Candlestick and chart patterns

Let’s take a look at how traders use candlestick patterns on charts to better understand and predict market movements.

1. What are patterns?

2. Trading with patterns

3. Candlestick patterns

• Doji

• Wide bar

• Hammer

• Morning star

4. Chart patterns

• Triangle

• Symmetrical triangles, flags, and wedges

What are patterns?

Patterns are distinct formations that appear on charts. Traders use them for quick analysis of market behavior and to gain important insights into potential future developments – which helps them make decisions about trading strategies.

Technical analysis is based on the assumption that chart patterns repeat themselves, which usually leads to similar price movements.

For example, if in 90% of cases in the past, a sharp rise was followed by a consolidation phase and subsequent market decline, a trader might predict that another downward reversal is approaching when the market recovers and then weakens.

Trading with patterns

Although patterns can help predict price movements, they do not provide certainty about the market’s future direction. Therefore, most traders wait for confirmation of the expected move – whether it’s the start of a new trend, a reversal, or a continuation – before entering a trade.

In practice, this means they monitor the market for several periods to check if it behaves as anticipated.

As always, cautious trading and effective risk management play a crucial role.

Patterns formed by one or more candlesticks provide a quick view of price movement and can indicate the likely future market direction. Below are some of the most significant examples.

Candlestick patterns

Candlestick patterns are formed from one or more individual candlesticks displayed on the chart.

Doji

Doji is considered a neutral pattern that indicates indecision between bulls and bears.
There are three main types of Doji:

• Long-legged Doji

• Gravestone Doji

• Dragonfly Doji

Long-legged doji

• This type of Doji shows a high level of indecision, as both buyers and sellers pushed the market up and down, but ultimately they canceled each other out.

Gravestone doji

• This pattern suggests that buyers initially pushed prices higher, but sellers took control and pushed prices back down, creating a formation resembling a gravestone.

Dragonfly doji

• In this type of Doji, the scenario is the opposite – sellers pushed the market lower, but then buyers took control and pulled the market back up.

A Doji is a pattern that forms during a single trading session, meaning it consists of just one candlestick. However, it becomes much more useful when analyzed in a broader context.

For example, if a red gravestone doji appears after a long uptrend, it may indicate that a trend reversal is approaching.

Let's look at what can happen during a four-hour gravestone doji to see how it plays out in practice.

At the beginning of the trading session, the market continued to rise. However, later on, sellers took control and pushed the price back to the opening level. If this negative sentiment continues, it could indicate that it might be a good time for a short trade.

Wide range bar

A wide range bar looks exactly as its name suggests. It is a long bar that is at least two to three times longer than the other candlesticks surrounding it on the chart.

Wide Range Bars

Wide range bars signal strong momentum in the direction the bar moves. This means that either buying or selling sentiment is dominating, which is often the result of important news, although this is not always the case.

Trading with a wide range bar can be tempting because it indicates clear volatility and sentiment in the market. However, it is often better to take a step back. These bars may suggest that any prior pattern may no longer hold, and support and resistance levels could be broken if the sentiment is strong enough.

Hammer

A hammer candlestick has a small body, a long lower wick, and a small or nonexistent upper wick. It can be either red or green and forms after a downtrend. Hammers are considered a signal that the bearish trend may reverse, and a reversal could occur.

Hammers can look like any of the following candlesticks:

Hammers not only resemble a hammer in appearance, but they also get their name from how they form – during this pattern, the market "kills" its bottom, only to rebound upward. Similar to the dragonfly doji, the hammer suggests that buyers overcame the strong selling sentiment before the end of the trading session.

When looking for hammers, it is important to pay attention to the length of the lower wick, as this length can indicate the strength of the formation. Ideally, the wick should be two to three times longer than the body of the candlestick.

If a hammer appears at the end of a bullish run, but does not form as a bearish pattern, it is a reversal pattern that signals the potential end of an upward trend. This pattern is not called a hammer but is referred to as the hanging man.

In the hanging man, during the trading session, sellers took control to push the price lower. Buyers then tried to push the price back up, but failed to surpass the opening price. This indicates that the buying sentiment may no longer be strong enough to maintain the upward trend.

Did you know?

There are several other one-session patterns that can be useful:

• Spinning tops are similar to long-legged doji, but they have a wider body.

• Marubozu are full-body candlesticks with no wicks.

Inverted hammer and falling star

You can also look for inverted hammers or falling stars. These patterns are also reversal formations that appear at the end of a bearish run and signal the potential end of a downward trend.

If an inverted hammer appears after a rally, it is called a falling star. This pattern is often considered a signal that the upward trend may be nearing its end.

Confirming hammers

It is not wise to immediately enter a trade when a hammer appears. Instead, it's better to wait for confirmation of the trend reversal. The easiest way to confirm a hammer is to check if the previous trend continues in the next trading session. If it does, it means the hammer was unsuccessful and the trend is continuing.

Morning star

The Morning Star is a commonly used three-candlestick pattern that suggests a downtrend may be ending and a reversal is approaching.

The Morning Star consists of three candlesticks:

1. A long red candle

2. A small red or green candle, which is below the gap of the previous session's close

3. A long green candle

If the second candle is a Doji, the likelihood of a trend reversal increases. The trend is considered stronger if the last candle closes above the close of the second candle.

The Morning Star begins with an unbroken downtrend, shown by a long red candle and a gap into the next session. However, the second candle suggests indecision, which may signal that a reversal is approaching. The long green candle that follows confirms that a trend reversal is on the way.

Chart patterns

Chart patterns form over multiple trading sessions, so they tend to be longer than candlestick patterns.

Triangle

One of the easiest chart patterns to recognize is the triangle pattern.
There are three types of triangles to watch for:

• Ascending triangle

• Descending triangle

• Symmetrical triangle

In an ascending triangle, the bottom gradually rises, indicating an upward trendline. However, the trend stalls because the market fails to reach new highs. Instead, it consistently bounces off a strong resistance level.

Ascending triangles, which often occur after significant upward trends, are continuation patterns. If the market breaks through the resistance level, a new rally could form.

However, if the market drops below the lower trendline, the pattern is considered invalid.

Descending triangles are the exact opposite of ascending ones. After a downward trend, the market encounters a strong support level, but the resistance is falling. If support breaks, a new bearish run could emerge.

Trading with triangles

The easiest way to trade a triangle pattern is to place an entry order just above the resistance level (for an ascending triangle) or just below the support level (for a descending triangle). You can then trade based on the emerging price action.

It is often a good idea to place a stop order just behind the opposite trendline. This way, if the pattern fails, your position will be automatically closed.

Symmetrical triangles, flags, and wedges

Although symmetrical triangles, flags, and wedges look slightly different, they are similar in how they function. These three patterns are formed by two trendlines that indicate indecision in the market. If either trendline is broken, it can lead to a new rally in that direction.

In a symmetrical triangle, two trendlines converge towards each other. The first connects a series of lower highs, while the second connects a series of higher lows.

In a wedge, two trendlines converge towards each other and are inclined in the same general direction.

• In an ascending wedge, both the upper and lower trendlines are slanted upwards.

• In a descending wedge, both the trendlines slope downwards.

In a flag, two trendlines run parallel, either sloping downward (for a bullish flag) or upward (for a bearish flag).

• Bullish flags appear after a strong upward movement, signaling a potential continuation of the rise.

• Bearish flags appear after a downtrend, suggesting the possibility of further decline.

Trading consolidation patterns

In all of these patterns, the market is in a consolidation phase, often accompanied by decreasing volatility and trading volume.

During the pattern's formation, the market cannot decide whether to go up or down. Once either trendline is broken, a significant move in the direction of the breakout may occur.

• If the market breaks upward, it could signal the start of a rally.

• If the market breaks downward, it might indicate a bearish escape.

Trading these patterns involves entering a position when the market breaks one of the trendlines. As always, it is wise to place a stop order just behind the opposite trendline, in case the move does not unfold as expected.