If you have joined us at least once at our webinar on Thursdays you probably know that we do a lot of looking at charts and patterns when talking about coins. We know it can get confusing so we decided to help our users with a series of articles on patterns. So, the first in line CANDLESTICK PATTERN.
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What is a candlestick pattern?
A candlestick is a way of displaying essential information about an asset’s price movement. Every professional trader uses candlestick charts, and as a fact, candlestick charts are one of the most popular components of technical analysis.
These types of charts enable traders to interpret price movements quickly. Also, candlestick bars are not used only for crypto trading. For example, you can use them when analysing stocks, indices, bonds, and forex trading.
Hammer candles can help traders spot potential reversals after bullish or bearish trends. This makes them more valuable than traditional open-high, low-close bars or simple lines that connect the dots of closing prices.
Are candlestick graphics reliable?
We can’t say that all patterns work well. For example, the popularity of candlestick graphs lowered reliability.
However, studies on the effectiveness of candlestick patterns seem to agree that the patterns are successful 50% of the time. As a result, traders now need to learn how to determine which patterns are likely to turn profitable.
Traders believe candlestick trading works because once a pattern forms, the price moves as the candlestick pattern suggests. Therefore, they assume the pattern causes the market to move as it did, and any future patterns will behave likewise.
How do candlesticks work?
According to your selected timeframe, every candle relates to one period in a candlestick chart.
Each candlestick has an opening and closing price that form the candle shape. They also have a wick, which indicates the highest and lowest prices within that period.
When using the candlestick graphics, there are three specific points (open, close, wicks) used to create a price candle.
As the name states, it represents the first price traded during the formation of the candle. If the price trends upwards, the candle will turn green/blue, but the candle will turn red if the price declines.
The closing price is the last price traded during the creation of the candle. Also, if the close price is below the opening price, the candle will turn red. However, if the close price is above the open price, the candle will be green/blue.
The following essential element of a candlestick is the wick. It shows the extremes in the price for a specific period of time. The wicks are identifiable as they are thinner than the candlestick.
How to read a candlestick graphic?
Currently, there are some ways to use and read a candlestick chart. Most traders attempt to take advantage of candle formations, while others try to recognize price patterns.
Individual candlesticks offer accurate insights into the market sentiment. Candlesticks offer clues as to changing momentum and potentially where the market prices may trend.
In the following paragraphs, you will find out how a hammer candle looks and what sentiment it offers to the trader. In this situation, the intuition behind this formation is simple: price tried to decline, but traders entered the market, pushing the price up. This situation marks a bullish signal for other traders to enter the market.
These candlesticks are advantageous because traders can implement ‘tight’ stop-losses. As a result, take-profit is larger than the stop-loss.
How many types of candlestick patterns are?
- Hammer pattern
A hammer candlestick is created when a candle is having a small body and a long lower wick. The wick should have at least twice the size of the candle body. The long lower wick indicates that sellers pushed the price down before buyers pushed it back up above the open price.
A hammer shows that although there were traders creating selling pressures during the day, ultimately, a strong buying pressure made the price go back up. The color of the body can show a strong buy or sell; however, the green hammers indicate a stronger bull market.
- Inverted hammer candlestick pattern
A similarly bullish pattern is the inverted hammer. The main difference is that the upper wick is long, while the lower wick is short.
An inverted hammer is created when the opening price is below the closing price. This time, the long wick that appears above the body signals there was buying pressure to push the price higher. Though, the price was eventually dragged down before the candle closed.
- Bullish engulfing
Two candlesticks form this pattern. The first candle is a short red candle that is completely immersed by a large green candle.
However, the second day opens lower than the first day. As a result – the bullish market pushes the price up, resulting in a great win for buyers.
- Bullish hammers
A bullish hammer pattern is usually formed when the closing price is above the opening price. This pattern suggests that buyers had control over the market before the end of that trading.
- Bearish hammers
The bearish hammer candlestick is also known in the market as a hanging man. Also, this pattern occurs when the opening price is above the closing price, resulting in a red candle. Keep in mind that the wick on a bearish hammer indicates that the market experienced selling pressure, suggesting a potential downside reversal.
- Morning star
The morning star pattern is a sign of hope in a downtrend market. A three-stick pattern forms it: one short-bodied candle between a long red and a long green one, and it signals that the selling pressure of the first day is subsiding, and a bull market is on the horizon.
- Three white soldiers
This pattern occurs over three days. It consists of consecutive long green candles with small wicks, which open and close progressively higher than the previous day.
A very strong bullish signal occurs after a downtrend and shows a steady advance of buying pressure.
A candlestick pattern is a helpful tool that helps traders spot potential trend reversals. It enables you to determine the current state of the market by looking at the color and length of a candlestick. Consequently, traders can instantly determine if the market is strengthening (becoming bullish) or weakening (becoming bearish).
You should also use proper risk management, evaluating the reward ratio of your trades. It would be best to use stop-loss orders to avoid significant losses in moments of high volatility.