades and Adjusting Strategies
Another effective way to develop as a trader is to learn from your mistakes. Review your past trades to identify what could have been better and tweak your current trading strategy with the information. Ultimately, you’ll continually build effective strategies.
Candlesticks Explained – eToro Complete Guide
Developing a candlestick pattern begins with finding a simple, secure, and safe online brokerage like eToro. Apart from being a free stock app, the digital asset exchange offers traders cryptocurrencies, and exchange-traded funds (ETFs) with the lowest fees and a built-in TradingView chart for candlestick patterns. Follow the steps below to get started on eToro.
- Visit the eToro website and click “Join eToro.”
- Complete the registration form with the required details.
- Click “Create Account” to complete the registration process.
- Complete the ID verification.
- Deposit funds and start trading using your candlestick strategies.
Candlesticks Explained – Conclusion
With candlesticks explained in this detailed guide, you can now answer the question, “What do candlesticks tell you?” At the same time, with forex candlesticks explains, you know that candlesticks are used across various financial markets to help traders build effective strategies.
Ultimately, doing your own research is essential, as candlesticks offer no guarantees. You can begin on crypto, forex, and ETF apps like eToro and effortlessly build your trading strategy with the broker’s tools, including built-in candlestick charts.
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FAQs
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Maryam Jìnádù
