Candlestick patterns with catchy names can tell us a lot about market trends.
We like to think our buying and selling decisions are rational, but the truth is humans often make decisions based on emotions. Crypto trading is no exception. Candlestick charts may be able to help — if you know how to read them.
In this article, we’ll explain how candlestick charts are constructed, how to understand their components, and the patterns that they reveal. You’ll quickly understand how to read them and why they can be so valuable.
Let’s first take a look at how they came about.
What Is a Candlestick Chart?
In the 17th century, a Japanese rice trader made an astute observation. The price of rice, though affected by supply and demand, was also strongly affected by the emotions of traders. From this observation arose an ingenious way to represent that emotion: candlesticks.
Candlesticks are named for their appearance: a vertical candle with a wick sticking out of each end. A single candlestick represents five pieces of trading information for a set time period: the item’s opening price, closing price, highest price, lowest price, and overall direction.
A candlestick chart is simply a collection of candlesticks over time. The chart itself can represent a period of days, weeks, months, or longer. Each candlestick can show trading information for a period ranging from minutes or hours to days, weeks, or months.
Why candlesticks rather than a traditional line graph or bar chart? A traditional line graph cannot show as much information as a candlestick chart. And although a bar chart can be constructed to show the same information, candlesticks visually convey it more easily.
So, how do you read a candlestick?
How to Read Candlesticks
First, the candle itself is sometimes called the “real body.” One end of it tells us the opening price, and the other the closing price during the period the candlestick represents.
Which end is which?
That depends on the direction of price movement. This direction — which also says a lot about the emotion of the trading session — is color-coded in the candlestick. Red (or black) indicates a downward movement; green (or white) an upward movement.
So for a red candlestick, its top represents the opening price and the bottom the closing price. A green candlestick would be the opposite — bottom opening, top closing.
Red candlesticks are bearish because of their downward movement; green candlesticks are bullish.
You can probably already see how quickly you can get information from this approach. A long candlestick shows a wide price journey during the session and perhaps an emotional ride up or down. A short one shows less price movement and perhaps a bit of price uncertainty.
The “wicks” of the candlestick (also known as “shadows”) are thin lines that protrude above and below the candle (real body). They show the highest and lowest price of the session.
But things get really interesting when you use candlesticks to begin sensing patterns — patterns that may indicate emotional trends and therefore could be pointers to future movement in the market.
Let’s take a look at a few of the basic patterns you’ll need to know to get your feet wet.
7 Basic Candlestick Patterns to Know
A candlestick all by itself can convey a pattern. And to make them more fun, candlesticks come with descriptive names related to their appearance and the nature of the pattern they imply.
A doji candlestick looks like a cross — the candle is just a line. Why? Because the opening and closing prices for that session were the same. The wicks will indicate if there were outliers during that session and if they were above and/or below that opening/closing price.
Here’s where candlestick reading requires some insight, experience, and context. A doji can be neutral, indicating an equilibrium between buyers and sellers. It may imply nothing about the next session.
But some traders may view a doji in the right circumstances as indicating a continuation of the last trend; others in slightly different circumstances might see it pointing to a reversal of that trend.
Hammer or Inverted Hammer
A hammer or inverted hammer is a small candlestick with a relatively long wick beneath it (hammer) or above it (inverted hammer).
A hammer usually appears during bearish sessions but can indicate the potential for a reversal, since, by the close of the session, buyers bid the price up to near or above its opening. An inverted hammer can indicate pretty much the same: a reversal of a current trend.
Engulfing candlesticks are a two-candlestick pattern. The second candle “engulfs” or extends both lower and higher than the candle that preceded it. They can be either bearish (a red candle engulfs a green) or bullish (a green engulfs a red). Both can point to a reversal.
Evening and Morning Stars
Next, there are three-candlestick patterns known as evening and morning stars. The “star” in each is a small-bodied candlestick that appears as the second candle in a trilogy. In the morning star, it’s beneath the initial candlestick; in evening, above it.
Both morning and evening stars may point to reversals. A morning star usually occurs during a bearish streak and, followed by a green candlestick covering at least half the body length of the first candlestick in the series, can indicate a reversal to a bullish trend.
The evening star is roughly the opposite. It is likely to show up amidst a bullish trend, with a small “star” showing after an up (green) session, followed by a down (red) candle covering at least half the length of the first candle in the series.
A harami pattern is another potential indicator of a reversal. In a three-candlestick series, it’s indicated by the relationship between the final two candlesticks. The final candlestick must be opposite in direction (color) to the previous AND entirely contained within its body.
If during a bearish sequence (red) the final small candlestick is green, it may signal a reversal to a bullish trend (called a bullish harami).
In the opposite, a bearish harami, the small final red candlestick follows a green (bullish) candlestick and may indicate a downward trend will ensue.
There are many more complex patterns, but armed with these, you’ll be able to begin to read candlestick charts and grasp their basic principles. But how do you put them to use?
How to Use Candlestick Charts
As we mentioned above, candlestick charts can give you insight into price history, trends, and the emotional leaning of a market at a particular point in time. That said, candlestick charts alone do not accurately predict where a market is going.
Instead, candlestick charts report the data they represent: opening price, closing price, upward or downward session, and the high and low price of that session. And they accurately show that data over time. But there are limits to what they can convey.
For a session with a very long upward (green) candle, you might assume the market opened with a low price and gradually climbed to close with a high price. But that might not be the case.
Within that time frame, the price could have fluctuated wildly. You just see where it ended.
You could, of course, change the time frame of the candlesticks you’re examining to get a better sense of what happened within a session. Change from days to hours, and you’ll get a better sense of the volatility of trading on a particular day.
Context is also important. Finding a harami means nothing in itself unless there is a prior trend that might be reversed. And keep in mind the emotional component of the data you’re examining. Sometimes emotional reactions are predictable, and other times they are not.
A final word of caution: Much of the insight and experience using candlesticks has been codified into algorithms by advanced traders using very powerful computers. They may be anticipating the behavior of traders using candlesticks and, in essence, seeking to counteract it.
But what’s all this got to do with crypto investing? Let’s take a look.
Candlesticks and Crypto
In a nutshell, trading currencies — in this case, trading cryptocurrencies — can be visualized and analyzed using the same principles as stocks, precious metals, or even rice. Candlestick charts are an excellent way to visualize what’s happening and start to see useful patterns.
Once you know how to read candlesticks, you can use candlestick charts to see what’s going on with your favorite crypto and perhaps even gain insight into how current trends might extend or reverse.
That’s why it’s a good idea to partner with a crypto platform that offers advanced options for graphically interrogating the crypto markets, such as Binance.US. With comprehensive education about crypto trading and investing, you’ll be armed to make informed choices.
To begin your crypto journey, visit Binance.US today.
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