As a day trader, understanding candlestick charts and patterns is essential.
They can help you make trade decisions, and see potential reversals before a stock falls off a cliff…
That way you can exit with your profits and prevent you from turning a winning trade into a loser.
This is crucial information for every trader, so study it and get ready for the short trading week ahead…
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Table of Contents
What Are Candlesticks?
Candlesticks visually represent price movements over a specific time period. Each candlestick represents the opening, closing, high, and low prices of that timeframe.
A green candle means the stock closed higher than it opened. A red candle indicates the stock closed lower than it opened. The wicks denote the high and low points during the trading day.
Each candlestick can represent the trading action during one day, one minute, five minutes, 30 minutes, or any time frame you choose.
When you put candlesticks together, they form candlestick patterns which can give traders a wealth of information about market sentiment, potential reversals, and price ranges.
The daily range of a stock can be determined by the size of the candles on the daily chart.
Small candles indicate a narrow price range, while larger candles represent a wider range.
But candlesticks can tell us even more about a stock’s price movements — they can even indicate potential bottoms or tops…
Here are a few examples…
Basic Candlestick Patterns
You may have heard of these three common candlestick patterns…
Bullish Engulfing Pattern
This pattern consists of a small bearish (red) candlestick followed by a bullish (green) candle that is larger than the body of the red candlestick, so it ‘engulfs’ it.
This pattern can indicate a potential trend reversal from bearish to bullish.
Bearish Engulfing Pattern
The bearish engulfing pattern is the opposite of the bullish engulfing pattern.
This pattern would occur after a stock has a run to the upside and could be ready to reverse…
It occurs when a smaller bullish (green) candlestick is followed by a larger bearish (red) candlestick. It suggests a possible shift from a bullish trend to a bearish one.
Doji Candlestick
A doji candlestick has a small body, indicating that the opening and closing prices are very close or even identical.
It represents market indecision and suggests a potential trend reversal. Pay attention to the candle following the doji to indicate which direction the market decided on.
Learn how to recognize trends here.
Advanced Candlestick Patterns
These are a few more complex candlestick patterns…
Hammer and Hanging Man
These patterns consist of a small body with a long lower wick. The hammer appears after a downtrend and signals a potential reversal to an uptrend.
The hanging man occurs after an uptrend, indicating a possible trend reversal to the downside.
Shooting Star and Inverted Hammer
These patterns also have small bodies but with long upper wicks.
The shooting star appears after an uptrend and suggests a potential trend reversal to the downside. It has a long top wick with little to no bottom wick.
Conversely, the inverted hammer (basically an upside-down hammer) occurs after a downtrend and indicates a possible reversal to the upside.
Applying Candlestick Patterns in Day Trading
When identifying candlestick patterns, pay attention to the volume at the same time. Higher volume during pattern formations provides stronger confirmation of potential trend reversals.
Combining candlestick patterns with support and resistance levels on your charts can also add confirmation to the potential reversal signal.
It takes practice to become proficient in recognizing candlestick patterns.
So spend time studying historical charts, identifying patterns, and analyzing their outcomes.
Stare at charts until your eyes bleed!
I also recommend you read, “Japanese Candlestick Charting Techniques” by Steve Nison.
The book influenced me a lot and I still refer to it regularly.
Candlestick charts are a powerful tool for traders. But they shouldn’t be used alone…
Remember to combine them with other technical analysis tools and always consider risk management strategies.
Happy Fourth of July, everyone!
I’ll see you at my FREE live webinar at 10 a.m. Eastern!
Tim Bohen