Predicting market movements is a universal desire among traders. While achieving 100% accuracy in this endeavor is challenging, there are indicators that significantly enhance predictability. Candlestick patterns stand out as one of the most favored indicators in technical analysis, thanks to their straightforward interpretability and visually appealing presentation featuring easily distinguishable colors.

Candlestick charts, now applicable to various investment instruments such as crypto, stocks, and forex, trace their roots back to 18th-century Japan. It wasn’t until the late 20th century that these charts gained popularity in the Western world. Initially designed for rice trading, traders soon recognized their broader utility in offering a transparent and concise portrayal of price data across different financial instruments.

In today’s dynamic financial landscape, candlestick patterns serve as a guiding light for traders, allowing them to navigate swiftly and make informed decisions. These patterns, acting as the pulse of market trends, offer a visual representation of price movements over time. Each candlestick imparts information about the opening, closing, high, and low prices for a specific period. The patterns formed by these candlesticks unveil the market pulse, reflecting the prevailing sentiments of market participants during that time frame.

Anatomy of a Candlestick

Japanese candlesticks employ a variety of colors and forms to depict fluctuations in prices.  The candlestick’s body, wick, and shadow convey data on the opening and closing prices, as well as the price range, within a certain time period. 

• The opening price refers to the initial price at which the item is exchanged within a specific period of time.
• The closing price refers to the final price at which the item was exchanged during a certain time interval.
• The high price is the maximum value that the item can obtain within the given timeframe.
• The low price is the minimum value that the item attained during the given time frame.

The section bounded by the opening and closing prices is referred to as the body. The color of the candlestick’s body signifies either a bullish or bearish price trend. If the initial price is less than the final price, the body color is green. In contrast, when the opening price is lower than the closing price, the body color is red. Similar to traffic lights, the green light represents a positive indication for the bull market, while the red light indicates the bear market, signifying a downward trend. In addition to the color, the dimensions of the candlestick body can provide useful insights for traders. A candlestick’s bullish or bearish nature is directly proportional to the length of its body. A lengthy red body signifies intense selling activity, indicating the spread of fear throughout the market. Conversely, a lengthy green body indicates strong market acceptance, reflecting optimism.

The candlesticks are complemented by the presence of shadows, which are present in practically every candle. The thin line between the top of the body and the highest point of the trading period is called the upper shadow. The line between the lower part of the body and the lowest level is called the lower shadow.  The boundary separating the lower section of the body from the lowest point is referred to as the lower shadow. The dimensions and placement of the shadows serve as significant indications of market behavior. If the upper shadow is quite lengthy, it suggests that prices have increased during the trading session but have faced selling pressure or profit-taking at the highest point. This may indicate the presence of resistance levels or the start of a negative trend. On the other hand, a brief upper shadow may indicate that buyers maintained control throughout the trading period, suggesting a robust bullish emotion.

Different Types of Candlesticks

A tricky part of candle patterns is recognizing the patterns they form. This admittedly takes time, effort, and experience. After practicing on the charts for a while, the patterns will naturally wink at you. But it can be difficult to recognize at first. To get you started, here are some of the most common and reliable candlestick patterns: 

Marubozu 

The Marubozu pattern is a candlestick characterized by a body that has no shadows and is rather lengthy. The pattern’s bullish or bearish nature is determined by its color, making it a very reliable indicator for trend continuation following pullbacks. A Marubozu bullish is a candlestick characterized by a lengthy green body and the absence of upper or lower shadows. This candlestick indicates that the market price is influenced by buyers throughout the whole trading session and signifies a robust bullish attitude. The bearish Marubozu is the opposite of the bullish Marubozu.

A fun fact to keep in mind: The term Marubozu means “bald head” or “shaved head” in Japanese. Think of a candlestick body with no shadow!

Doji

The Doji pattern, a traditional candlestick pattern, signifies market hesitancy and uncertainty. This pattern signifies a condition of balance in the market when neither buyers or sellers have dominance. Traders perceive the existence of a doji pattern as a signal to exercise caution and postpone making a decisive buy or sell decision until receiving more confirmation or new information.

Here’s an interesting fact: In Japanese, the word “doji” translates to “same thing” and is used to describe candlesticks with almost identical starting and closing values. The extent of the top and lower shadows may differ.

Common Mistakes to Avoid

While candlestick charts are powerful, they are not foolproof. Traders must be aware of common pitfalls.

Over Reliance on Patterns

As we have already mentioned, different candle patterns have different reliability. Unfortunately, it would be foolish to assume that every pattern is 100 percent correct. In order to utilize the full potential of candlestick patterns, combining them with other technical indicators will strengthen your efficiency. For example, Bollinger Bands or Moving Average. The moving average, in particular, will be useful for expanding the picture painted by candlestick patterns, which only provide short-term indications, to a larger scale and eliminating momentary fuzziness. 

Ignoring Fundamental Analysis

The question of technical analysis or fundamental analysis is one that comes up often. But smart traders know that there is no single answer to this question. To ignore one or the other is to leave half of the market’s indicators in the dark. This is highly inadvisable, as it makes your job of predicting the markets more difficult.

Conclusion

In conclusion, candlestick charts offer valuable insights into market sentiments and can significantly enhance predictability in trading. By understanding the anatomy of candlesticks and recognizing common patterns, traders can make informed decisions based on market trends. However, it is important to note that candlestick charts should not be relied upon as the sole indicator for trading decisions. Combining candlestick patterns with other technical indicators and fundamental analysis can provide a more comprehensive understanding of the market and improve trading efficiency. By utilizing a holistic approach to market analysis, traders can increase their chances of success in predicting market movements.

(Republished with Amendments)