Candlestick Analysis

Written by Edward Gonzales

March 6, 2021

Reading Candlestick Charts

Price is reflected in candlestick patterns. As a day trader, you should focus on the 15- minute candles but also look at the hourly and daily candles. Regardless of the time frame, certain rules apply when reading candlestick patterns.

Here is a picture of BTC/USDT on the 3-minute time frame. As you can see, this is a candlestick chart. It displays the same price information as a line chart in a more colear, graphic format. Candlestick charts are easy to interpret and easy to use. Your eyes adapt almost immediately to the information in the bar notation. Candlesticks are also good at identifying market turning points such as reversals from an uptrend to a downtrend or a downtrend to an uptrend. 

On the chart each candlestick includes an open, high, low, and close price for the time frame. You are able to see the timeframe of each candle. For example, the chart above is set at a 3-minute timeframe, which means that each of the candlesticks represent 3 minutes of price action. In this case, every three minutes a new candlestick is created, and it takes three minutes to complete before another one begins. Candlesticks show the current price, whether the price moved up or down over the time frame, and the price range the currency pair covered in that time. Now let’s learn to analyze a candlestick.

If you take a look at these two candlesticks, you will see a figure in the shape of a rectangular box. This is what is known as the body, which is the widest part of the candlestick. This is the first step of how to read candlestick charts. This body demonstrates the open and the close of the specific period. This implies that if the chart is a 1-hour chart, for example, then every candlestick body will demonstrate the opening and closing price for that one-hour period.

In addition, the thin lines above and below the body are called “wicks” or “shadows.” The wicks at the bottom and at the top of the candlestick present the lowest and the highest prices reached during that one-hour period of time. 

Furthermore, the color of the body tells you whether the candlestick is bullish (meaning that it rises) or bearish (meaning that it falls). If the body is green, then the currency pair closed higher than it opened. If the body is red, it means the currency pair closed lower than it opened.

  • Open Price: the open price depicts the first traded price during the formation of the new candle. 
  • High Price: the top of the upper wick. If there is no upper wick, then the high price is the open price of a bearish candle or the closing price of a bullish candle. 
  • Low Price: the bottom of the lower wick. If there is no lower wick, then the low price is the open price of a bullish candle or the closing price of a bearish candle. 
  • Close Price: the close price is the last price traded during the formation of the candle.

Candlestick Elements

Understanding candlestick patterns goes far beyond just remembering and recognizing certain formations. Many books have been written about candlestick patterns, featuring hundreds of different formations that supposedly provide secret information about what is going to happen next. Truth be told, it will make no difference to your trading performance whether you know what the “Concealing Baby Swallow”, “Three Black Crows”, or “Unique Three River Bottom” are. What really matters is that you understand what the candlesticks in front of you tell you about price structure, trend strength, buyer and seller dynamics, and the likely path for future price movements. 

Before we start talking about the four elements of candlesticks, it’s important that you are in the right mindset. The first step is to think about price movements as a war between bulls and bears. Every candlestick is a single battle in an overall war and the elements of the candlestick tell us who is ahead, who is pulling back, who is in control, and who has a better chance of winning the next battle.

The next step is to think about context. It’s crucial to understand that candlesticks cannot be observed alone. A candlestick must always be analyzed in the context of what has happened in the past. Whenever we try to analyze a candlestick or a formation, we need to ask ourselves the following questions – Is the current candlestick larger or smaller than the previous ones? Is the change in size meaningful? And, is the change happening during an active or inactive trading period? This is a good starting point because it helps us avoid the closed mindset that limits many traders.

There are four elements of a candlestick. The first element is the size of the body. The candle body is a great starting point because it gives us a lot of information. A long body shows strength. When bodies become larger, it shows an increase in momentum. And when bodies become smaller, it shows slowing momentum. The body shows us how far the price has traveled over the duration of the candle.

The second element is the length of the wicks. Wicks can show the volatility of price movements. Larger wicks show that price has moved a lot throughout the duration of the candlestick, but it got rejected. When wicks become larger it shows an increase in volatility. This tends to happen after long trending phases before a reversal happens, or at major support and resistance levels.

The third element is the ratio between the wicks and bodies. Now we can start putting information together. Do you see longer wicks or bodies? In a high momentum trend, you will often see long bodies with small wicks. When uncertainty rises, however, the volatility picks up and bodies become smaller while wicks become larger.

The fourth and final element is the position of the body. This is an extension of the previous point. Can you see a long wick with a body on the opposite side? This is often showing price rejection. In addition, when you have a small body in the middle of a candle with long wicks, it shows indecision between the buyers and sellers.

You can see that once we start combining the information that the wicks and bodies provide us, we can analyze every candlestick formation. Having said that, there are two particular candlestick formations that have improved my trading drastically. Let’s go over them right now.

Bullish Pin Bar

A bullish pin bar is a specific candlestick pattern where the body of the candle is small. There is little or no upper wick. The lower wick is relatively long and at least 2/3rd of the range of the candle. Here is a photo example. 

When you see a bullish pin bar, it means the price opened high and then dropped down significantly. Half way during that interval, the buyers came back in and pushed the price way up back to where it started. This means that the bulls won. The bears tried to push the price down, but the bulls were so strong that they pushed the price back up. This means the buyers are in control, the demand is higher than the supply. 

The bullish pin bar must appear in the right context. You can’t just see a bullish pin bar anywhere in the chart and think it’s a good opportunity to go long. It’s all about location. The bullish pin bar should appear at a support level. Ideally, the bullish pin bar should appear not only in a support, but in a support during an uptrend. An uptrend is one where the price is going up, with higher highs and higher lows. In this case, the best bullish pin bars will show at the bottom of the uptrend pullbacks, on top of the support level. Then, and only then, will you get a statistical edge over the markets. 

Bullish Ice Cream Bar

A bullish ice cream bar is a specific candlestick pattern where the lower wick is at least 50% of the range of the candle and there is little to now upper wick. Here is a photo example.

Now that you know what these bullish candlesticks look like, let’s see them on a chart.

Notice how the price was in a downtrend, and then had a reversal to become an uptrend. As you can see, the bullish pin bar was fighting the support zone created and ended up being a profitable long trade.

Bearish Pin Bar

A bearish pin bar is a specific candlestick pattern where the body of the candle is small. There is little or no lower wick. The upper wick is relatively long and at least 2/3rd of the range of the candle. Here is a photo example.

The bearish pin bar is a bearish reversal pattern. We would trade this setup in the expectation that the price of a currency pair will go down. The bearish pin bar should appear at a resistance level. If it appears anywhere else, it does not mean anything. The overall trend must be going down, with lower highs and lower lows. As the market is going down, the bearish pin bar must appear at a level of resistance (usually a moving average). Only then would we place a sell order. 

Bearish Ice Cream Bar

A bearish ice cream bar is a specific candlestick pattern where the upper shadow is at least 50% of the range of the candle and here is little or no lower shadow.

Now that you have seen what these bearish candlesticks look like, let’s see them on a chart.

We can see that this is a downtrend. We have previously covered how the moving averages sloping down indicate that we have a downtrend in this article. The bearish pin bars appear at the resistance of the moving average. In this case, the moving average where the reversal bearish pin bar appears is the 25 moving average. The others are the 7 and the 99 moving averages.

Bullish Engulfing Candlestick

The bullish engulfing pattern is typically a buy signal that signals a potential upcoming uptrend. The pattern applies after there has been a period of consolidation or downtrend. It happens when a bearish candle is immediately followed by a larger bullish candle. This second candle “engulfs” the bearish candle, meaning that the bulls are showing more strength than bears. The change in strength with the bulls shows a reversal of momentum that is likely to continue. Here is a bullish engulfing candlestick example.

Notice how the larger bullish candlestick “engulfs” the bearish candlestick; the low of the bullish candle is below the low of the bearish candlestick, and the high of the bullish candlestick is above the high of the bearish candlestick. However, when looking for engulfing candlesticks you should not be looking at the wicks for highs and lows. Instead, you should be focused on the bodies of the candles.

Candles with long upper or lower wicks and small bodies are generally very bad engulfing candlesticks. As I told you earlier, large bodies are a sign of strength and momentum in the market, whereas smaller bodies are a sign of weakness. When looking for engulfing candles, make sure that the body of the second candlestick is large and engulfing the previous body, and only then afterwards look at the wicks.

Bearish Engulfing Candlestick

The bearish engulfing pattern is the opposite of the bullish pattern. It is typically a sell signal because it hints that a bullish trend is reversing. This type of candlestick pattern occurs when the bullish candle is immediately followed by a larger bearish candle that completely “engulfs” it. This means that sellers overpowered the buyers and the momentum might continue. Here is bearish engulfing candlestick example.

Notice once again how the larger bearish candlestick “engulfs” the bullish candlestick; the low of the bearish candle is below the low of the bullish candlestick, and the high of the bearish candlestick is above the high of the bullish candlestick. A bearish engulfing candlestick is the same as a bullish one, except for the direction of the candlesticks.

You can observe candlesticks with indicators to help you find quality trades in the market. There are a lot of indicators you can use to help you be more profitable, but you need to understand how to read candlesticks. Candlesticks are the ultimate source of information for traders. All indicators are algorithmically produced after price takes action. If you can read candlesticks, you can predict future price movements more accurately. Fine tune your trading skills through one of our easy to follow courses here.

By viewing any material or using the information within this publication you understand that this is general education material and you can not hold any person or entity responsible for loss or damages resulting from the content or general advice provided here. Trading cryptocurrency has potential rewards, but also potential risks. You must be aware of the risks and be willing to accept them in order to invest in the markets. Only trade with funds you can afford to lose. This publication is neither a solicitation nor an offer to buy/sell cryptocurrency or other financial assets. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed in any material on this website. The past performance of any trading system or methodology is not necessarily indicative of future results.

Written by Edward Gonzales © Crypto University 2021

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1 Comment

  1. Godwin Gabriel

    Very educative,thanks

    Reply

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