Reading Candlestick Patterns

In short: A candlestick shows what the price did during a period. Certain shapes of one to three candles are used by many traders as a clue that the trend may reverse or continue. They are clues, not guarantees, and they often give false signals.

How is a candlestick built?

Each candle summarises one period, such as a day or an hour. It shows four prices (together called OHLC):

• Open: where the price started.
• High: the highest point in the period.
• Low: the lowest point in the period.
• Close: where the price ended.

The wide part is the body: the distance between open and close. The thin lines above and below are the wicks (also called shadows). They show how far the price went before it came back.

Many platforms show a rising candle (close above open) in green and a falling candle in red. This is a setting, so check the colours in your own platform.

A long body means the price moved in one direction. A short body with long wicks means the price moved far but came back, which points to uncertainty.

One-candle patterns

Hammer

A hammer has a small body at the top and a long lower wick (about twice the body or more). It appears after a decline. The price fell sharply, but buyers pushed it back up. That can point to fading selling pressure. It is only interesting when it forms at a support level. See also the tutorial Support and Resistance.

Shooting star

The shooting star is the mirror image: a small body at the bottom and a long upper wick, after a rise. Buyers pushed the price up, but sellers took over. This can signal that the rise is losing strength, especially at a resistance level.

Doji

In a doji, the open and close are (almost) equal, so the body is just a line. Buyers and sellers were in balance. A doji is therefore not a buy or sell signal but a sign of doubt. Look at what the next candle does.

Two-candle patterns

Engulfing candle

An engulfing candle has a body that completely covers the body of the previous candle.

• Bullish engulfing: after a decline, a large rising candle covers the small falling candle before it. This can point to a turn upward.
• Bearish engulfing: after a rise, a large falling candle covers the small rising candle before it. This can point to a turn downward.

The larger the second candle and the higher the volume, the more weight the signal has. You can read more about volume in Volume Analysis.

Three-candle patterns

Morning star and evening star

• Morning star: a large falling candle, then a small candle (doubt), then a large rising candle. A possible turn upward.
• Evening star: the mirror image after a rise: a large rising candle, a small candle, then a large falling candle. A possible turn downward.

Three white soldiers and three black crows

Three rising candles in a row with higher and higher closes are called three white soldiers. Three falling candles in a row are called three black crows. They point to a strong move. After such a run the price has often already travelled far, so an entry may be late.

How do you use a pattern?

A pattern is a reason to look more closely, not to trade blindly. A practical order:

1. Check the trend. A hammer in a downtrend means something different from a hammer in an uptrend.
2. Look for context. Is the pattern at a support or resistance level, or in the middle of nowhere?
3. Check the volume. Higher volume than normal gives the signal more weight.
4. Wait for confirmation. Many traders wait until the next candle confirms the direction.
5. Set your stop-loss in advance. For a hammer it usually sits just below the candle’s low.

Worked example (hypothetical)

Suppose stock X has fallen to about €50. A hammer forms with a low of €48.40 and a high of €49.90, close to an earlier support level. You wait for confirmation: the next candle moves above €49.90 and you buy at €49.95.

• Stop-loss: €48.30 (just below the low). Risk per share: €49.95 − €48.30 = €1.65.
• You accept a maximum loss of €100 (1% of a €10,000 account). Number of shares: €100 ÷ €1.65 = 60 shares (rounded down). The maximum loss is then 60 × €1.65 = €99.
• Price target at a ratio of 2:1: €49.95 + 2 × €1.65 = €53.25.

This is a calculation example, not a forecast. The price may simply keep falling, in which case your stop-loss limits the loss. Run your own numbers with the position size calculator and the risk/reward calculator.

Limitations of candlestick patterns

• False signals: a pattern can look perfect and still fail. News, a strong trend or a weak market can overrule the signal.
• Hindsight bias: on an old chart you only notice the patterns that worked and quickly forget the failures. Test on historical data first and record the losers too.
• Subjectivity: two traders do not always draw the same “hammer”. Decide in advance what rules you apply, such as the length of the wick.
• Timeframe and market: a pattern on a 1-minute chart contains far more noise than on a daily chart. What works for stocks does not have to work for crypto.
• Costs: transaction costs and spreads (the difference between the buy and sell price) count. With many small trades they eat your result.

Practice questions

Try these without looking back. The answers are in the text above.

1. What are the four prices a candle shows?
2. Why is a doji not a buy signal?
3. What has to happen before you treat a hammer as confirmed?
4. Why can a pattern on a 1-minute chart be less reliable than on a daily chart?

What next?

Combine candlestick patterns with support and resistance and volume analysis. Practise first on old charts or with a demo account. Also learn how to limit your risk per trade in the risk management tutorial.