Trading With Candlestick Patterns

6 min readJun 5, 2024

Step into a realm where ancient wisdom meets modern technology, where red and green candlestick patterns guide traders through the dynamic volatile landscape of the futures markets. Developed in the rice markets of 18th century Japan, these patterns are more than just colorful boxes — they provide a narrative of market emotions, helping traders identify bullish and bearish pullbacks and reversals.

Japanese candlesticks are a popular charting style that allows traders to analyze the price action for any trading market, providing valuable insights into price movements, market reversals, and short-term sentiment. While the candlestick charts use the same data as a basic OHLC bar, candlesticks provide a clearer visual way to identify price direction.

Candlestick Basics

Just like a standard bar chart, each candlestick represents a specific time period or interval, like five-minute, 30-minute, daily, or weekly bars. Each candlestick bar consists of a body and up to two wicks. The body of the candlestick represents the price range between the open and close prices for that period. When the close price is higher than the open price, the body is colored green, indicating a bullish move. When the close is lower than the open, the body is colored red and is said to be a bearish candle. (Figure-1)

The thin lines (wicks) extend from the top and bottom of the body, indicating the highest and lowest prices reached during the bar. When that candle’s high or low equals either the open or close, a wick may not be present. The upper wick often indicates that sellers have rejected the high price set by buyers, and the lower wick often indicates that buyers have rejected the low price set by sellers.

Figure 1: Basic Candlestick chart construction

What Are Candlestick Patterns?

Combinations of one or more candlesticks form unique patterns that can provide insights into potential future price movements. These patterns are repeatable behaviors, based on the premise that traders will respond to certain trading environments in the same way over and over again.

Candlestick patterns can be grouped by the number of candles in the pattern — one-candle, two-candle, and three-or-more candle patterns — and generally provide both a bullish and bearish indication.

The Doji

The most common one-candle pattern is the doji. A doji occurs when the open and close prices on a single bar are equal or very close to the same price, resulting in a very small or no-candle body. A doji is considered a neutral candle, as neither buyers nor sellers can move the price in a particular direction. (Figure-2)

Figure 2: Doji candlestick pattern

Engulfing Candles

Engulfing candle patterns are similar to outside bar patterns and serve as a visual alert for potential market reversals. In a bullish engulfing pattern, a large body green candle completely engulfs a smaller red body candle, suggesting buyers are outpacing sellers. Conversely, a bearish engulfing pattern features a larger red body candle engulfing a smaller green bodied one, signaling sellers are in control. (Figure-3)

These patterns can be especially significant when they appear after a sustained up or down trend, as this may indicate a reversal or shift in market sentiment.

Figure 3: Bullish and bearish engulfing patterns

Harami Candle Patterns

The Harami candle pattern is similar to an inside bar pattern and is also seen as a signal for a potential reversal in market direction. The word “Harami” itself is derived from an old Japanese term meaning “pregnant,” which vividly describes the pattern: a small candle (the “baby”) is nestled within the range of a larger preceding candle (the “mother”).

A bullish Harami occurs in a downtrend, with a small green candle following a large red candle, hinting at rising buyer interest. A bearish Harami unfolds in an uptrend, where a small red candle follows a large green one, suggesting waning momentum among the bulls. Its appearance is a cue for traders to pause and reassess, as it often signals the weakening of the current trend. (Figure-4)

Figure 4: Bullish and bearish Harami patterns

Hammer Candle Pattern

The hammer candle pattern is a beacon of hope for traders in the midst of a downtrend. Characterized by its small body at the upper range and a long lower wick, it resembles a hammer, ready to strike a blow against the bears. The pattern emerges when prices fall only to rebound and close near the open of the bar, suggesting that the market is rejecting the lower prices. This scenario indicates potential buying interest at the lower price level, hinting at a forthcoming reversal or at least a pause in the downward trend. The hammer pattern is considered confirmed when followed by a bullish move in the subsequent bars. (Figure-5)

Figure 5: Bullish hammer pattern

Note: The opposite of a hammer pattern is a shooting star pattern. A shooting star may indicate a potential price top and reversal and is most effective when it forms after several consecutive rising candles with higher highs and higher lows. With a shooting star, there is a large sellers wick above a small body red candle closing near the low of the bar.

Limitations Of Using Candlesticks Patterns

There are no guarantees that the market will reverse or continue higher or lower when any candlestick pattern is formed and identified. Candlestick patterns are best used in conjunction with other technical analysis tools to build the case for potential market movements and sentiment.

We have just scratched the surface here with some of the most common candlestick patterns traders utilize in their trading. But these patterns represent just the tip of the iceberg. The universe of candlestick charting is vast, with a wide variety of patterns that can provide key insights into market sentiment and potential price movements.

From simple single-bar formations to complex multi-bar scenarios, each pattern offers a unique lens to view price action. Whether you’re just starting out or an experienced trader sharpening your trading plan, the journey to understanding candlestick pattern analysis can provide you with new insights into market analysis and the ability to make better informed trading decisions.

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This article was originally published on NinjaTrader.com: https://ninjatrader.com/futures/blogs/trading-with-candlestick-patterns/