Candlestick charts are the most widely used chart type in technical analysis. Each candle shows four data points in a visual pattern: the opening price, the closing price, the highest price, and the lowest price of a given period. Certain combinations of candles provide signals about potential price changes.
Anatomy of a candlestick
A candlestick consists of two parts:
- Body: the wide part between the opening and closing price. A green (or white) body means the closing price is higher than the opening price. A red (or black) body means the opposite.
- Wicks/shadows: the thin lines above and below the body. The upper wick shows the highest point, the lower wick shows the lowest point of the period.
A long body indicates strong buying pressure (green) or selling pressure (red). Long wicks indicate rejection: the price moved far but was pushed back.
Reversal patterns
Engulfing pattern
The most powerful candlestick pattern. In a bullish engulfing, the new candle opens below the low of the previous candle and closes above its high. The new candle completely "engulfs" the previous one. This signals that sellers have been overwhelmed by buyers.
A bearish engulfing is the opposite: the new candle opens above the previous high and closes below the previous low. On weekly and monthly timeframes, engulfing patterns are rare but very powerful.
Hammer and hanging man
A candle with a small body at the top and a long lower wick (at least twice the body length). When this pattern appears after a decline, it's called a hammer and is a bullish signal. The long wick shows that sellers pushed the price significantly lower, but buyers brought it back before the close.
The same pattern after an uptrend is called a hanging man and is a warning that the trend may reverse.
Doji
A candle where the opening and closing price are nearly identical. The body is therefore a thin line. This indicates indecision: buyers and sellers are in equilibrium. A doji after a strong trend can mark the beginning of a reversal.
Harami (inside bar)
A small candle that falls entirely within the range of the preceding large candle. The opposite of an engulfing: here the new candle is "enclosed" by the previous one. The smaller the second candle, the stronger the signal.
A harami signals that momentum is fading. After a strong rally, a bearish harami can mark the beginning of a correction. Note: the lows of a harami are often retested later. Markets form bottoms as W-patterns, not V-patterns.
Fractal pattern
A fractal is a pattern of five candles (in practice, three are often sufficient) that identifies a local top or bottom. In a bullish fractal, the middle candle has the lowest low, with higher lows on both sides. In a bearish fractal, the middle candle has the highest high, with lower highs on both sides.
Fractals help identify support and resistance levels and serve as building blocks for recognizing market structure (higher highs/higher lows or lower highs/lower lows).
Timeframe matters
The same pattern on a daily chart is less significant than on a weekly chart. A weekly engulfing represents an entire week of trading activity and carries more weight than a daily engulfing. Monthly patterns are the strongest but also the rarest.
Choose your timeframe based on your investment horizon. Day trading? Then look at 15-minute and hourly charts. Investing for the medium term? Then daily and weekly charts are relevant.
Candlesticks in context
A candlestick pattern by itself is not a buy signal. It's the final piece of the puzzle. Before looking at candlesticks, you should have done your homework:
- Is the market structure bullish or bearish?
- Does volume confirm the move?
- What do momentum indicators like RSI or MACD say?
- Is the price at a relevant Fibonacci level?
Only when these factors converge do you look for confirmation in a candlestick pattern. 90% of the work is in the preparation. The candle is merely the trigger.
After entry, let the market do its work. Set your stop-loss and profit target in advance. Most mistakes are made after a trade is opened, not before. Discipline after entry is at least as important as the analysis that preceded it.