How to do Technical Analysis of Candlestick?

Technical analysis  is a powerful technique for identifying and evaluating potential investing and trading opportunities in the stock and cryptocurrency markets. Unlike fundamental analysis, technical analysis focuses on security price and trading volumes and not on the business fundamentals and financial results of the stock issuer.

In other words, analyzing price and volume trends or patterns, help you understand the overall market momentum and identify buy/sell opportunities. These trends and patterns also reflect the interaction between demand and supply forces and the resultant security market price. Thus, technical analysis is an indispensable tool for making price forecasts and predicting market volatility.

Technical analysis comprises a large number of charting tools and indicators that help you study price and volume movements. Candlestick charts are one of the most popular and commonly used technical analysis tools by stock traders across the globe.

Technical Analysis of candlestick charts

Technical analysis
(5-day candlestick chart of Apple Inc. stock)

Candlesticks are a method of depicting a security’s price movement. Every candlestick has three basic components. They are as follows:-

  • Body : It represents the difference between the open and close prices of the security in a trading session.
  • Wicks : They represent the highest and the lowest prices of the security within a trading session. There are two wicks – upper and lower.
  • Color : The color of a candlestick determines if the price has moved above or below the session’s open price. If the close price is higher than the open price then, the candlestick is green or bullish. Similarly, a red or a bearish candlestick indicates that the session’s close price is lower than the open price.

These individual candlesticks form candlestick patterns that help you understand the price direction and market momentum. We will doing the technical analysis on some of the main candlestick patterns in the consecutive sections.

Bullish candlestick patterns

technical analysis

Bearish candlestick patterns start forming when the end of a bullish trend is nearing. In other words, they indicate a bullish trend reversal and the beginning of a price downtrend. They represent strong signals for traders to go short as the stock price is poised to spiral downwards. Some of the commonly occurring bearish candlestick patterns are listed below.

Hanging man

Hanging man is the technical analysis chart which is most popular in forex. The hanging man is the bearish version of the hammer occurring at the end of a bullish trend. It is a red candlestick with a small body and an elongated lower wick. It implies that heavy offloading activity has occurred during the day. In other words, sellers outnumbered the buyers thereby exerting downward pressure on the security price leading to a bullish trend reversal.

On June 3, 2021, 8.40pm, you see the hanging man pattern occurring in the Apple Inc chart. The price falls from $124.13 to $123.37 and thereafter starts rising again.

Bearish engulfing

This two-candlestick pattern comprises of a small green candle completely engulfed by a big red candle. It indicates that the bullish trend has attained its peak and is poised to spiral downwards. The lower the big candle goes, more stronger is the impending price downtrend. This technical analysis helps you to understand the bullish trends and movement of candles.

Evening star

This is a 3-candlestick pattern with a small red candle hemmed between a long green and red candle. The longer the red candle than the green candle, the more stronger will be the bearish trend.

You can see the evening star pattern occurring in the Apple Inc chart on June 2, 2021, 12.10am. A price downtrend occurs which lasts for about one and a half hours.

Three black crows

 This is a 3-candlestick pattern comprising successive red candles with extremely short or no wicks. This pattern implies that the open price was same as the previous day but heavy selling volumes pushed the close price lower and lower for three consecutive days resulting in a strong price downtrend.

If you study the Apple Inc chart, a 3 black crows pattern occurred on June 2, 2021, 9.15pm. A price downtrend followed that sustained for about 2 hours.

Bullish candlestick patterns

Bullish candlestick patterns form towards the end of a price downtrend. In other words, they signal a bearish trend reversal and commencement of a price uptrend. These patterns are strong indications for traders to go long as at this point in time, the stock price is low. Traders buying stocks at low prices can maximize their gains from the impending upward trajectory of price.

While there are many bullish candlestick patterns, we would enlighten you on some of the most common patterns. They are listed below.

Hammer

Hammer is the most popular technical analysis in the forex trading. This candlestick pattern comprises a smaller body with an elongated lower wick. It occurs at the bottom of a declining price trend. The body color of the candlestick is immaterial, but a green hammer candlestick pattern is consider a stronger bullish signal. A hammer implies that buying pressures have overtaken the selling pressures. The security price is assure for an upward movement.

You can see the hammer pattern occurring on June 1, 2021, 8.25p.m, in the Apple Inc chart. Thereafter, a price uptrend set in but wasn’t strong enough to sustain.

Inverted Hammer

 A reverse hammer has a small body like the hammer, but with an elongated upper wick. This implies that selling pressures overtook buying pressures for some time but couldn’t sustain themselves. Eventually, buying pressures regained strength and surpassed the selling pressures indicating the beginning of a bullish trend.

Bullish engulfing

This candlestick pattern gives the best technical analysis and is formed by two candlesticks – one small and one big. A small red candlestick is completely overlapped by a big green candlestick. A bullish engulfing pattern means that the big candlestick opened lower than the previous close price but eventually finished higher than the previous open price.

This implies that the demand for the concerned stock is higher than its supply. In other words more buyers have entered the market exerting upward pressure on the stock price. This candlestick pattern is a strong bullish sign if it is precede by more than four red candlesticks. Hence, you can expect a bearish trend reversal.

If you observe the Apple chart a bullish engulfing pattern has occurred on June 3, 2021, 8.15pm followed by a short rally that lasted for about half an hour.

Piercing line

This candlestick pattern comprises two long candles – a red candle succeeded by a green candle. There is a considerable gap down between the red candle’s close price and green candle’s open price. It implies that heavy buying volumes have pushed the stock price above the mid-price of the previous trading session or day.

You can see the piercing line pattern occurring on June 1, 2021, 19.40 pm in the Apple candlestick chart. However, the uptrend that ensued following this pattern lasted for just 30 minutes.

Final words

Candlestick patterns are valuable technical analysis tools for stock-market trading and investing. There are 1-candlestick, 2-candlestick, 3-candlestick, and 4-candlestick patterns that are widely use. While some candlestick patterns are easy to analyse, you will gain mastery over the complex ones with discipline and relentless practice.

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