Tradings of cryptocurrencies or other financial assets need to nail the basics of reading price charts. One way to do so is by educating oneself on the topic of candlestick charts. A price chart contains a lot of information, yet candlesticks make it easier to digest the details.
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Why A Candlestick Chart Matters
Traditionally, opening a price chart presents traders with a clear line and some minor information. While useful, it only tells a part of the bigger story. You can gauge a lot of information from switching the chart layout to a candlestick. Doing so makes it easier to measure the current market sentiment and analyze previous market trends.
The candlestick chart’s main selling point is how it depicts price movements for an asset within a specific timeframe. It is not unique to candlesticks alone, but they often distinguish between a bull market, the bear market, sideways trading, and the identification of swing trading possibilities. Its colors also help determine what is going on and where the market may head next.
Historically, candlestick charts have been in use for decades. Were it not for Japanese rice trader Homma; the concept may not be in use today. Although Homma never intended for candlesticks to serve as a cryptocurrency trading tool, his ideas have proven versatile. Thanks to further refinement by Charles Dow, a candlestick chart is now a crucial tool in any trader’s arsenal.
The Candlestick Chart Is Your Friend
As the name suggests, a candlestick consists of multiple parts.
- Body: the “chunky part” of the candle depicting one’s preferred time interval
- A wick: either on the top, bottom, or both sides of the candle’s body. A wick depicts a value which the asset has hit in that time frame. However, due to insufficient buying or selling support, traders could not sustain that level for long.
Known as the OHLC values, the wicks and body all have their meaning to traders. It represents an asset’s Open, High, Low, and Close values for that specific timeframe.
If the gap between the open and close is significant, the candle’s “body” will be quite substantial. However, there may be a very tiny body and two large wicks on either end. In the next section, we will discuss how to interpret this information best.
Analyzing these data points correctly will help traders determine where the market may be heading shortly. This pattern creates the candle, either green (bullish) or red (bearish).
Reading The Candlestick Chart
Even though a candlestick chart is – in general – more comfortable to read than bar charts or line charts, it still has a bit of a learning curve. While the candlestick depicts the price action in a more digestible format, one still needs to understand what the individual candles mean before entering a market.
With the candle’s pattern in mind, the body and wick vividly depict the ongoing battle for control between bulls and bears.
Suppose the candle’s body is relatively long. In that case, it confirms more trading volume for the asset during that time frame, resulting in bullish or bearish momentum.
How bullish or bearish the market is can be gauged from looking at the candle’s wick. Shorter wicks mean that the preferred time frame’s high or low value was near the closing price for that timeframe.
The Common Candlestick Patterns
Traders will often use indicators to look for specific patterns on a candlestick chart. The reliability factor of these patterns and trends is not 100%. As candlestick patterns are gaining popularity, they also become less reliable over time. Even hedge fund managers leverage this technique to analyze financial markets, turning this approach into a race against the clock.
A Three Line Strike
Analysts looking for a bullish trend will often try and identify a three-line strike reversal pattern. It materialises when a bearish trend is in place, and three consecutive red candles are formed. Every candle posts a lower low, and the third one will be engulfed by a large bullish candle afterward. This fourth bar must close above the first bar’s high point. Otherwise, it will not count.
Assuming this pattern occurs, there is still just a 83% accuracy rate to contend with. Not an ideal situation, but it is to be expected when exploring financial markets.
Three Black Crows
As the name indicates, this is another bearish pattern to look for. When three bearish candles form as a reversal pattern, it will start near the high of an ongoing uptrend. Every bearish bar posts a lower low, indicating the bearish trend will continue.
In some cases, the Three Black Crows pattern will signal the beginning of a steep downtrend. More specifically, it does so at an accuracy rate of 78%. Again, not perfect, but it is still better than guessing.
When it comes to candlestick chart patterns, the Evening Star is one to watch out for. It signals a bearish market reversal despite the chart depicting a substantial bullish candle. While the market tries to maintain the momentum, a small bearish candle will ensue.
In most cases, this minor bearish candle is followed by a more significant bearish candle. It may not break the uptrend fully but will often lead to a price retracement. With an accuracy rate of 72%, the Evening Star candlestick pattern is worth exploring.
The name of this candlestick chart pattern will not go over too well with a lot of people. Even so, it can make traders money half of the time. It is a bullish pattern depicting the end of an ongoing downtrend. For this to materialize, there need to be multiple bearish candles going lower and lower. However, the trend is running out of steam and trading volume.
A little bearish candle with two long wicks and a small body will become apparent before the reversal happens. If there is a higher high on the second chart following this “baby”, the reversal is confirmed and likely to continue for a while.
Two Black Gapping
The final prominent pattern on the list is 68% accurate and goes by the name of Two Black Gapping. It requires a bearish continuation pattern to appear after a solid top completing the bull trend. If two solid bearish bars with lower lows are created, one may witness Two Black Gapping in action.
The big question is whether this confirms the downtrend will continue to lower lows. It happens in two-thirds of the cases, and a proper analysis seems warranted.
It’s Not A Perfect Solution
Like other trading tools, indicators, and patterns, a candlestick chart is not the only tool to use. Instead, traders often use candlestick charts in conjunction with a set of other tools. A candlestick chart only tells a few things for that market but leaves out any further details.
Traders who want to perform a comprehensive analysis of the market – something everyone should do – will need to dive deeper into a price chart. A candlestick doesn’t explain what happened during the timeframe’s open and close price. Instead, it shows how the timeframe ended, but that is only part of the bigger story.
Knowing how the action unfolded on an hourly or daily candlestick is crucial. With those details, traders can determine if the same pattern may repeat itself or whether the market is ready to go in a different direction.
Thankfully, there is a way to get a bit more information out of a candlestick chart by switching to a slightly different “template.”
The Power Of Heikin-Ashi
Fans of candlestick charts will be familiar with the Heikin-Ashi layout. It is a trading “technique” that depicts the ‘average bar’ which smoothes out price action and removes some of the “noise” generated by the market during the timeframe. Not only will this make it easier to interpret data, but it also aids in analyzing trends, patterns, and swing trading points.
As is the case with any price chart, traders need to avoid falling for false price signals. Volatile markets, such as cryptocurrencies, will often give off these fake signals, depending on which candlestick pattern one uses.
Analyzing a Heikin-Ashi chart is still the same as the traditional layout:
- A green candle with no lower wicks often signals a bullish trend
- A red candle with no upper wick indicates a bearish trend
Despite the improvements Heikin-Ashi offers over traditional candlesticks, it remains a limited tool. Traders may need to adjust their charts to identify patterns and trends correctly. It is a tool to be used alongside other indicators.
Both novice and experienced traders can benefit from the candlestick chart layout. Whether one prefers the Heikin-Ashi approach or the traditional one, either method is valid to analyze a market. Many traders consider candlesticks a fundamental tool in their arsenal and use them accordingly.
Despite the prowess of a candlestick chart, you cannot use it without other tools and indicators. Candlesticks are a tool for analyzing markets but not an indicator for making trades without conducting further analysis.