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Prominent Candlestick Patterns Used in Technical Analysis
Candlestick patterns are one of the most important tools used in technical analysis. A candlestick holds four crucial pieces of information about a cryptocurrency asset: the opening price, highest price, lowest price, and closing price for a particular time frame.
Candlesticks are also utilized in traditional financial instruments like stocks to help gauge the probability of an asset or security’s trend.
They are able to provide a trader with valuable information about the market, such as price direction, momentum, and reversals.
It's important to note that candlestick patterns are just one tool among many that traders can use to make informed decisions about buying and selling cryptocurrencies.
As with any investment strategy, it's important to carefully consider the potential risks and rewards before making a decision.
What are Pros and Cons of Using Candlestick Patterns in crypto trading?
Pros:
Candlestick patterns can provide valuable insights into market sentiment and investor behavior.
They can help traders identify potential trends and make informed decisions about when to enter and exit trades.
Candlestick patterns are easy to interpret and can be used by traders of all skill levels.
Cons:
Candlestick patterns are based on past price data, and may not always accurately predict future price movements.
They can be subject to interpretation, and different traders may interpret the same pattern differently.
Candlestick patterns should not be used in isolation, and should be combined with other technical and fundamental analysis tools for a more comprehensive view of the market.
How to read a candlestick pattern?
To read candlestick patterns, follow these steps:
Identify the time frame: Candlestick patterns can be used to analyze price data over different time frames, such as hourly, daily, or weekly charts.
Identify the open, high, low, and close: Candlestick patterns are based on the open, high, low, and close prices of a cryptocurrency over a given time period. The open price is the price at which the cryptocurrency began trading during the time period, the high price is the highest price reached during the time period, the low price is the lowest price reached during the time period, and the close price is the price at which the cryptocurrency closed trading during the time period.
Identify the body and the shadows: The body of a candlestick represents the range between the open and close prices, and the shadows represent the range between the high and low prices. A candlestick with a small body and long shadows may indicate indecision or uncertainty in the market, while a candlestick with a large body and small shadows may indicate strong buying or selling pressure.
Identify the color: Candlesticks are typically colored either red or green, with red representing a downward price movement and green representing an upward price movement.
Identify the pattern: Candlestick patterns are formed by the combination of the body, shadows, and color of the candlestick. Some common patterns include the doji, hammer, and shooting star. Each pattern has its own meaning and can indicate different potential trends in the market.
How to determine if a candlestick is bearish or bullish?
Four price data points determine whether a candlestick is bearish or bullish. A green candlestick indicates a bullish price movement, while a red one suggests a bearish movement. These four price data points include:
Open - The candlestick records a snapshot of the first trading price during that specific time frame.
High - This is a recording of the highest price of an asset within the represented time frame.
Low - This is a recording of the lowest price of an asset within the represented time frame.
Close - Represents the last price of an asset within the represented time frame.
Other popular terminologies include the body, wick/shadow, and range. The body is the distance between the open and close. The wick or shadow is the distance between the body and the low/high. Finally, the range is the distance between the low and the high.
Candlesticks work best when used alongside other technical analysis techniques such as the relative strength index, Elliot Wave Theory, Ichimoku Cloud, Bollinger Bands, and the Moving Average Convergence Divergence (MACD).
Most importantly, remember that Candlestick patterns are not buy/sell signals. They are only used to interpret market structure and identify upcoming opportunities.
What are common Candlestick Patterns?
There are a few candlestick patterns that are considered to be fairly common and often used by technical analysts when conducting their chart analysis. Some of the most popular candlestick patterns include the following:
Bullish reversal patterns
Bullish Harami A Bullish Harami is formed when a small green candle follows a long red candle. The pattern could unfold within two or more days and usually suggests selling momentum is suppressing.
Three White Soldiers These three candles predict a reversal in a prevailing downtrend market. The Three White Soldiers feature three long green candlesticks in a row, which open within the previous candle’s body. They usually close at a price level above the previous high. You are going to observe long wicks on these patterns suggesting that the price is surging as a result of buying pressure.
Hammer This candlestick pattern occurs at the lower limits of a downtrend and consists of a long lower wick. The wick is twice as long as the body and suggests that the bulls were strong enough to sustain the price upwards despite high sell-offs. A Hammer could be either green or red; red hammers suggest weaker bullish movement.
Inverted Hammer Similar to the hammer, but its wick is long and above the body. This pattern appears at the lower limits of a downtrend and suggests an imminent price reversal upwards.
Bearish Reversal Patterns
Bearish Harami A Bearish Harami is formed when a small red candle follows a long green candle within the actual body of the immediate previous candle. These patterns unfold within two or three days, usually at the close of an upswing. They suggest suppressing buying pressure and an imminent bear market.
Three Black Crows Three Black Crows feature three consecutive red candles suggesting the reversal of a prevailing uptrend. These candlesticks open inside the previous candle and end at a price level beneath the previous low. The wicks are longer to suggest continuous sell-offs and imminent decline in prices.
Hanging Man The Hanging Man candlestick pattern is similar to the hammer pattern but bearish in nature. It occurs at the end of an upswing and consists of a long lower wick and a tiny body. These features suggest that the bulls could lose control of a prolonged uptrend, and the market could decline.
Dark Cloud Cover The Dark Cloud Cover is a red candle that closes beneath the midpoint of the previous candle once it opens above the close of the former green candle. This pattern is often followed by high trading volumes, suggesting that momentum could change from the uptrend to the downtrend. A third red candle validates this pattern and gives traders confirmation of an imminent bear market.
Shooting Star This pattern forms when an uptrend approaches a close and consists of a little/no lower wick, a long upper wick, and a tiny body. The pattern suggests the market has attained a high, and sellers are regaining control to drive the price downwards.
Continuation Patterns
Doji A pattern forms the Doji when the open and close touch the same level or remain within a close distance from each other. Price could move up or down the open but will only close at the open. This pattern indicates indecision between buyers and sellers.
Rising Three Method The continuation of an upswing following three red, small-bodied candlesticks in a row indicate a rising three method pattern. Traders confirm the continuation of the trend when they observe a green candle (large-bodied), which suggests the bulls have regained control of the market.
Falling Three Methods This is the reverse/inverse of the rising three methods and indicates a continuation of a downtrend.
Conclusion
Candlesticks are fundamental tools for traders and technical analysts in any financial market. They help visualize what’s taking place in the market and help analyze price movements within short time frames.
Please note candlestick patterns do not have any scientific principles behind them, and they are only meant for conveying price actions based on selling/buying pressure. Combine candlesticks with a variety of technical analysis techniques to derive maximum value on Cryptohopper.
Moreover, one still needs an analytical mind, practice, and knowledge of the broader economy to interpret these patterns effectively.
