Candlestick Analysis in Forex Trading
A Candlestick is a type of price chart in the forex trade that is used to display the changing prices of a security of a particular period; the price could be high or low or whether the price is open or closed. This price chart assists investors in determining the best period to enter or exit trades.
Candlestick charts, therefore, are used to pack data for numerous time frames into a single price bar. Accomplishing this yields a prediction of the direction taken by the price of the security, therefore, giving the trader a chance to make a sound decision that will yield profit. Understanding the concept of candlesticks charts is a good method of understanding the general analysis of the forex trade market.
Basics of a Candlestick
The candlestick can be structured to a rectangular shape with two lines protruding from its northern and southern direction. The rectangle which is the wide part of the candlestick is commonly referred to as the real body. The real body is used to inform the trader whether the closing price at the end of the trading period was higher or lower than that of the opening price.
Black or red shading on the body indicates that the stock closed lower than the opening price while a white or green color indicates an increase in security price as compared to the opening price.
The candlestick’s lines are referred to as shades show the highs and lows of the security price for the period stated in comparison to the opening and closing price of that security.
There are three main patterns to be considered when using candlestick charts to analyze the foreign market. These patterns assist in the analysis of the market’s price action and make predictions about the immediate directional changes of the security price.
A point to note is that there are two expected pattern outcomes of the price action; either reversal or a continuation. A candlestick reversal pattern is used to predict a change in the price direction while a continuation pattern is used to predict an extension from the current path of the security price.
1. Single Candlestick pattern
This pattern is formed using one candlestick thus the trading pattern is generated based on the trading action of a single day. Therefore deeper analysis is utilized on the length of the candle as the length signifies the trading day.
The different forms of single candlestick patterns are:
· Doji Patterns
This formation is easily identified as it is observed whenever the closing price of a security is at the same point as the opening price. The Doji is thus related to a dash with a wick or just a dash in case there is no price change.
The Doji has a reversal outcome when it is formed; the reason behind this is that during a bullish or bearish market, the outcome of the Doji reveals that the bull market is losing their influence while the bear market is gaining its power. A bull market entails the price of the security rising while a bear market is a falling price trend.
· Spinning Tops
This candle is characterized by incorporating a small body and a longer upper and lower wick; the wicks, however, are of the same size. The shape indicates that both buyers and sellers are in stiff competition with neither party dominating the other.
However, in a market structure, the candle can be observed on either a downtrend or rising price change. In case of a falling price trend, the sellers are losing the fight while in an upward trend the sellers are gaining dominance over the buyers.
· Marubozu Pattern
This candlestick is characterized by having a body with no trace of the wick; this implies that it is a continuation pattern trend. Suppose the candle is a bull market trend then it means the uptrend is high enough so that the price will continue increasing and never reach the opening of the bar.
· Hammer and Hanging Man Pattern
Both patterns are characterized by having small bodies with a small upper wick but a long lower wick. They are both classified under the reversal pattern. The only distinct difference between the two patterns is that the hammer pattern describes the reversal nature of the bear market trend while the hanging man describes that of the bull market trend.
· Inverted Hammer and Shooting Star
Both patterns are the inverse of the hammer and hanging man patterns. They have small bodies with a small lower wick but a long upper wick. They are also classified under the reversal pattern where the inverted hammer describes the bear market trend while the shooting star represents the end of a bull market trend.
2. Double Candlestick Patterns
As the name suggests this pattern is generated using a pair of candlesticks. There are two distinct types namely Bullish and bearing Engulfing patterns and the tweezer tops and bottoms patterns.
· Bullish and Bearing Engulfing patterns
The Bullish engulfing pattern is a double bar type of candlestick formation in which a bigger bull candle is formed after a bear candle is observed.
The Bearish engulfing pattern is also a double bar candlestick formation that consists of a bull market candle being observed to be followed by a bigger bearish candle. They are characterized as reversal patterns trends.
In both patterns, the latter candle is analyzed to be engulfing the body of the former. Using this analysis it implies that a bullish engulfing pattern reveals a reversal of a bear market trend while a bearish engulfing pattern relates to the reversal of a bull market trend.
· Tweezer Tops and Bottoms Patterns
The Tweezer tops entail a bullish candle that is followed by a bear candle; both candles are characterized by having small bodies and no lower wick. The two candles have similar parameters.
The tweezer Bottoms, however, entail a bearish candle that is followed by a bull candle. The two candles are characterized by having small bodies but no upper wick.
Both patterns are classified as reversal pattern trends; the main difference of the two is that Tweezer Tops signify a reversal of a bull market trend to a bear market trend while tweezer bottoms are observed at the end and warn of a bullish reversal.
3. Triple candlestick patterns
· Morning Star and Evening Star
The Morning star entails a bear candle that is followed by a small bear or bull candlestick which is lastly followed by a bull candlestick that is larger than half the first candlestick.
The Evening Star Candle pattern starts with a bullish candle that is followed by a small bear or bull candlestick and lastly followed by bear candlestick that is larger than half the first candlestick.
Both of these patterns have reversal pattern trends; the morning star indicates the end of a bear market trend while the evening star implies the end of a bullish trend.
· Three Soldiers Candlestick patterns
This pattern is characterized as a reversal trend; it could either be a bull or bear trend.
The Three Bull Soldier consists of three bull candlesticks arranged in a row. It is characterized by ending a bear trend and initiating a new bull trend. The three candles are:
- A smaller Bull candle.
- A big bull candle that closes near its highest point.
- A bigger bull candle that has a small wick.
The three bear soldier will also have three bear candlesticks arranged in a row. It is characterized by ending a bull trend and initiating a new bear trend. The three candles are:
- A smaller Bear candle.
- A big bear candle that closes near its lowest point.
- A bigger bear candle that has a small wick.
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Candlesticks are intricate aspects that are used to analyze market patterns of the forex trade. They will display both high and low as well as the opening and closing prices of a security. The opening and closing prices are reflected on the body while the highest and lowest price is indicated on the wicks.
The trader ought to know the different pattern types namely single, double and triple candlestick patterns with an in-depth analysis of their characteristics. All these patterns are either classified to continuation or reversal patterns; reversal patterns are the most common candle patterns that are used.