Cryptocurrency Trader’s Guide to Reading Candlestick Patterns
While candlestick charting may seem common today, this approach didn’t gain worldwide popularity until 1990 when they were first introduced to the Western World. With humble beginnings dating back to investors forecasting rice prices in 18th century Japan, candlesticks are now the most common way of charting in most financial markets, including of course digital assets.
To many novice investors, these charts containing varied and often complex patterns can be overwhelming. However even a basic understanding of how to read and recognize these patterns can help give traders price action insights to help plan their next moves.
In this article, we break down the basic anatomy of the candlestick, along with some of the most important patterns a crypto trader should know.
- What are candlestick charts?
- How to read a candle
- Key trading patterns to know
What are candlestick charts?
Simply, candlestick charts are used by traders to represent the price evolution of an asset. While candlesticks may be harder to understand initially, they offer far more information than a simple line chart.
As you can see in the chart above, they are made up of literal candlesticks, each one representing a trading period that can be 1 minute, 1 hour, 1 day or more. This is an example of 1 hour candles, as indicated by the 60 (minutes) at the top left.
How to read a candle?
As you can see below, there are two colours: red and green. When a candle is red, its closing price was lower than the opening price: the price of the asset decreased during that trading period. When a candle turns green, the closing price was higher than the opening price as the asset’s price increased.
Beyond colour, let’s break down the rest of the visual above:
Body: The body indicates the open-to-close range. In other words, it indicates the difference between the closing and the opening price.
Wicks: These are also called tails or shadows. They reveal the highest and lowest price of an asset within the candlestick period. If there is no wick, the opening and closing prices are the lowest/highest price.
Highest Price: The top of the upper wick indicates the highest price traded during the period.
Lowest Price: The lowest price traded during the period is indicated by the bottom of the lower wick.
Opening price: This is the price at which the first trade happened during the new candlestick time period. If the price goes up, the candle turns green and conversely turns red on a price decrease.
Closing price: The closing price is the last price traded during the period of the candle formation. If this price is above the opening price, the candle will be green, otherwise, it will be red.
Key trading patterns to know
While there are many ways to use and read a candlestick chart, pattern recognition is often used to predict price direction, trends, and overall momentum. They can be made of one, two, or even more candlesticks so we’ve created this handy list of the main bearish and bullish patterns for you below.
Appearance: The hammer is one of the easiest pattern to recognize. Like a hammer, this pattern is made of a candlestick with a long lower wick at the bottom of a downtrend. The body is usally small with little to no upper wick. A hammer may be either red or green.
Indications: It may indicate a strong reversal trend and a potential price surge. This pattern shows high selling pressure, however during the same period the buying pressure retook the control of the price action.
Appearance: The Inverted Hammer’s only visual difference to the Hammer is the long wick above the body rather than below. An Inverted Hammer may be either red or green.
Indications: An Inverted Hammer indicates the potential begining of an uptrend, with the ended downtrend indicating buyers might soon gain control.
Appearance: This pattern is made up of two candlesticks, occuring at the bottom of a downtrend. The first one is bearish (red) while the second is green and engulfs the other. In other words, the second candle’s body is bigger than the previous. There should be a gap between the closing and opening price, however this gap is rarely seen in crypto markets.
Indications: This pattern indicates increasing buying pressure and the begining of an uptrend as buyers are likely to drive the price up.
Appearance: The piercing line is a pattern made up of a long bearish (red) candle followed by a long green candle, occuring at the bottom of a downtrend. There’s a gap down between the closing and opening prices, with The closing of the second candle more than half-way up the bearish candle’s body.
Indications: The begining of the period looks very bearish. However, the buying pressure increases throughout the candle, indicating the bulls are interested in buying at the current price.
Appearance: The Morning star is a pattern made up of three different candles in a downtrend. The first is a long bearish candle. The second, the star, presents very long wicks, a short body and closes below the previous closing price. The third candle is a long bullish candle that closes above the midpoint of the first.
Indications: The star signals that the current trend is losing steam, often confirmed with the third candle launching an uptrend.
Appearance: The three white soldiers pattern consists of three green candlesticks inside of a downtrend. The second and third candles open within the body of the previous one’s and close above it. The candles usually have little to no lower wicks.
Indications: This patterns indicates a strong buying pressure which drives the price up and even indicate an upcoming price reversal. The bigger the candles are, the stronger the pressure is.
Appearance: The hanging man is the bearish equivalent of a hammer. It usually forms at the end of an uptrend with a small body and a long lower wick. It can be either green or red.
Indications: This patterns signal the weakness of the uptrend and traders often associate it as a sell signal.
Appearance: The Shooting Star is made up of one candle stick with a small body and lower wick. Conversely, the upper wick is very long. Unlike the very similar Inverted Hammer, this pattern occurs at the top of an uptrend.
Indications: This pattern indicates a strong price rejection after a significant push up. The Shooting Star is often associated with a signal of bearish reversal.
Appearance: This pattern is made up of two candlesticks. The first one is bullish (green) while the second is red and engulfs the other. In other words, the second candle’s body is bigger than the first one. With gaps between closing and opening prices rarely seen in the crypto, this pattern occurs at the top of an uptrend.
Indications: This pattern indicates increased selling pressure and the beginning of a potential downtrend.
Appearance: The Evening Star is the exact opposite of the Morning Star. It is made up of three different candles in an uptrend. The first is a long bullish candle. The following candle, the star, presents very long wicks and a short body. The third candle is a long bearish candle that closes below the midpoint of the first candle.
Indications: The star signals that the current trend is losing strength, and traders may use it to sell positions. The confirmation occurs with the third candle which often launches a downtrend.
Appearance: The Three Black Crows pattern is recognizable by three red candlesticks inside of an uptrend. The second and third candles open within the body of the previous one’s and close below it. The candles usually have little to no lower wicks.
Indications: This patterns indicates a strong selling pressure which drives the price down and can announce an upcoming price reversal.
Appearance: The Dark Cloud Cover pattern is made up of a red candle that opens above the closing price of a previous green candle, but then closes below the midpoint of that candle. This pattern appearing in an uptrend generally creates a new high.
Indications: This pattern can indicate two things: a pullback or at least ending of the current uptrend. In both scenarios, traders tend to read this pattern as a sell signal.
Unlike simple line charts, candlestick charts carry much more information and are a very useful tool for traders. However they of course have many limitations in isolation and are often used in combination with technical indicators such as RSI or Moving Average.
The patterns above are some of the most popular but far from the only ones, so stay tuned for a follow up post about more advanced patterns.
Disclaimer: contents of this article are for general market education and commentary and are not intended to serve as financial, investment, or any other type of advice.
Sertaç Yılmaz (Boredoomed)
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