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Candlestick Patterns: Types, Components and Importance

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Are you planning to understand the stock market's vast seas without a map? That’s a bold strategy, but let’s give you something similar to a map: an understanding of candlestick patterns. Picture this: a world where red and green aren't just for traffic lights but signals that could either make or break your next stock market move.

Before you dive headfirst into this chapter, let’s get acquainted with the anatomy of these candlesticks - understanding their bodies, wicks, and colours is akin to learning the language of the markets. Now, buckle up because you’re about to learn one of the most important concepts in the stock market.

Anatomy of a Candlestick and Understanding Candlestick Components

Imagine a candlestick as a simple way to see how stock prices move. It has three main parts:

  1. The Body: This is the big part of the candlestick. It shows the range between where the stock price started and where it ended during a specific time. If the body is tall, it means there was a big change in price.
  2. The Wick: These are the thin lines above and below the body. They tell us the highest and lowest prices during that time. The upper wick shows how high the price went, and the lower wick shows how low it dropped.
  3. The Color: Candlesticks use colours to show if the stock price went up or down. Generally, green or white means the price went up, and red or black means it went down.

What These Parts Tell Us?

  1. Top and Bottom of the Body: The very top and bottom of the body show the starting and ending prices, depending on the candlestick's colour. For a green or white candlestick, the bottom is where it started, and the top is where it ended. For a red or black one, it's the opposite.
  2. Colours Matter: The colour of the body helps us quickly see if the stock price went up (green/white) or down (red/black) during that time.
    • Red or black candlestick: The colour of a candlestick indicates whether it was formed by a positive or negative trading day. If a stock's closing price is lower than its opening price during the day, the body of the candle becomes either red or black. In the case of a red candlestick, the top of the rectangle shows the opening price, and the bottom shows the closing price. 
    • Green or white candlestick: If a stock's closing price is higher than its opening price on the same day, the body of the candle becomes either white or green. A white candlestick is also called an Open candlestick, indicating that the price has increased. 

By looking at these three parts, you can get a quick idea of what's happening with a stock's price. This helps investors decide when to buy or sell.

Importance of Candlestick Patterns

Candlestick patterns are important indicators of market performance.  Let’s try to understand why candlestick patterns are important: 

  • Candlesticks give you a visual representation of how the prices of a stock are moving. Hence, it helps you uncover trends and figure out the support and resistance levels
  • These charts give investors the opening and closing prices, which helps them uncover price movements and aids investment decisions. 
  • Candlestick patterns are an important part of technical analysis. They are used in conjunction with several other technical indicators to give a snapshot of market trends.
  • These patterns act as market indicators regardless of the timeframe you choose. Hence, investors use candlestick patterns for both short—and long-term trading. 

Common Candlestick Patterns

Now that you know what a candlestick chart and pattern is, let’s have a look at some of the common candlestick patterns that you can spot during your day-to-day trading. 

Bullish Patterns

Bullish patterns can be witnessed when the market moves in a downward direction, resulting in a reversal of the upward price trend. Some candlestick patterns that show a bullish trend are as follows: 

  • Hammer: In this case, the candlestick has a short body with a long lower wick. It is usually spotted at the end of a downward trend. A hammer is an indicator of recovery—the market might have experienced selling pressure during the trading hours, but the prices have come up again, indicating a bullish trend. 
  • Inverse Hammer: Even an inverse hammer shows a bullish market trend. The only difference between an inverse hammer and a hammer is that the upper wick becomes long. It shows buying pressure followed by weak selling pressure, which could not bring the prices down. 
  • Bullish engulfing: This pattern involves two candlesticks. The first one is a short-bodied red candle, followed by a large-bodied candle. The red candle shows the stock opening at a lower price on the second day. However, the green candle indicates an upward movement of the price owing to the bullish market. 
  • Piercing Line: This pattern is also a two-stick pattern. It comprises a long red candle and a long green candle. While the candles are parallel, there is a gap between the red bar's closing price and the green bar’s opening price. The pattern results from strong buying pressure. 

Bearish Patterns

Bearish patterns are formed after an uptrend, showcasing resistance. Traders tend to close their long positions and enter into short positions to benefit from the falling prices. 

  • Hanging man: The hanging man resembles a hammer. However, it showcases the onset of a bullish market. You can spot a hanging man at the end of an upward trend. 

This candle is usually red in colour, showcasing a significant sell-off of stocks during the day. It is an indicator of bulls losing control of the market. 

  • Shooting star: The shooting star is shaped like the inverted hammer as can be spotted during an uptrend. This candlestick is usually red and has a small body with a long upward wick. 

It shows a potential downward direction of the market. In this case, the market opens at a higher price as compared to the day before and adjusts itself to fall like a shooting star. 

  • Bearish engulfing: You can spot this candlestick at the end of an uptrend. It comprises two candles - the first one is green in colour with a small body, followed by a longer red candle, showcasing a downward trend. 

It depicts a slowdown of prices after reaching a peak, indicating a bullish trend in the market. 

  • Evening star: The evening star consists of three candlesticks, with a short candle between a long red and a long green candlestick. It shows a reversal of an upward trend in the market. The third candlestick tends to impact the gains made through the first candle, leading to a downward trend. 

Bottom Line

You've now stepped into the world of candlestick patterns, holding the key to unlocking stock market secrets. Remember, mastering these patterns isn't just about knowing their names; it's about understanding their stories—what they tell you about market sentiment, potential turns, and opportunities.

As we venture into the next chapter, we'll dive deep into bullish candlestick patterns. These are your signals of optimism, where the market hints at climbing higher. Learning to read these patterns is like learning the language of growth in the stock market. So, gear up! You're about to get even closer to making informed, savvy investment decisions that could pave the way to your financial growth.

Stay curious, stay informed, and let's decode the signals of success together in the next chapter.

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