What You Need to Know About Candlestick Trading
Candlesticks should provide different visual cues that make understanding price action easier. Time frame trading with Japanese candlestick charts allows traders to better understand market sentiment. Thanks to Steve Nison, candlestick charts offer a greater depth of information than traditional bar charts.
On bar charts, highs and lows are emphasised more than anything else, while Japanese candlesticks put emphasis on the relationship between the open price and the close price.
Candlestick charting gives a detailed depiction of a price graph with almost a three-dimensional effect. What stands out most is that a chartist can see patterns more clearly and distinctly than with other types of charts.
Traders who use different candlestick patterns should identify different types of price action that tend to predict reversals or continuations of trends. Additionally, when we combine them with other technical analysis tools, we should get an accurate estimate of possible price movements.
Source: Nenad Kerkez
As we can see from the picture above, a price closing higher than where it opened will produce a white candle (bullish). A price closing lower than where it opened creates a black candle (bearish).
The boxes that are formed by price action are called the body. The extremes of the daily price movement, represented by lines extending from the body, are called the tail (wick or shadow). A small part of the candle that is left behind is called the nose.
A price closing where it opened, or very close to where it opened, is called a doji. Memorising Japanese candlestick names and descriptions of candlestick trading formations is not a prerequisite for successful trading. Nevertheless, it is helpful for every price action trader.
By looking at candlesticks, traders can see momentum, direction, now-moment buyers or sellers, and general market bias.
Source: EUR/USD H4 Chart, Admiral Markets Platform, Jun 26-Aug 4
How to Measure the Length of a Candle
The candle is a kind of measure from its high to its low. The high of the candle acts as resistance, while the low, as support. The bigger the candle, the stronger are the levels of support and resistance (especially during Master Candle Trading – see paragraph below).
Source: AUD/USD H1 Chart, Admiral Markets Platform, Aug 3-7
The window to your left – the data window – shows you the crucial candlestick data you need to know, including the high and low as well as the open and close price. This is default data in our MetaTrader4 platform.
Watch the video below (English only) to find out the basics about candlesticks and trends!
Three Main Components of Candlestick Charts
- Size/length of the whole candle;
- Correlation between open and close;
- Shadows and correlation to the body of the candle.
Size/Length of the Whole Candle
Candles that open at the low, close at the high, or candles that are extremely long, are also a common occurrence. If there is a long downtrend, such a candle indicates a major trend reversal is occurring.
On the contrary, after a long uptrend, if an unusually long candle closes that would show a long wick to the upside or a strong bearish body right from the top, then we are talking about exhaustion or blowoff-top condition. See the example below. The reversal candles are highlighted in blue.
Source: EURUSD H4 chart, Admiral Markets Platform, Feb 23- Apr 7
Correlation between the Open and the Close
As the coloured body of the candle represents either a negative or a positive reading, during uptrends or in bullish market conditions, buying will usually occur on the open. The price should rise, and a hollow, white candle is formed. As the bulls control the price action in the market, the length, or the distance, between the open and the close reflects their dominance.
In bearish market conditions, or during a strong downtrend, a dark body candle should form. This represents sellers entering the market on the open and dominating that particular time.
Candlestick charts allow for great analyses from the shape and colour of the body of the candle, in comparison with bar charts.
Shadows and Correlation to the Body of the Candle
The length of the wick that represent the price low and/or high, when comparing with the open and close prices shown in the real body of the candle, can illustrate the market's denial of a support or a resistance level.
If we see long tails, shadows, or wicks, as they are called, whether they form after a long downtrend, indicate a potential that the trend has exhausted itself and that demand is increasing or supply is dwindling.
If we have tails, shadows, or wicks formed at the tops of real bodies, especially after a long price rise, this indicates that demand is drying up and supply is increasing. The larger the shadow, the more important it is to analyse in relation to the real body, as this may signify the strength of the reversal. The strongest of those are pins.
Source: Nenad Kerkez
Bullish pin bar's tail is pinning down, rejecting support. Indicated by the bullish "pin", we see a surge of now-moment buyers, and, consequently, the price goes up.
Conversely, when bearish pin bar's tail is pinning up, rejecting resistance, we see a surge of now-moment sellers, and the price usually drops. Strongest reversal candles have wicks that are much longer than bodies, and a very small or no nose at all.
Source: GBP/JPY H4 Chart, Admiral Markets Platform, Feb 6-Mar 21
Strong Momentum Candles
Strong momentum candles, which usually open either at support or resistance, are called Marubozu candles. The Marubozu candle is a momentum candle with a very little or no tails or shadows. This type of candlestick patterns is really powerful and means a lot in regard to the price movement. Our professional analyst and trader Nenad Kerkez T has developed a special trading technique using only Marubozu candles.
Marubozu defines a strong selling off resistance or a strong buying off support. Marubozu means bald head or shaved head in Japanese. This is because such a candle does not have at least one shadow, or the shadow is very small. In modern market trading, Marubozu can also have a very small wick to both sides and still be considered valid. That is why the term momentum candle is used.
The White Marubozu appearing in an uptrend may suggest its continuation, while in a downtrend, a White Marubozu can signify a potential bullish reversal pattern. Here are some examples of White Marubozus (momentum).
Source: GBP/JPY H4 Chart, Admiral Markets Platform, Jun 1-Jun 27
Conversely, the Black Marubozu appearing in a downtrend may suggest its continuation, while in an uptrend, a Black Marubozu can signify a potential bearish reversal pattern. Here are some examples of Black Marubozus (momentum).
Source: GBP/JPY H4 Chart, Admiral Markets Platform, Mar 17-Apr 7
Watch the video below (English only) to see how Marubozu candlesticks are used in the practical naked trading method!
Common Candlestick Patterns
Common candlestick patterns show up very often in Forex, CFD, stock, and indices (equity) markets. Some of the most popular ones are :
- Shooting Star
- Hanging Man
- Piercing Line
- Bullish/Bearish Engulfing
- Dark Cloud
Source: GBP/USD H4 Chart, Admiral Markets Platform, Nov 10-Nov 22
The Hammer has a long lower shadow, usually twice the length of the real body. It is a bullish reversal candlestick pattern, usually appearing at the bottom of downtrends. The body can be either bullish or bearish, but it is considered to be stronger if it's bullish.
The Shooting Star
Source: GBP/USD H4 Chart, Admiral Markets Platform, Oct 31-Nov 10
The Shooting Star appears in uptrends, signifying a potential reversal. The wick is long, upside, and it is longer than the body. The body can be either bullish or bearish, but it is considered to be stronger if it's bearish.
The Hanging Man
Source: EUR/USD D1 Chart, Admiral Markets Platform, Sep 29, 2009 - Nov 22, 2009
This pattern is similar to the Hammer, but it occurs mainly at the top of uptrends and can act as a warning of a potential downward reversal.
The Piercing Line
Source: EUR/USD D1 Chart, Admiral Markets Platform, Oct 22, 2015 - Mar 2, 2016
This is a bullish reversal candlestick pattern. It is very common in Forex market. The pattern is characterised when the second bullish candle closes above the middle of the first bearish candle. The second candle's low is lower than the first candle's low. In Forex market pattern is valid even if the second candle's low equals to the first candle's low.
Bullish and Bearish Engulfing Candle
Bullish and bearish engulfing candle are reversal patterns whereas bullish usually occurs at the bottom of a downtrend while bearish engulfing is spotted at the top of an uptrend.
Bullish engulfing pattern is characterized by the two candles. The first one is contained within the real body of the second candle which is always bullish.
Bearish engulfing pattern is also characterized by the two candles. The first one is contained within the real body of the second candle which is always bearish. Here is the example of a bullish engulfer.
Source: EUR/USD H1 Chart, Admiral Markets Platform, Jul 10-Jul 14
An example of a bearish engulfer:
Source: GBP/USD H1 Chart, Admiral Markets Platform, Jun 28-Jul 4
The Dark Cloud Cover
Source: AUD/USD H1 Chart, Admiral Markets Platform, May 4-May 9
A bearish reversal pattern that shows in uptrends. It consists of two candles. The first one is bullish, and the second one, bearish. The Dark Cloud Cover is formed when the second candlestick opens above the high of the first candlestick, but then it drops and closes above the open price of the first candlestick. This pattern is the reverse of the Piercing Line. Similarly, in the Forex market, the Dark Cloud Cover is valid even when the second candlestick opens at the high of the first one. The important thing, however, is that the second candle in this pattern should close somewhere lower than the 50% mark of the first, bearish candle's real body.
Master Candle Concept
Source: AUDUSD H1 Chart, Admiral Markets Platform, July-Aug, Nenad Kerkez's Master Candle Indicator
The Master candle is a concept known to most price action traders. Originally presented on Forex Factory, it has been further developed by professional analyst and trader Nenad Kerkez to suit his own needs and trading decisions.
The Master candle is defined by a 30-150 pip candlestick that engulfs the next four candlesticks. The breakouts of the Master candle can be traded if the 5th, 6th, or 7th candlestick break the range in order for a breakout trade to become valid.
Source: GBP/USD H1, Admiral Markets Platform, Jan 13, 2015 - 20 Jan, 2015
Source: NZD/USD H1, Admiral Markets Platform, Jan 2-6
This concept is also used in his Live Trading Sessions (in English). It goes in a perfect synergy with the Admiral Pivot for profit taking and placing stop loss orders. It's a great candlestick pattern formation that you should definitely check on a regular basis.
Check out the video below (English only) for an explanation.
Another strategy that we present you with is based on candlestick patterns that we explained in the paragraph above and is suitable for all types of traders – intraday, swing, even scalpers who want to profit on short-term movements.
Candlestick Pattern Trading Strategy
Indicators: EMA 30,60,100 set on close
Entry signal: Candlestick pattern
Time frame: 4H
First, we need to set up the Exponential Moving Average to correspond to the general trend direction. We also need to install three EMAs on the chart. As shown in the example below, EMA 20 is blue, EMA 60 is red, and EMA 100 is green.
The strategy is pretty straightforward as we like to keep it simple. Three EMAs need to be aligned properly in order to show a trend. When the blue EMA is below the red and green EMA, the trend is bearish. When the blue one is above the red and green ones, the trend is bullish.
Source: GBP/JPY H4 Chart, Admiral Markets Platform, Sep 16, 2016 - Oct 28, 2016
Source: GBP/JPY H4 Chart, Admiral Markets Platform, Nov 9, 2016 - Dec 20, 2016
Please keep in mind that EMAs need to be aligned correctly in order to show the trend. If the EMAs are intertwining, it means that we don't actually have a trend.
Entries are made when the price makes a pullback towards EMAs. When we see a pullback, the next thing is a bullish or bearish candlestick, depending on the trend direction. Entries are made on any of the candlesticks we mentioned above.
- Shooting Star
- Hanging Man
- Piercing Line
- Bullish/Bearish Engulfing
- Dark Cloud
Stop-loss is placed 10 pips above the entry candle. For targets, we recommend using Admiral Pivot set on Weekly Timeframe.
Source: Admiral Markets MT4SE
Bearish Trade Example
Source: GBP/JPY H4 Chart, Admiral Markets Platform, Feb 16-Mar 30
Bullish Trade Example
Source: GBP/JPY H4 Chart, Admiral Markets Platform, Oct 20-Jan 12
Tip: It is always best to wait for a pullback to touch at least the blue EMA before making an entry decision.
Candlestick trading can be very profitable if your risk management is properly managed. Always practise on a Demo Trading Account first before going live!
Author and Webinar Host
Nenad Kerkez is a professional Forex and CFD trader and dedicated analyst. He's well known on numerous trading websites as Tarantula.