Your guide to trading with candlesticks

A candlestick chart is most traders’ preferred method of visualizing price action. Japanese candlesticks offer greater information regarding market sentiment as they depict the open and close price as well as the highest and lowest points for a specific period.

Your guide to trading with candlesticks

One of the great advantages of trading forex with candlesticks is the amount of information they provide to traders with just a look at the chart. By showing the highs and lows of the price according to the timeframe, traders can gauge the market sentiment and determine where there is an imbalance between supply and demand.


Candle Sticks

Candlestick charts are applicable in all financial markets and after learning the different aspects of candlesticks and what they mean, traders can more effectively identify opportunities in the market.

Depending on the trading platform and the default settings, candlesticks may appear in green and red or black and white. A green or white candle is typically a representation of a bullish market. When the prices are moving upward, the closing price will be higher than the opening price for that time period and therefore the candle is considered bullish and its body takes a green or white color. On the other hand, when the price is going down, the opening price will be higher than the closing price and the candle’s body will be either red or black.

Besides the body, however, candlesticks also have wicks or shadows which represent the high and low points the price achieved before closing for that timeframe.

Therefore, just by looking at a candlestick, you can gauge the market’s direction – if the candles are green or white, the prices are moving up and when the candles are red or black, the sellers are dominating and driving the prices down.

Also, you will be able to:

  • Identify lows and highs during a trading session
  • Understand the momentum and strength of the market

If you are trading on the daily chart (D1 on the MT4 platform), each candle represents the price movement for that day and the open price shows the first price the asset opened with and the close price is the final price for that day.


Candlesticks and technical analysis

Due to the valuable information offered by candlesticks regarding price action, they are employed by technical traders in order to identify favourable entry and exit points to the market.

When you switch your chart to the candlestick type, you will see that some candles are much longer than others, which is quite common in volatile markets such as is the case with currencies.

The candle size or length is an important indicator of the market direction. For example, a candlestick with a substantially long green or red body translates to increased demand from buyers or sellers respectively.

If these long candlesticks are formed on key support/resistance levels they particularly indicative of where the market is going to head next.

If the market is witnessing a strong uptrend, but a long candle forms with a long downward wick or shadow, this means that a reversal may be occurring the trend is about to shift direction.


Candlestick patterns

Through the history of the markets, traders have come to realize that candlestick formations sometimes come in patterns that repeat themselves and being able to identify these patterns can help you determine the most favourable time to buy or sell an asset.

Candlestick patterns may consist of one or more consecutive candles and some of the most popular ones include:

  • Hammers
  • Engulfing patterns

A hammer pattern is a single bullish candlestick that has a long downward wick and a short body. This pattern typically shows up during a bearish market and it signifies that the lowest price was rejected by the market and that there is sufficient demand. Therefore, this pattern acts as a trend reversal pattern and a signal that the prices will start rising.

On the other hand, a hammer can be inverted as well, which means its long wick will be above its short body resembling a hammer held upside down. Inverted hammers appear during upward trends and usually suggest that the prices will start shifting downward. 

Engulfing patterns are formed by two candlesticks and can be either bullish or bearish. As the name suggests, in this pattern, the second candlestick completely engulfs the first with a much bigger body. An engulfing pattern in either direction is an indication of a trend reversal as well.


Final thoughts

There are hundreds of candlestick patterns that indicate more than just a trend reversal, but it’s important to note that candlestick patterns, while useful in market analysis and can be applied across markets and timeframes, they shouldn’t be your sole entry or exit signals.

Traders should be aware of both technical and fundamental analysis methods and ideally should try and improve their skills in both aspects of market analysis if they want to achieve consistent results.

CM Trading provides clients with daily market commentary as well as free forex signals and technical analysis.

If you want to learn how to profit from the financial markets, open a CM Trading account to get started today.

Register here!

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