In the world of stock markets, everyone eyes for a strategy that can make them money. In this quest of finding a profitable strategy, people often end up exploring candlesticks and set of candlestick pattern. These elegant, yet highly informative patterns, have been used for centuries to predict market trends and make strategic decisions. For most beginner folks, candlestick pattern is synonymous to profits in their trading setup. Even several stock market free webinar tells that beginners should start their trading journey with candlestick patterns. Unfortunately, that is not the case as ever strategy comes with general fact that losses are inevitable. In this blog, we’ll try out very best to unravel the mystery behind candlestick pattern and show you how to harness its power for your trading journey.
The Basics of a candlestick pattern
Definition and Origin
Before we dive into the complexities of any candlestick pattern, let’s get back to the basics. As per best stock market courses, candlestick pattern is a visual representation of price movements for a certain duration, say 1 min, 1 hr, 1 day or even a month, etc. Each candlestick on a price chart tells a story about how the price has behaved in that period. When a certain number of candlesticks are analysed together, it’s a story that reveals a lot about the market sentiment. It is noteworthy that, candlesticks are thought to be discovered by Munehisa Homma, a Japanese rice trader.
Components of a Candlestick
To understand a candlestick pattern, one must understand what a candlestick is and what it is made up of. So, let’s dissect a candlestick into its constituents as you would learn in a stock market training institute.
Body: The rectangular area between the open and close prices. It is often coloured as green or red. The colour denotes that the asset or instrument has undergone price change on the upside or the downside recently in the period of formation of that candlestick. You may often find candlesticks with no body which are called Doji candles.
Wicks: The thin lines extending above and below the body, which represent the highest and lowest prices during the timeframe. These thin lines are often called as shadows. One might even find candlesticks without wicks which denote that the high and low are equivalent to open and close of the candlestick.
Bullish Candlestick: When a candlestick is referred to as bullish, it means that the price of the instrument has risen for that duration or is poised to rise. It is annotated in green colour.
Bearish Candlestick: When a candlestick is referred to as bearish, it means that the price of the instrument has fallen for that duration or is poised to fall. It is annotated in red colour.
<Image of a candlestick>
II. Types of Candlestick pattern: Since we have now understood what a candlestick is, lets understand different types of candlestick pattern, as you would in a stock market courses online free with certificate.
- Single Candlestick pattern: These patterns are formed by just one candle and can indicate potential reversals or continuations. Let’s discuss a few single candlestick patterns:
- Doji: To understand it better, a Doji candle signals a market indecision. This indecision is made because of almost equal buying and selling by people in the market. The reason this candlestick pattern is reflected with no body is due to open and close being same price.
- Hammer: A Hammer pattern suggests a potential reversal in a trend, as it has a long wick on one end and no wick on the other side with a very small body. It is noteworthy that the colour of the body of the hammer doesn’t matter. This candlestick pattern is further classified into two types: Hammer and Inverted Hammer. While a hammer denotes bullishness, inverted hammer candlestick pattern formation signifies bearishness.
- Shooting Star: A shooting star is a bearish candlestick pattern that indicates a potential reversal in a market’s upward trend. This candlestick pattern has a small real body (the difference between the open and close prices) near the bottom of the candlestick, with a long upper shadow (the difference between the high price and the real body) that’s at least twice as long as the real body. The lower shadow, if present, is usually very short or nonexistent. It signifies a failed attempt by buyers to push the price higher but by the end of the session, sellers prevailed, closing it near or even below the opening price. This reversal in price action from bullish to bearish often signals a potential trend reversal. It is very important to note that Inverted hammer and shooting star patterns are not the same.
- Multiple Candlestick Pattern: These are formed by a combination of two or more candlesticks and are often used for more significant trend reversals or continuations. A few classic examples of multiple candlestick patterns are Engulfing (Bullish and Bearish) pattern, Harami (Bullish and Bearish) patterns. <Link them to respective blogs>
- Continuation Patterns: These patterns indicate that the current trend is likely to continue. Example of these patterns include Rising Three Methods and Falling Three Methods. For instance, the Rising Three Methods pattern suggests that an uptrend is poised to persist. On the other hand, Falling Three Methods pattern suggests that the downtrend would persist.
Interpreting Candlestick pattern
- Bullish vs. Bearish Signals: After identifying candlestick patterns, people, especially beginners often get troubled in reading these patterns to make informed decisions. Even To solve this dilemma, here are some key pointers, as coached in best stock market courses in Delhi:
- Bullish vs. Bearish Signals: A bullish candlestick pattern suggests upward price movement, while a bearish one indicates the opposite. To locate a candlestick pattern, one must locate a trend first as these patterns indicate a trend reversal. For example, a Hanging Man is a bearish pattern often seen at the end of an uptrend. Similarly, a bullish engulfing pattern appears at the culmination of a downtrend.
- Pattern Strength: The size of the candlesticks and the volume traded during the pattern’s formation can give clues about the pattern’s strength. Larger candlesticks and higher volumes typically indicate stronger signals. Experienced traders only prefer trades in which patterns are supported by volume and candles are fairly sized.
Common Candlestick pattern Strategies
Now that you understand the basics of candlestick pattern and how to locate them, let’s talk about practical application about how you can apply them to trades.
Swing Trading: Swing traders often use candlestick patterns to identify potential entry and exit points for short to medium-term trades. For example, they might look for Bullish Engulfing patterns on 1 or 4 hr, or 1 Day timeframe chart to take a long position for around 1 week or lesser.
Day Trading: Day traders rely on the quick insights offered by a candlestick pattern along with a strategy like price action or support resistance to make rapid decisions within a single trading day. In Intraday, experienced traders don’t solely rely on candlestick patterns. For example, an evening star pattern formed at support would indicate that the price might further crack down and thus a short trade could be executed.
Long-Term Investing: Even long-term investors can benefit from candlestick patterns if their investment horizon is less than a year. For instance, spotting a Bullish Engulfing candlestick pattern on a monthly chart might confirm an uptrend for an investor. Although for a long-term investor who’s looking to invest for more than a year and utilise the power of compounding, any candlestick pattern on any chart timeframe is not of much use.
Candlestick pattern in Different Markets
While many people would argue that candlestick pattern strategy would be effective only in stocks, as per our opinion, it is valid in all segments. The reasoning behind this opinion is simple- candlestick pattern is a type of technical analysis strategy and to identify a short-term trend, technical analysis is carried out. Although it is very important to understand that these pattens are not enough to initiate a trade. Therefore, the scope of candlestick patterns is not reserved to stocks, but is expanded to derivatives, index, forex and even cryptocurrency (which aren’t manipulated) too!
Candlestick pattern and Risk Management
A. Setting Stop Loss and Take Profit Levels: Just like any technical strategy, traders must incorporate stop loss into any candlestick pattern. Beginners often get overwhelmed by learning this strategy, that they often miss out on this crucial aspect and suffer big losses. It is a harsh reality that no trading strategy, including candlestick pattern is 100% accurate and will generate profit every time one takes a trade. As per the nature of this strategy, the SL to be put alongside it would be static in nature and not dynamic. Also, trailing profits in this candlestick pattern becomes difficult due to it signifying a relatively short-term sentiment. Thus, if the target hits, one must exit from the trade.
B. Position Sizing: Like any trading strategy, while trading with any candlestick pattern, it is important to note that one must never deploy all their capital in one single trade. If the trade goes the other side, a significant dent would be laid on the capital. Any experienced trader would risk 2-5% of their trading capital in a candlestick pattern trade. Even if the strategy is applied to the blue-chip stocks or even the best penny stocks,proper risk management is quintessential.
C. Instrument Selection: It is extremely crucial to understand that this strategy could not be applied to every stock, you come across. For trading with this strategy, you need to follow the following criteria for stock selection.
- Market Capitalisation of the stock > Rs 3000 Cr
- Price > Rs 100 (preferably)
- ATR on Daily Chart > 10
- No corporate actions within 2-3 days of emerging of buy signal.
- Should not be in circuits for past 3 months.
Candlestick patterns are synonymous to the ancient hieroglyphs of financial markets. Learning to decipher them can open a world of countless trading opportunities. However, one must remember that no tool guarantees success in the market. Losses are inevitable and one can’t afford to miss out on placing Stop loss. A skilled and experienced trader will always look to combine candlestick pattern analysis with other forms of technical analysis to make well-informed decisions and initiate trades.
If you’re someone who is intrigued by candlestick patterns, we recommend you dive deeper, practice, and refine your skills in candlestick pattern trading. The journey of mastering these patterns is challenging, but the rewards can be substantial as it has the potential to turn the strategy into a trading setup as students do in stock market institute near me.
To learn more about candlestick pattern, one could refer to sources such as Investopedia, Varsity by Zerodha or even top 5 Online Stock Market Courses in India.