A Comprehensive Guide To Reading Candlestick Charts Effectively

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A Comprehensive Guide To Reading Candlestick Charts Effectively

Technical traders use various tools to analyze the global financial markets. With the advent of technology and the internet, traders can easily access these valuable trading tools for free. However, the problem could be choosing the right and comprehensive tool among the lot. For instance, novices can get confused with what chart to pick to analyze the cryptocurrency market. Of the available options like the Line, Bar, Area charts, etc., what is the right option?  

Almost all the chart types mentioned above cover only a limited set of data points, making them less rounded while analyzing the markets. The one chart type that gives a comprehensive outlook of the market is the Candlestick chart. This chart type gives a varied number of data points. As our trading decisions depend on the previous price action of a crypto token, the candlestick chart clearly describes the lowest price of an asset at a given timeframe, the highest it has gone, along with its opening and closing prices. What’s more? They also provide directional movement of the asset’s price with extreme accuracy.

In this article, let’s dive into more details about the candlestick charts and their reliability while trading the crypto market.

What are Candlestick Charts?

The story of the candlestick chart emanated from Japan in the 1700s. Traders of a particular commodity in the Asian country were trying to determine what influences the volatility in the price of the commodity they sold. They discovered that the major sway of the commodity prices was due to emotions, the sentiments of people towards the commodity. The candlestick gives a detailed representation of the market reaction towards a particular commodity across a specific period and makes it the most used tool in financial analysis.

A candlestick chart is a method of displaying a commodity’s traditional price movement over time. Each candlestick represents a specific period. The movement of an asset’s price in a single trading day or a single trading hour, or even a single trading minute can be represented with a candlestick.

The candlestick’s central part is its body, and it displays the disparity between the opening and closing prices of traded cryptocurrencies. Candlesticks possess wicks, a straight faint line that runs through the middle to both ends of the candle. It is otherwise called a shadow.

Candlestick Anatomy
Figure 1 | Candlestick Anatomy

A faint line stretches between the top of the body and the high of the trading period and likewise another line stretching from the low of the body and the low of the trading period. These lines are referred to as the upper shadow and lower shadow, respectively. It represents the highest and lowest price of a token during a particular period.

The colors allotted to candles are not mere aesthetics. They represent the difference in the opening and closing price of an asset. A Red candle illustrates that the opening price is higher than the closing price. This is referred to as a bearish candle. On the other hand, the Green candle indicates a lower opening price and a higher closing price. This is a bullish candle.

The body represents an asset’s open and closing price. The close will be higher than the open in a bullish market and vice versa in a bearish market. As much as a candlestick gives a detailed price movement of crypto, it would be more advisable to make a financial analysis using more than one candlestick. Sets of candlesticks create a pattern that helps create a wider view and influences a holistic decision during trading.

Crypto and Candlestick Charts

Due to the comprehensive details the candlestick charts provide, crypto traders have adopted this trading style from the Forex and Stock trading. Candlesticks form chronologically (days, weeks, months, and so on) and build a pattern. They take a certain shape to represent the buy and sell signals. However, the time frame varies according to the default pattern set by crypto trading platforms.

The crypto market is always open 24-hrs, unlike the Stock market. The candlestick chart is relevant in crypto trading as it proves an efficient tool to keep track of crypto’s volatility.

Terms Used in Candlestick Charts Trading

  • Close – It is the last price transacted during the candle creation phase.
  • Open – It is the first transaction price for a period.
  • High – It is the highest level attained by the price during the time frame covered by the candle.
  • Low – The price’s lowest point throughout the period covered by the candlestick.
  • Completed Patterns – These are the existing patterns that can be interpreted as bullish or bearish indicators.
  • Emerging Patterns – These are candlestick patterns that have not yet formed but are in the process of forming.

Types of Candlestick Patterns

One of the most complete and extensive ways to show the price of a digital asset is by candlestick patterns. These patterns adopted by crypto traders show the historical prices of cryptocurrencies during a trade.

Depending on how many candlesticks are incorporated, there are single, dual, and triple candlestick patterns. The primary goal of detecting any candlestick pattern is to comprehend the market’s future price movement. This movement pattern is structured into two types:

  • The Continuation Pattern – The appearance of this pattern indicates that the chart will progress in the same direction as the prevailing trend after the pattern formation.
  • The Reversal Pattern – This changes the direction of price patterns from downtrend to uptrend or vice versa.

In this section, let’s discuss a few popular and reliable candlestick patterns you must know to ace the crypto markets.

Bullish Engulfing Pattern

When accompanied by a cluster of bearish candlesticks indicating a downward trend, the Bullish Engulfing pattern denotes a bullish trend reversal. The bullish Green candle body surrounds or engulfs the previous day’s Red or black candlestick, signifying the start of a fresh upswing.

Bullish Engulfing Pattern
Figure 2 | Bullish Engulfing Pattern

When a Bullish Engulfing pattern occurs, it indicates that additional buyers joined the market, pushing the price higher and thereby resulting in a trend reversal. In a Bullish Engulfing pattern, the first candle must be Red (bearish) while the second candle must be Green and engulf the previous Red candle. This means that the opening price of the engulfing candle must be lower than its closing price.

Bearish Engulfing Pattern

It is the direct inverse of the Bullish Engulfing pattern. The first candle, which is Green and small, is entirely covered by the next Red candle and has a longer body. This pattern appears at the apex of an uptrend and indicates a reversal. The lower the second candle remains, the stronger the negative or bearish move.

Bearish Engulfing Pattern
Figure 3 | Bearish Engulfing Pattern

Evening Star Pattern

It is a bearish, triple candlestick pattern that indicates a trend reversal. The first candlestick appears bullish and promises large market gains. The second candlestick might not have much information to go on with because it does not show a particular trend pattern. It is usually small and can appear neutral, bearish, or bullish. The third and the most crucial candle is a Red (bearish) one. It shows declining prices of a crypto token, a downward trend, and therefore a bearish signal.

Evening Star Pattern
Figure 4 | Evening Star Pattern

Dark Cloud Cover

It is a bearish reversal pattern that occurs in an uptrend and signals the possibility of a weak rise. It’s a two-candlestick design that resembles the piercing pattern (a bullish candlestick reversal pattern that appears in a downtrend). In this pattern, the Red candle opens above and shuts below the preceding Green body’s middle. It implies that bears have gained market control, causing prices to fall. In other words, if the candle shadows are short, traders might predict a significant downturn.

Dark Cloud Cover
Figure 5 | Dark Cloud Cover

Identifying a Dark Cloud Cover pattern on the candlestick chart is easy. A bullish Green candle larger than the average candle comes first. This is critical to the pattern’s setup since it shows a high level of buying interest in the market. Then the candle that comes next is a bearish one as it tends to have a higher earning price but finishes in the lower half of the first candle body.

Gaps are rare in a candlestick when searching for a Dark Cloud Cover pattern in a crypto chart. This is majorly due to the 24-hour crypto trading rule, which ensures there is no open or close trading. To accommodate this complexity inside crypto, you want to see a large-bodied Red candle that retraces more than 50% of the previous large-bodied Green candle.

Three-line Strike

It is a series of candlesticks that consists of three bars in the direction of a trend, followed by a final candle that pulls back to the start point. Traders use the Three-line Strike to purchase at a current trend low or sell at a current high. Traders may use candlesticks to identify a trend that is likely to continue. There are two variants of the Three-line Strike pattern: the bullish three-line strike and the bearish three-line strike.

The bullish three-line strike has four candles – the first three are bullish, while the fourth tend to be bearish. The three bullish candles grow progressively before a final strike candle. The final candle starts progressively well but ends below the first candle opening price. In summary, it is three progressively bullish candles and one bearish candle.

Three-line Strike
Figure 6 | Three-line Strike

Contrarily, a bearish Three-line Strike is a four candle continuation pattern that appears in a bearish trend. It comprises three progressively bearish candles; however, the last candle is bullish and closes above the highest closing of the preceding three candles.

The three-line strike tells the crypto traders the movement of the market. While the market believes in ascending prices (bullish) or descending prices (bearish), the market goes in a particular direction for a long time. It tends downwards and upwards, respectively, after the appearance of the fourth candlestick. The fourth candle is just a slight glitch, and normal service is resumed as the next candle most likely follows a bullish or bearish run depending on the first three candles.

Three Black Crows

This reversal pattern comprises three consecutive red candles, with every candle opening at the previous close. We can consider the appearance of this pattern as a strong bearish signal. 

Three Black Crows
Figure 7 | Three Black Crows

This pattern typically appears in an uptrend, and the formation of three Red candles indicates the losing momentum of buyers in the crypto market. You can place your trades betting on the downside after the formation of the last bearish candlestick.

Three White Soldiers

It is an inverse of the Three Black Crows candlestick pattern. It occurs in a downtrend and indicates the reversal of the ongoing downtrend.

Three White Soldiers
Figure 8 | Three White Soldiers

As shown in the above figure, the pattern is formed when three Green candles and can be easily identified as each candle opens and closes higher than the previous. It is characteristic of a strong bullish run after a downtrend.

Abandoned Baby

It is a three-candlestick reversal pattern that can be seen in an uptrend or a downtrend. The baby can appear as a baby bull (calf) or baby bear (cub), as shown in the below image. The tiny baby or Doji is surrounded by its parents, either a step higher or lower. Doji is a small candlestick body with a long shadow or wick, which signifies market indecisiveness.

Bullish and Bearish Abandoned Baby Pattern
Figure 9 | Bullish and Bearish Abandoned Baby Pattern

The pattern is considered a Bearish Abandoned Baby when the first candle shows a rise in price, the second withholding prices, and the third shows a price fall. This clearly indicates a bearish signal. Opposite to this is the Bullish Abandoned Baby, which starts as a bearish, then a tiny body or a Doji, and finally a bullish candle indicating a reversal to the upside.

Pros and Cons of Using Candlestick Charts

Pros

  • Interaction between buyers and sellers becomes seamless and easy because the chart patterns are easy to comprehend with fewer complexities.
  • Candlesticks display more rounded statistics than any other trading tool.
  • Trading candlestick patterns proved to be very reliable. Also, we can pair them with other analysis tools to give a broader interpretation of the markets.

Cons

  • Except you have an expansive knowledge of the market, the direction of chart patterns is difficult to judge.
  • Due to the expanse of knowledge the candlesticks offer, it can be confusing for novices. However, with practice, they can easily be mastered. 

Conclusion

Candlestick charts have proven to be an effective tool for Forex traders and Stockbrokers. They are now proving their relevance in cryptocurrency trading. As mentioned, it would take a small learning curve to master the trading of these patterns. Therefore it is recommended to practice these patterns on a demo account before trying them on real crypto trading.

Also, to avoid any false trading signals generated by these patterns, you can pair them with reliable trading tools like indicators and oscillators for additional confirmation. We hope you find this article useful and informative. In case of any questions or queries, let us know in the comments below. Cheers!

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