Best Candlestick Patterns for Trading: What are the key components of a candlestick?

Best Candlestick Patterns for Trading: What are the key components of a candlestick?
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Best Candlestick Patterns for Trading: Overview

Trading in the stock market is a game of various technical analyses and that is the conglomeration of various charts, graphs, and strategies that are depicted in the style of trading of a trader. Real-time investors are generally the ones who follow an idealistic approach as the trick of their trade, specifically when it comes to intra-day trading. There are various intraday trading techniques that are widely and popularly used by investors to yield high returns and curtail the risk that is associated with the trade. One such technique is known to be the candlestick pattern. Let us understand the various notions related to this term as we move forward with this article.

Candlestick Analysis: Meaning of Candlesticks

Candlestick is a type of price chart that is typically used in technical analysis. These are then displayed as the high, low, open, and closing prices of the securities for a specified period. A candlestick's shape may vary based on this relationship of the day's high, low, opening, and closing prices. Thus they help to reflect the idea and impact of an investor’s sentiment adapted from the security prices and are therefore used by high-end technical analysts so that they can determine the time period to enter and exit a trade.

It first originated from Japanese rice merchants and the traders who used to track market prices as well as the daily momentum some hundreds of years ago. This was even before the concept became popularized in the US. Candlestick charting is thus known to be based on a technique that was developed in Japan back in the 1700s. These were then used to track the price of rice. Candlesticks are known to be a suitable technique that can be used for the trading of any kind of liquid financial asset like stocks.

The candlestick charts are known to be technical tools that are used to pack data in multiple time-frames to obtain single price bars. Candlestick analysis is thus considered to be the best tool for detailed short-term volume analysis. They help to identify signals even before they appear on a price chart and have the potential to assist with the short-term timings as well as setting limits. These are also used to strengthen or weaken the long-term signals that are on trend.

It is also to note that the wide part of a candlestick is known as the "real body". This indicates to investors if the closing price of a stock was on the higher or lower end than that of the opening price, Usually, it is black/red colored if the stock closes lower while it is white/green when the stock closes on the higher side.

Candlestick Trading: Components of Candlesticks

A Stock price is influenced by a variety of factors. These may comprise industrial performance, political instability, employee layoffs, market fluctuations, etc, But when it comes to the Indian stock market, the emotional viability of an investor plays an equally important role. The tendencies of such traders must therefore not be taken for granted. Rather, it shall be wise for real-time investors to take these into account and must be acted upon. 

The Japanese man named Homma in the 1700s followed a similar technique for depicting the price of rice. He soon realized that the fluctuations in the price movements of the rice in the market is essentially affected by the emotion of the market traders and are not just a byproduct of demand and supply. Candlestick charts are similar to the visual cues of the emotional trends in the market. These visual representations are known to contain a body as well as a wick. The wick is said to be visible on both ends and is therefore called a shadow. The body, however, is the wide part of a  candlestick and is indicated as the real body. Let us now understand the important terms associated with a candlestick in detail.

  • The real body: The gap between an opening price and a closing price of a stock is represented by the height of the real body. When the real body is large, it depicts that there exists a substantial gap between an opening and a closing price. However, in contrast, a short real body indicates a smaller difference.
  • Doji: When the opening and the closing price of stock tend to be the same or maybe even identical, it is said to be a Doji. A Doji comes across like a cross.
  • The wicks or the shadows: The top wick is identified as the highest price of the chosen stock as of the day. While the bottom of it suggests the lowest price.
  • The colors: When the closing price of stock appears to be more than the opening price, it suggests an uptrend. In this case, the candlestick appears as white or green. But in the case when the closing price tends to be lower than that of the opening price, the candlestick is black or red.

Candlestick Chart Patterns: 5 Most powerful candlestick patterns

Three Line Strike-

The bullish three-line strike reversal pattern carves out three black candles within a downtrend. Each bar posts a lower low and closes near the intrabar low. The fourth bar opens even lower but reverses in a wide-range outside bar that closes above the high of the first candle in the series. The opening print also marks the low of the fourth bar. According to Bulkowski, this reversal predicts higher prices with an 83% accuracy rate.

Two Black Gapping-

The bearish two black gapping continuation pattern appears after a notable top in an uptrend, with a gap down that yields two black bars posting lower lows. This pattern predicts that the decline will continue to even lower lows, perhaps triggering a broader-scale downtrend. According to Bulkowski, this pattern predicts lower prices with a 68% accuracy rate.

Three Black Crows-

The bearish three black crows reversal pattern starts at or near the high of an uptrend, with three black bars posting lower lows that close near intrabar lows. This pattern predicts that the decline will continue to even lower lows, perhaps triggering a broader-scale downtrend. The most bearish version starts at a new high (point A on the chart) because it traps buyers entering momentum plays. According to Bulkowski, this pattern predicts lower prices with a 78% accuracy rate.

Evening Star-

The bearish evening star reversal pattern starts with a tall white bar that carries an uptrend to a new high. The market gaps are higher on the next bar, but fresh buyers fail to appear, yielding a narrow range candlestick. A gap down on the third bar completes the pattern, which predicts that the decline will continue to even lower lows, perhaps triggering a broader-scale downtrend. According to Bulkowski, this pattern predicts lower prices with a 72% accuracy rate.

Abandoned Baby-

The bullish abandoned baby reversal pattern appears at the low of a downtrend after a series of black candles print lower lows. The market gaps lower on the next bar, but fresh sellers fail to appear, yielding a narrow range Doji candlestick with opening and closing prints at the same price. A bullish gap on the third bar completes the pattern, which predicts that the recovery will continue to even higher highs, perhaps triggering a broader-scale uptrend. According to Bulkowski, this pattern predicts higher prices with a 49.73% accuracy rate.
 

Candlestick patterns are idealized for their quality to capture the attention of market players. However, in terms of many reversal and continuation signals, these are emitted by such patterns that may not provide a reliable result while working in a modern environment. Although the statistics provided by Thomas Bulkowski suggest an unusual accuracy when it comes to a narrow selection of such patterns. This offers the traders an actionable buy and sell signals. As per these insights gained in terms of candlestick patterns, it can be cautiously used as an investing asset, specifically with the distinct analysis pattern in terms of intraday trading fundamentals.


Important things to remember:

1. Do Not Blindly Follow Hot Tips

No matter how credible the source is, never follow a stock marketing tip blindly without conducting thorough research personally. Always select the stocks after doing proper research and analysis on the performance as well as the companies. While some tips can work out to give you huge benefits, the wrong ones can push you down under the risk pretty quickly. 

2. Eliminate Loser Stocks from Portfolio 

There is absolutely no guarantee that a stock will rise after a great fall. Know that it is extremely important to be practical about what is possible and what's impossible in the stock market. So, upon realizing that a stock is performing poorly in your portfolio, accept your mistake and sell it immediately to prevent further losses. 

3. Don't Exceed Your Investment Budget Abruptly 

While it's true that long-term investments are way better than other forms of investment, you shouldn't exceed your investment budget in a haste. Instead, decide on a fixed amount and invest it across various good stocks. Rather than investing in only one stock, divide your budget evenly across multiple good-performing stocks and shares. 

  • What is the total number of Candlestick Patterns?

  • Are candlesticks reliable?

  • How to analyze a candlestick?

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