With humble beginnings dating back to the 18th century, candlesticks are now the most common way of charting in most financial markets, including the crypto markets. 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 an edge through price action insights to help plan their strategies.
In this article, we break down the types of candlesticks and their meaning, along with some of the most popular patterns a crypto trader should know.
Candlestick Meaning
A candlestick is a graphical representation of the price action of a trading asset. It allows chartists and traders to visualize the open, high, low, and closing prices within a specific time period. While candlestick charts may also be used for analyzing other types of data, they were initially created as a tool that facilitates the analysis of financial markets.
For instance, a 1-hour chart consists of multiple candlesticks, each one illustrating a 1-hour market movement. Each candlestick displays the opening and closing prices (body of the candlestick), as well as the high and low price points (long lines above and below the body, also known as wicks).
Depending on the direction of the market movements, candlesticks have a different disposal of the closing and opening price, as well as different colors. Ascending candlesticks are usually depicted in green or black (filled), while descending candlesticks are usually red or hollow (white).
How To Read A Candlestick
Most traders utilize candlestick charts in their two colors: red and green, due to their easy interpretation:
- 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; the asset's price increased during that trading period.
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.
How Do Traders Use Candlesticks?
As candlesticks illustrate the movement of the asset during the defined period, it can visually indicate bullish or bearish sentiment, especially when candlesticks are viewed as a group – traders call these candlestick patterns. Candlestick charting is extremely relevant in Bitcoin and cryptocurrency trading as a whole.
As candlesticks utilize raw price data and updates as soon as a period is completed, candlestick patterns are said to be “leading” indicators and not “lagging.” This makes candlestick pattern recognition a must-have in your trading arsenal. By learning how candlestick patterns can indicate bullish or bearish reversals, you can get ahead of the trend by acting on these leading indicators before the rest of the traders pile on.
Types Of Candlesticks And Their Meaning
Bullish Reversal Patterns
Hammer
A candlestick with a long lower wick at the bottom of a downtrend, where the lower wick is at least twice the size of the body.
A hammer shows that even though the selling pressure was high, the bulls drove the price back up close to the open. A hammer can be either red or green, but green hammers may indicate a stronger bull reaction.
Inverted Hammer
Also called the inverse hammer, it’s just like a hammer, but with a long wick above the body rather than below. Similar to a hammer, the upper wick should be at least twice the size of the body.
An inverted hammer occurs at the bottom of a downtrend and may indicate a potential reversal upward. The upper wick shows that price stopped its continued downward movement, even though the sellers eventually managed to drive it down near the open. As such, the inverted hammer may suggest that buyers soon might gain control of the market.
Three White Soldiers
The three white soldiers pattern consists of three consecutive green candlesticks that all open within the previous candle’s body, and close at a level exceeding the previous candle’s high.
Ideally, these candlesticks shouldn’t have long lower wicks, indicating that continuous buying pressure is driving the price up. The size of the candles and the length of the wicks can be used to judge the chances of continuation or a possible retracement.
Bullish Harami
A bullish harami is a long red candle followed by a smaller green candle that’s entirely contained within the body of the previous candle.
The bullish harami can unfold over two or more days, and it’s a pattern indicating that selling momentum is slowing down and might be coming to an end.
Bearish Reversal Patterns
Hanging Man
The hanging man is the bearish equivalent of a hammer. It typically forms at the end of an uptrend with a small body and a long lower wick.
The lower wick indicates that there was a large sell-off, but bulls managed to take back control and drive the price up. Keeping that in mind, after a prolonged uptrend, the sell-off may act as a warning that the bulls might soon be losing control of the market.
Shooting Star
The shooting star is made of a candlestick with a long upper wick, little or no lower wick, and a small body, ideally near the low. The shooting star is a similar shape as the inverted hammer but is formed at the end of an uptrend.
It indicates that the market reached a high, but then sellers took control and drove the price back down. Some traders prefer to wait for the next few candlesticks to unfold for confirmation of the pattern.
Three Black Crows
The three black crows are made of three consecutive red candlesticks that open within the previous candle’s body, and close at a level below the previous candle’s low.
The bearish equivalent of three white soldiers. Ideally, these candlesticks shouldn’t have long higher wicks, indicating continuous selling pressure driving the price down. The size of the candles and the length of the wicks can be used to judge the chances of continuation.
Bearish Harami
The bearish harami is a long green candle followed by a small red candle with a body that’s entirely contained within the body of the previous candle.
The bearish harami can unfold over two or more days, appears at the end of an uptrend, and may indicate that buying pressure is decreasing.
Dark Cloud Cover
The dark cloud cover pattern consists of a red candle that opens above the close of the previous green candle but then closes below the midpoint of that candle.
It can often be accompanied by high volume, indicating that momentum might be shifting from the upside to the downside. Traders might wait for a third red candle for confirmation of the pattern.
Continuation Patterns
Rising Three METHods
This pattern occurs in an uptrend, where three consecutive red candles with small bodies are followed by the continuation of the uptrend. Ideally, the red candles shouldn’t breach the range of the preceding candlestick.
The continuation is confirmed with a green candle with a large body, indicating that bulls are back in control of the trend’s direction.
Falling Three METHods
The inverse of rising three mETHods, indicating the continuation of a downtrend instead.
Doji
A Doji forms when the open and the close are the same (or very close to each other). The price can move above and below the open but eventually closes at or near the open. As such, a Doji may indicate an indecision point between buying and selling forces. Still, the interpretation of a Doji is highly dependent on context.
Depending on where the line of the open/close falls, a Doji can be described as:
Gravestone Doji – Bearish reversal candle with a long upper wick and the open/close near the low.
Long-legged Doji – Indecisive candle with both a lower and upper wick, and the open/close near the midpoint.
Dragonfly Doji – Either bullish or bearish candle (depending on context) with a long lower wick and the open/close near the high.
According to the original definition of the Doji, the open and close should be exactly the same. But, what if the open and close aren’t the same but are instead very close to each other? That’s called a spinning top.
However, since cryptocurrency markets can be very volatile, an exact Doji is rare. As such, the spinning top is often used interchangeably with the Doji.
Closing Thoughts
Candlestick patterns are essential for any trader to at least be familiar with, even if they don’t directly incorporate them into their trading strategy. This makes learning the types of candlesticks and their meaning beneficial for any aspiring trader.
While they can be undoubtedly useful to analyze the markets, it’s important to remember that they aren’t based on any scientific principles or laws. They instead convey and visualize the buying and selling forces that ultimately drive the markets.
