Candlestick Chart Patterns: 10 Key Formations
This article covers the information contained within a single candlestick's body and wicks, as well as the interpretation criteria and limitations of major patterns like the Hammer, Morning Star, and Long Black Candlestick.
Information Contained in a Single Candlestick
A candlestick chart represents the open, high, low, and close prices for a specific period using a single bar. If the closing price is higher than the opening price, it's a bullish candle (or 'up' candle); if lower, it's a bearish candle (or 'down' candle), and they are colored differently. In the Korean market, bullish candles are often red and bearish candles are blue, while in the US market, bullish candles are typically green and bearish candles are red. Therefore, one should not determine price movement solely by color.
The body represents the distance between the open and close prices, and the thin lines extending above and below are the wicks (or 'shadows'). For example, if the open is $100, the close is $108, the high is $110, and the low is $99, then the body spans 8 points from $100 to $108. The upper wick is 2 points from $108 to $110, and the lower wick is 1 point from $100 to $99. A longer body indicates stronger buying or selling pressure during that period.
Single Candlestick Patterns Formed by Wicks
A Hammer pattern has a lower wick that is at least twice as long as the body, with little to no upper wick. If the price opened at $100, dropped to $92 at one point, and then recovered to close at $99, it's interpreted as buying pressure overcoming intraday selling pressure. Its significance increases when it appears near the bottom of a downtrend.
Conversely, if there is a long upper wick and a short lower body, it's a Shooting Star, indicating that buying pressure failed to sustain the high at the end of an uptrend. If the body is almost non-existent, forming a cross shape, it's a Doji. A Doji, where the open and close prices are the same, suggests a tight balance between buying and selling, indicating a loss of momentum in the trend.
Reversal Signals Formed by Multiple Candlesticks
A Morning Star pattern consists of three candlesticks: first, a long bearish candle; second, a short candle with small wicks (sometimes accompanied by a gap); and third, a long bullish candle that recovers more than half of the first bearish candle's body. It depicts a transition at the end of a downtrend where selling pressure is exhausted, and buying pressure takes control. The inverted, mirror image of this pattern, appearing at the end of an uptrend, is an Evening Star.
An Engulfing pattern occurs when the body of the second candle completely covers the body of the first candle. If a small bearish candle is followed by a large bullish candle that completely engulfs its body, it's a Bullish Engulfing pattern, meaning buying pressure has overwhelmed the previous day's selling pressure. A Long Black Candlestick (or Marubozu) is a long bearish candle that moves in one direction from open to close, clearly showing a day of strong selling pressure.
Criteria for Interpreting Patterns in Practice
Patterns should be interpreted within the context of the trend and location, not in isolation. The same Hammer pattern, if it appears near a support level after a long downtrend, could signal a potential reversal. However, if it appears during an ongoing uptrend, its significance is weaker. Therefore, the reliability of candlestick patterns increases when combined with other tools like support and resistance levels or moving averages.
Volume should also be considered. If a Bullish Engulfing pattern appears with increased volume compared to usual, it suggests stronger buying conviction than the same pattern formed on low volume. Pattern confirmation is typically sought in the subsequent candle. For example, for a Morning Star, the signal is considered confirmed if the closing price rises further on the following day.
Pitfalls and Limitations
Candlestick patterns are probabilistic tendencies, not guarantees. It's common for a textbook-perfect Hammer pattern to appear, only for the price to continue falling the next day. Betting one's entire capital on a single pattern is risky; a stop-loss criterion, predetermined to limit potential losses, should always be used in conjunction.
It's also important to note that the same stock can display entirely different patterns depending on the timeframe. A Morning Star visible on a 5-minute chart might appear as just an ordinary bullish candle on a daily chart. Furthermore, for stocks with frequent after-hours trading or gaps, the meaning of open and close prices can be distorted, making pattern interpretation prone to error.
Key Takeaways
In summary, candlesticks use their bodies and wicks to illustrate the balance of power during a period. Patterns like the Hammer, Morning Star, Engulfing, and Long Black Candlestick are attempts to identify moments when this balance shifts or breaks down. The key is not the pattern itself, but the context in which it's read, considering trend, location, and volume.
The practical checklist is simple: First, what is the current trend and where is the price within it? Second, does the pattern align with support/resistance levels or moving averages? Third, is it supported by volume? Fourth, where is the stop-loss level if the pattern fails? This article is an educational resource explaining the principles of patterns and does not recommend buying or selling any specific stock.
Related reading
Get the app
Your watchlist and portfolio, one tap from your home screen — the Margin Call app