The Ultimate Guide to Forex Candlestick Patterns for Smart Trading
If you've opened a forex chart before you most likely seen those rectangular shapes with thin lines protruding from the top and bottom. Those aren't just random squiggles, they are candlestick patterns and they will soon become your best friend in trading.
Candlestick charts do not simply show you prices moving up and down, they tell the story behind every price movement by indicating what buyers and sellers were thinking each time. Basically, candlestick charts are the pulse of the market. Each candle tells you if the traders are confident, scared, indecisive or ready to rock and roll.
Here is what makes candlestick analysis effective: it combines hard price data with the human element of market psychology. When you have a hammer pattern after a downtrend, you are visually seeing not just a price reversal, but you are seeing sellers giving up control and the buyers are coming back into the market. When you have three white soldiers climbing your charts, you are watching the effect of sustained buying pressure that all of the major institutions are watching as well.
Basic Candlestick Concepts
Every candlestick contains four pieces of useful information -- the open price, close price, high price and low price for the time period. These four numbers are what create the candlestick shape that you visually see in the charts.
The thick rectangular part (the body of the candlestick) represents the range between the open and close price. If the close price was greater than the open price you would have received a bullish candle, represented in the chart with a green or white color. If prices closed lower than they opened, that would be a bearish candle, represented in the chart typically as a red or black color.
Single Candlestick Patterns
Some of the more dependable trading signals arise from single candles with unique shapes. These single candle patterns are like market headlines that indicate very important sentiment changes.
So what did we just see in that candle? Sellers were making their moves, selling down and working it pretty well until buyers showed up, basically saying "not so fast," as they bought up the selling and took price back up to the open of the candle.
Multi-Candlestick Patterns
While single-candles are useful, multi-candle patterns tell a more complete story about a market's behavior and psychology. These normally take two to three candles to form, you can usually expect signals that are better than their single-candle counterparts.
These are some of the most potent reversal patterns you can see. A bullish engulfing pattern is where a small red candle is completely "engulfed" by a green candle the next day. The body of the second candle completely covers the body of the first candle, indicating it was the buyers that overwhelmed the selling force with some serious thrust.
Morning Star and Evening Star
These three-candle patterns offer one of the highest probabilities of a reversal in candlestick formation. A morning star occurs near the bottom of downtrends, and consists of three candles: a large red candle, followed by a smaller-bodied candle (which is sometimes a doji) and then followed by a large green candle which closes deep into the first candle.
The middle candle represents indecision as price has shown that sellers are exhausted but buyers have not fully committed. The third candle confirms that buyers are in control. It is like watching a movie in which the villian is dominant in the first act, confusion reigns in the second act, and the hero prevails in the third act.
Conclusion
Candlestick patterns are one of the most useful skills any forex trader can learn. They provide more information about market psychology than anything simple line charts can do; they show the battle between buyers and sellers at every price level.
The patterns we looked at today - both single candles like hammers and dojis, and multiple candles like morning stars and three white soldiers, are corner stones in technical analysis. But remember, candlestick patterns work best with trend analysis, support and resistance levels and have appropriate risk management.
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