Candlestick Patterns for Trading
Understanding Candlesticks
Candlesticks are the foundation of price action analysis. Each candlestick shows the open, high, low, and close (OHLC) for a specific timeframe. A bullish candle (usually white or green) closes higher than it opened, showing buyers had control. A bearish candle (usually black or red) closes lower than it opened, showing sellers had control. The body size indicates conviction, while wicks show price rejection.
The High-Probability Pin Bar Pattern
A pin bar is a candlestick with a long wick on one end and a small body on the other. The long wick shows price rejection at an extreme level - smart money tested stops and then reversed. Pin bars at support in uptrends or resistance in downtrends are high-probability reversal signals. Trading pin bars with confluence (at key support/resistance) dramatically improves win rates.
Pin Bar Entry: When a pin bar forms at support in an uptrend, wait for the next candle to close above the pin bar's body, then buy. Stop losses go below the pin bar's low. This gives you defined risk with high probability.
Engulfing Patterns
An engulfing pattern consists of two candlesticks where the second completely covers the range of the first. A bullish engulfing pattern (small down candle followed by large up candle) shows buyers overwhelming the previous selling. A bearish engulfing pattern (small up candle followed by large down candle) shows sellers overwhelming the previous buying. These patterns indicate a shift in power and potential reversal.
Hammer and Hanging Man
A hammer appears at the bottom of downtrends. It has a small body with a long lower wick, showing sellers couldn't sustain the selling pressure. Buyers fought back, creating the rejection wick. A hanging man appears at the top of uptrends and has the same shape, but signals a potential reversal downward because it shows sellers pushing price lower despite the uptrend.
Inside Bar Pattern
An inside bar forms when a candle's range (high to low) is completely contained within the previous candle's range. Inside bars show consolidation - neither buyers nor sellers have conviction. When price eventually breaks out of the inside bar range, it often accelerates in that direction. Professional traders enter on the breakout of the inside bar with tight stops.
Three-Line Strike Pattern
Three consecutive bearish candles followed by one large bullish candle that closes above all three (three-line strike) signals a bullish reversal. Similarly, three bullish candles followed by one large bearish candle signals a bearish reversal. This pattern shows institutional strength overcoming previous selling or buying pressure.
Harami Pattern
A harami forms when a large candle is followed by a small candle that's completely contained within the large candle's range. This signals hesitation and potential reversal. The large candle shows strong directional conviction, but the small candle shows that conviction is fading. The next candle's direction determines the reversal.
Using Volume with Candlestick Patterns
Candlestick patterns are much stronger when accompanied by high volume. A pin bar with high volume on the wick rejection is more reliable than one with low volume. Engulfing patterns on high volume show strong institutional participation. Always check volume bars below candlestick patterns - high volume confirms the pattern's validity.
Pattern Validity Rules: 1) Pattern must form at support/resistance. 2) Volume must confirm. 3) Pattern must be in direction of major trend (unless reversal pattern). 4) Stop loss should be below/above the pattern (depending on direction).
Avoiding False Patterns
Not all patterns trade the same way. Patterns at support in uptrends are more reliable than patterns at random levels. Patterns that form at moving averages or previous swing points are more reliable. Always qualify patterns with confluence - the more confluence factors present, the higher the probability of success.
Practical Application
- Study candlestick patterns for 2 weeks on daily charts
- Only trade patterns at key support/resistance levels
- Confirm patterns with high volume
- Trade patterns in the direction of the major trend
- Use tight stops below/above the pattern
- Aim for 1:2 or 1:3 risk to reward ratio
Conclusion
Candlestick patterns are a powerful tool when used correctly. By understanding what each pattern represents (institutional rejection, consolidation, or reversal), you can identify high-probability trading opportunities. Combine patterns with support/resistance levels, volume confirmation, and trend analysis for maximum success.