Understanding Candlestick Patterns in Forex Trading

candlestick chart

To understand a book, you need to be able to read the words. To understand sheet music, you need to be able to read the notes. To understand price behavior, you need to be able to read and interpret the charts. So, let’s get to one of the cornerstones of Technical Analysis, which is understanding candle charts and patterns. 

Candle Anatomy and Meaning 

Charts come in different styles, but we will focus on Japanese candlestick or candle charts, which have become by far the most popular because they provide the quickest visual grasp of price action and the market sentiment behind it. Much has been written about the advantages of candle charts and why they’ve become the dominant charting style since they were first introduced to the West by analyst Steve Nison in 1989, and popularized in his seminal book, Japanese Candlestick Charting Techniques, nearly a decade later. However, we’ll stick to an overview of what you need to know to make money in forex trading

Understanding Candle Charts

First, study the parts of each candlestick, shown in Figure below. 

candlestick

Relationship between Body, Wick, and Its Significance 

The length of the bodies and the wicks, in absolute terms and relative to each other, can tell us a great deal about market sentiment over the duration of a given candle. That can be significant for candles covering longer periods like an entire day, week, or month. As with any technical indicator, candles and their patterns over shorter durations are less meaningful because price movements within a given day or less often can be caused by random money flows unrelated to any real market sentiment. 

Here’s the key to understanding the relationship between wick (or shadow) and body length and the meaning of an individual candle: 

  • The longer the wicks are relative to the body, the greater the indecision and the greater the back and forth struggle between buyers and sellers, and the more likely the current trend will cease or reverse. 
  • The shorter the wicks are relative to the body, the more decisive the move up or down, and the more likely that the move will continue in the same direction. 
  • A long higher close body with few or no shadows shows buyers outnumbered sellers and were in control during the entire period covered by the candle, steadily pushing price higher. The longer the candle body, the greater the buying strength. 
  • A long lower close body with few or no shadows shows that sellers outnumbered sellers and were in control during the entire period covered by the candle, steadily pushing price lower. The longer the candle body, the greater the selling strength. 
  • A small body relative to the wicks suggests the same indecisiveness to a lesser degree. If the body is red, the sellers were modestly stronger; if green, the opposite is true.


Lower Wicks 

A relatively long lower wick suggests initial strong pessimism and selling which reversed as buying increased at the lower bargain price, and short-sellers took profits. In other words, a lower price level was tested and held firm, turning back attempts to drive the price lower. 
A short lower shadow suggests less indecision, less testing of lower prices, and lighter selling pressure that required few buyers to reverse it. If the currency pair closes at its low for the period covered, the candle won’t have a lower wick.

Upper Wicks 

A relatively long upper wick suggests initial optimism or buying pressure that reversed as sellers stepped in and buyers took profits. In other words, a higher price level was tested and held firm, turning back attempts to drive price higher. 
A short upper wick shows less indecision, less testing of higher prices, less struggle between buyers and sellers. If the closing price is the high for the period covered, the candle won’t have an upper wick.

Continue reading the introduction to Japanese candlestick patterns or play around in a risk-free forex demo account and notice them in real-time.

Introduction to Japanese Candlestick Patterns

Japanese candle charts mostly indicate reversal or indecision (i.e., possible reversal), whereas Western charting patterns tend to indicate continuation (trend pausing before resuming) or reversal. Candle patterns are a vast topic. Our goal here is to introduce you to the most important among them. 

Note that the table classifies candles and patterns as bullish, bearish, or neutral. The adjective “bullish” refers to candles that show price rising or patterns that suggest the price will rise because a bull gores its adversary in an upward motion. “Bearish” is used to refer to candles that show price falling or patterns that suggest the price will drop because a bear swipes at its adversary in a downward motion.

1. Notes on Single Candle Patterns

Spinning Top

Spinning Top

Depends on whether higher or lower close. Significance increases if occurs after an extended move in the opposite direction of the close.

In this example, the most recent candle showed a black, lower close. If these spinning tops occurred at the top of an extended uptrend, it would suggest a coming reversal. If they occurred at the bottom of a downtrend, they’d merely suggest continued downtrend, already the default assumption in an ongoing downtrend. 

Doji

Doji

Neutral: The more wick relative to the body, the more indecision because buyers and sellers are more evenly matched. The lack of a body means that the doji pattern suggest indecision and possible end or reversal of a trend. Thus they’re more meaningful when finding after a long move up or down because they suggest the move may end and perhaps reverse. 

White Marubozu – Bullish/Black Marubozu – Bearish

White Marubozu – Black Marubozu


Conversely, the more body relative to wick, the more decisive the move and the clearer the dominance of buyers or sellers. White suggests buyers dominant, so usually suggests more upside. The black version suggests the opposite. 

Hammer – Bullish/ Hanging Man - Bearish

Hammer – Hanging Man

Hammer and Hanging Man have the same shape: Long lower wick, little or no upper wick two to three times the length of the body.

Opposite meaning depending on the following:
a. Occurs after extended move lower = Hammer, bullish, suggests market probing and hitting a bottom.
b. Occurs after extended move higher = Hanging Man, bearish, suggests market hitting a top.
In either case, higher or lower close unimportant.

Inverted Hammer - Bullish/Shooting Star - Bearish

Inverted Hammer

Inverted Hammer and Shooting Star share the same shape and are the inverted forms of the Hammer and Hanging Man shown above. It has a long upper wick, little or no lower wick two to three times the length of the body. As usual, needs to occur after a move higher or lower, needs the start of reversal to confirm the pattern.

Opposite meaning depending on the following:
a. Occurs after extended move lower = Inverted Hammer, bullish, suggests markets hitting bottom, confirmed by a bounce higher
b. Occurs after extended move higher = Shooting Star, bearish, suggests markets hitting a top, confirmed by bounce lower. 

In either case, higher or lower close unimportant though if it’s in the opposite direction of the prior candles, it’s a bit more suggestive of a halt or reversal of prior candles’ trend.

2. Notes on Double Candle Patterns

Bullish Engulfing

Bullish Engulfing

Bullish Engulfing occurs when a bearish candle (lower close) is followed by a noticeably longer bullish candle (higher close), which “engulfs” the range of the prior bearish candle. The longer the bullish candle, the more it “engulfs” or exceeds the range of the prior bearish candle, the more bullish the pattern. Obviously, as always, context and timing matter. The pattern is more bullish if this pair appears after an extended downtrend, at strong support, or both, because these other signs confirm that the odds are higher that the downtrend is exhausted. 

Bearish Engulfing

Bearish Engulfing

Bearish Engulfing occurs when a bullish candle (higher close) is followed by a noticeably longer bearish candle (lower close), which “engulfs” the range of the prior bullish candle The longer the bearish candle, the more it “engulfs” or exceeds the range of the prior bullish candle, the more bearish the pattern. Obviously, as always, context and timing matter. The pattern is more bearish if this pair appears after an extended uptrend, at strong resistance, or both, because the odds are higher that the uptrend has become exhausted. 

Tweezer Tops – Bearish

Tweezer Tops

Looks like a pair of tweezers at the top of an uptrend. Ideally: 

  • The first candle closes in the direction of the uptrend, the second closes down.
  • Upper wicks are longer than the bodies and should be about the same length and terminate around the same resistance (confirms resistance to further upward progress), hence the tweezers shape.


Think of these wicks as knocking against a ceiling of resistance, or the market rejecting a certain higher price as it probes for a top. 

Tweezer Bottoms – Bullish

Tweezer Bottoms

The opposite of the above. Looks like a pair of tweezers at the bottom of a downtrend. Ideally:

  • The first candle closes in the direction of the downtrend, the second close up.
  • Lower wicks are longer than the bodies and should be about the same length and terminate around the same resistance (confirming a floor preventing further downside), hence the tweezers shape. 


Think of these wicks as knocking against a floor or support, or the market rejecting a certain lower price, as it gropes for a bottom.

3. Notes on Triple Candle Patterns

Morning Star – Bullish/ Evening Star – Bearish

Morning Star

Evening Star and Morning Star are the bearish and bullish variations on the same theme:

  • The first candle is in the direction of the trend, ideally with a long body that suggests a strong final push that exhausts the move.
  • The second candle is a Doji, suggesting indecision and that the first candle was the last big push for the trend.
  • The third candle is in the opposite direction of the trend and should close beyond the midpoint of the first candle, preferably with a long body showing a decisive reversal move. 
     

Three White Soldiers – Bullish

Three White Soldier

This pattern is comprised of three long-bodied bullish (higher close) candles after a downtrend and signals a longer-term reversal higher.
To be a valid pattern: 

  • The second candle’s body should be longer than that of the first and should close near its high with little or no upper wick.
  • The third candle’s body should be the same size or larger than that of the second and also should close at or near its high with little or no upper wick. 
     

Three Black Crows – Bearish

Three Black Crows

The opposite of the above Three White Soldiers. This pattern is comprised of three long-bodied bearish (lower close) candles after an uptrend and signals a longer-term reversal lower.
To be a valid pattern: 

  • The second candle’s body should be longer than that of the first, and close near its low with little or no lower wick.
  • The third candle’s body should be the same size or larger than that of the second and also should close at or near its low with little or no lower wick. 
     

Three Inside Up – Bullish

Three Inside Up

Found during a downtrend and signals its possible end. Characterized by:

  • The first candle closes lower and has a relatively long body in the direction of the downtrend.
  • The second candle closes higher to about the midpoint of the first candle.
  • The third candle closes above the high of the first candle. In sum, this is a very basic bullish swing pattern. The longer the second and third candle, the more convincing the reversal signal. 
     

Three Inside Down – Bearish

Three Inside Down

The opposite of Three Inside Up. Found during an uptrend and signals its possible end. Characterized by: 

  • The first candle closes higher and has a relatively long body in the direction of the uptrend.
  • The second candle closes lower to about the midpoint of the first candle.
  • The third candle closes below the low of the first candle.
     

In sum, it’s a very basic bearish swing pattern. The longer the second and third candle, the more convincing the reversal signal.

More Key Points about Japanese Candle Patterns

Though the patterns are classified as a reversal (indicate a reversal of the trend’s direction), continuation (indicate trend continuation), or indecision, depending on which is their more common role, these are generalizations. Like any technical indicator, they don’t always work and should be used in combination with others that confirm or refute them.

The evidence from Technical Analysis is useful for timing entries and exits but is rarely unequivocal. It’s up to you to weigh contradictory or inconclusive forex signals from the total of your Technical Analysis and fundamental analysis and discern where the balance of evidence points. Your interpretation of these candlestick patterns and any other indicator depends on the context in which it occurs in the forex market and stock market.

Final notes about the Candlestick Patterns

As with everything, context and timing make a difference when interpreting Japanese candle patterns: A bullish reversal pattern (like a hammer or bullish engulfing pattern) is more suggestive of a bullish reversal pattern if it comes after an extended downtrend than it is after a brief one, especially if that brief one comes within a longer-term uptrend.

That same bullish reversal pattern will have more credibility if it happens to occur at a strong support level where we’d expect a downtrend to be more likely to reverse.

If the picture isn’t clear enough, look for another opportunity. Remember, some of the best trades you’ll ever make are the ones you decide not to take. Missed opportunities only hurt your ego; bad trades hurt your capital. Remember this if you want to learn how to trade forex and make money from it.

Understanding candle charts and candlestick patterns is important, but if you want some help, MT5 AM Broker offers a useful charting toolkit and our trainers can provide you the right guidance. Play around in a ​forex demo account and notice how candlestick patterns can make you serious money.

You can test the trade signals of candlestick patterns by creating Forex EAs in Robo-Advisor 007 (14 Days FREE Trial).

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