Master the art of reading candlestick charts - a practical guide for traders

Key Findings

Candlestick charts are one of the most popular tools in the arsenal of any market analyst. Candlestick formations such as hammer, harami, or hanging man allow for the identification of potential entry and exit points from positions. However, when choosing a trading strategy, it is also worth considering other parameters – volume, market sentiment, and available liquidity.

Foundations of Candlestick Analysis

Candlestick charts originate from 16th century Japan, where they were used to analyze rice prices. Today, they are an integral part of every cryptocurrency trader's arsenal. The structure of a single candle contains key information about market dynamics during a specific period – whether it be an hour, a day, or a week.

Each candle consists of a body ( representing the range between the opening and closing price ) and wicks ( that show the price extremes of the given period. The color of the candle – green for an increase, red for a decrease – immediately informs about the direction of the price movement. Several candles arranged in a specific sequence create candlestick formations that can signal a trend change, its continuation, or market players' indecision.

How to interpret candlestick charts?

A candlestick is a method of visualizing the price data of an asset ) whether it is a stock or cryptocurrency ( over a selected period. Its construction is simple: the body occupies the space between the opening and closing, while the wicks indicate the highest and lowest price reached in the given time window.

The green body indicates that the close was higher than the open. The red body tells us the opposite – selling pressure prevailed. The wicks ), also known as shadows (, show how intensely buyers or sellers tried to change the direction of price movement before the final close.

How to Analyze Candlestick Patterns – A Practical Approach

Candlestick formations do not operate in a vacuum. Each of them has its own interpretation, but practice shows that combining several indicators reduces the risk of error. Traders use them together with the Wyckoff method, Elliott wave theory, or indicators such as RSI, MACD, trend lines, or parabolic SAR.

It is also crucial to take into account support and resistance levels – places where historically higher supply or demand has changed the direction of movement. Candlestick formations observed near these levels have greater reliability.

Important disclaimer: candlestick formations are not signals to act on their own. They are an indicator that should be confirmed with other tools and always analyzed in a broader technical context.

Bullish formations – signals to watch for

) Hammer – a classic of the genre The hammer appears at the bottom of a downtrend and is characterized by a long lower wick at least twice the length of the body ###. This means that despite strong selling pressure, buyers managed to push the price back close to the opening point. A red hammer indicates weaker strength, while a green one indicates a strong buyer reaction.

( Inverted Hammer This formation is a mirror image of a regular hammer – the wick is located above the body. It also appears at the bottom of a downtrend and suggests that sellers are losing strength. The long upper wick shows that the price temporarily rose but ultimately fell close to the opening – a signal that the initiative is slowly shifting into the hands of buyers.

) Three white soldiers Three consecutive green candles, where each opens within the body of the previous one and closes above its maximum. The formation signals increasing strength of buyers. It performs better when the bodies are large, indicating the determination of buyers.

Bullish Harami

A long red candle, followed by a significantly smaller green candle that is completely contained within the previous one. This indicates the exhaustion of the downward momentum and a possible change in dynamics.

Bearish formations – warnings of change

The Hanged Man – threat after the increase

The Hanging Man is a bearish reversal pattern that appears after an uptrend. It has a small body and a long lower wick, indicating that after a sell-off, buyers temporarily regained the price, but the situation is unstable. This is a point where more sellers begin to enter – the start of uncertainty.

Falling star

A candle with a long upper wick, a small body close to the bottom, and little or no lower wick. It appears after an uptrend and signals that the market has reached a local peak, but sellers have taken control. Some traders wait for confirmation from the next candle before acting.

Three black crows

Three consecutive red candles opening within the body of the previous one and closing below its minimum. This is the symmetrical equivalent of three white soldiers – a signal of sustained selling pressure with no sign of weakening.

Bearish Harami

A long green candle, followed by a small red one completely engulfed by the previous one. It appears in an uptrend and indicates that buyers are losing momentum. This could be a signal to consider a downward trend.

Dark Cloud Curtain

A red candle that opens above the close of the previous green candle but closes below its midpoint. Particularly significant with high volume – indicates a change in the nature of the trend from bullish to bearish. Many are waiting for the third red candle as confirmation.

Engulfing Patterns – Trend Continuation

Bull Market

In an uptrend, three small red candles are then “engulfed” by a large green candle. This indicates that the bulls are taking control and the uptrend will continue.

Bear Market

Mirror image – bulls lose control and bears take over. It usually signals a continuation of declines.

Doji and its variations – turning point or balance?

A Doji forms when the opening and closing prices are at the same or very close level. The price may oscillate above and below, but ultimately returns to the starting point. It signals a point of indecision – the forces are in balance.

Tombstone

A candle with a long upper wick, opening and closing near the minimum. It heralds a downward breakthrough.

Dragonfly

Long lower wick, opening and closing near the top. In context, this could be a bullish signal.

Long-legged doji

Knots at both the top and bottom, opening and closing roughly in the middle. Indicates deep market uncertainty.

An ideal doji with the opening and closing at the same point is a rarity in volatile cryptocurrency markets. The term “spool” is commonly used for similar cases.

Price Gaps – Rarity in the Cryptocurrency Market

A gap appears when the opening comes above or below the previous close. In stock markets, gaps are significant formations, but in the crypto market, which operates 24/7 without session breaks, they are of little use. Moreover, they may only indicate low liquidity and wide spreads.

Practical trading principles using candlestick patterns

1. Build the foundations

Before you start relying on candlestick formations, master them deeply. Learn to read charts, recognize shapes, understand the psychology behind each formation. Risk without knowledge leads to losses.

2. Connect with other indicators

Candlestick patterns are just a part of the puzzle. Add moving averages, RSI, MACD, volume to that. Each additional indicator increases the confidence in the forecast.

3. Test on different time scales

If the formation appears on the daily chart, check how it looks on the hourly or 15-minute charts. Convergence of signals across multiple timeframes significantly increases the chances of a hit.

4. Always limit risk

Any formation may not work out. Set stop-loss orders, trade only in risk-to-reward ratios that make sense to you. Avoid overtrading and emotional decisions.

Summary

Knowing how to read candlestick charts is a skill worth mastering. Although candlestick formations are a useful tool, they are never foolproof. They are indicators that reflect the interplay between buyers and sellers – the forces that drive the markets.

The key to success is using them in combination with other analytical tools, proper risk management, and a deep understanding of the market. Candlestick patterns can provide valuable insights, but the ultimate responsibility for trading decisions always rests with you.