Candlestick Formations

1. Candlestick Formations

Candlestick formations are a visual representation of price movements over a specific period, used extensively in Technical Analysis to predict future price direction. They originated in 18th-century Japan, used by rice traders to track market sentiment and are now a cornerstone of modern financial markets, including Binary Options trading. This article provides a comprehensive guide to understanding candlestick formations for beginners.

Understanding the Anatomy of a Candlestick

Each candlestick represents the price action for a defined timeframe – a minute, hour, day, week, or month. A single candlestick conveys four crucial pieces of information:

Open Price: The price at which the asset began trading during the period.
High Price: The highest price reached during the period.
Low Price: The lowest price reached during the period.
Close Price: The price at which the asset finished trading during the period.

The “body” of the candlestick represents the range between the open and close prices. The “wicks” or “shadows” extend above and below the body, showing the high and low prices for the period.

Bullish Candlestick: If the close price is *higher* than the open price, the body is typically colored white or green. This indicates buying pressure.
Bearish Candlestick: If the close price is *lower* than the open price, the body is typically colored black or red. This indicates selling pressure.

A long body indicates strong buying or selling pressure, while a short body suggests indecision or consolidation. Similarly, long wicks suggest significant price volatility during the period, while short wicks indicate less volatility.

Single Candlestick Patterns

Before delving into formations (multiple candlesticks), it's essential to understand individual candlestick patterns:

Doji: A Doji candlestick has a very small body, indicating that the open and close prices are nearly identical. This signifies indecision in the market. Several types of Doji exist, including the Long-Legged Doji, Dragonfly Doji, and Gravestone Doji, each with slightly different implications. It often indicates a potential Trend Reversal.
Hammer: A bullish reversal pattern found at the bottom of a downtrend. It has a small body at the upper end of the trading range and a long lower wick (at least twice the length of the body). It suggests that sellers initially drove the price down, but buyers stepped in and pushed it back up. Used in conjunction with Support and Resistance levels.
Hanging Man: Looks identical to the Hammer but appears at the *top* of an uptrend. It’s a bearish reversal pattern, suggesting that sellers are starting to gain control.
Inverted Hammer: A bullish reversal pattern with a small body at the lower end of the trading range and a long upper wick. Indicates potential buying pressure.
Shooting Star: Looks like an Inverted Hammer but appears at the *top* of an uptrend. A bearish reversal pattern.
Marubozu: A strong bullish or bearish candlestick with a long body and no wicks, indicating decisive buying or selling pressure. A bullish Marubozu closes at the high, while a bearish Marubozu closes at the low.

Two-Candlestick Patterns

These patterns involve the interpretation of two consecutive candlesticks.

Piercing Line: A bullish reversal pattern. The first candlestick is bearish, followed by a bullish candlestick that opens lower than the previous close but closes more than halfway up the body of the previous candlestick.
Dark Cloud Cover: A bearish reversal pattern. The first candlestick is bullish, followed by a bearish candlestick that opens higher than the previous close but closes more than halfway down the body of the previous candlestick.
Engulfing Pattern: A powerful reversal pattern. A bullish engulfing pattern occurs when a bullish candlestick completely "engulfs" the previous bearish candlestick. A bearish engulfing pattern is the opposite – a bearish candlestick engulfs the previous bullish candlestick. This is a strong indication of a potential shift in Market Sentiment.

Three-Candlestick Patterns

These patterns require analyzing three consecutive candlesticks.

Morning Star: A bullish reversal pattern. It begins with a bearish candlestick, followed by a small-bodied candlestick (a Doji or Spinning Top) representing indecision, and then a bullish candlestick that closes well into the body of the first bearish candlestick.
Evening Star: A bearish reversal pattern, the opposite of the Morning Star. It begins with a bullish candlestick, followed by a small-bodied candlestick, and then a bearish candlestick that closes well into the body of the first bullish candlestick.
Three White Soldiers: A bullish pattern consisting of three consecutive long bullish candlesticks, each closing higher than the previous one. Indicates strong buying pressure and a potential uptrend. Requires confirmation with Trading Volume.
Three Black Crows: A bearish pattern consisting of three consecutive long bearish candlesticks, each closing lower than the previous one. Indicates strong selling pressure and a potential downtrend.

Multi-Candlestick Patterns & Advanced Formations

Beyond three-candlestick patterns, more complex formations exist:

Rising Three Methods: A bullish continuation pattern. A long bullish candlestick is followed by three smaller bearish candlesticks that trade within the range of the first candlestick. The pattern is confirmed by a subsequent bullish candlestick that breaks above the high of the first candlestick.
Falling Three Methods: A bearish continuation pattern, the opposite of the Rising Three Methods.
Triangles (Ascending, Descending, Symmetrical): While not strictly candlestick patterns, these are often identified *using* candlestick analysis within the triangle formation. They indicate consolidation before a breakout. Chart Patterns are vital for spotting these.
Head and Shoulders & Inverse Head and Shoulders: Similar to triangles, these patterns utilize candlestick interpretation to confirm the formation and potential breakout direction. They are considered reliable Reversal Patterns.