How to Read Candlestick Patterns: Types, Meaning, & More

Candlestick charts are the backbone of technical analysis in the Indian stock market that offer traders a way to interpret price action and market sentiment. Understanding candlestick charts and their patterns such as the doji candle, hammer candlestick, and other bullish candle patterns can significantly boost your trading decisions. 

In this article, we will talk about the basics of candlestick patterns, their types, and their meaning. Let’s begin!

What is a Candlestick?

A candlestick is a graphical representation of price movement for a specific time period in the market—be it a minute, an hour, a day, or longer. Each candlestick displays four data points: the opening price, closing price, highest price, and lowest price of the security during that period. The “body” of the candlestick shows the range between the open and close, while the “wicks” or “shadows” indicate the highs and lows.

Japanese rice merchant Munehisa Homma invented candlestick charts in the 18th century. They have since become a global standard for technical analysis, including in Indian equities, commodities, and even cryptocurrency markets.

How Many Types of Candlesticks Are There?

There are dozens of candlestick patterns, each with its unique implications. While some sources list up to 75 different types, most traders focus on a core set of patterns that consistently signal market sentiment and potential reversals or continuations.

Types of Candlesticks

• Single Candlestick Patterns: Formed by one candle (e.g., doji candlestick, hammer candlestick).
  
• Double Candlestick Patterns: Formed by two candles (e.g., bullish engulfing, piercing pattern).
  
• Triple Candlestick Patterns: Formed by three candles (e.g., morning star, evening star).
  

Types of Common Candlesticks and Their Meaning

1. Doji Candlestick
A doji candle is a candle with a very tiny body that is formed when the open and closing prices are almost equal. This pattern indicates indecision in the market where neither buyers nor sellers are in control. A doji candlestick often signals a potential reversal, especially after a strong trend.

Source: TradingView

2. Hammer Candlestick
The hammer candlestick is a single bullish reversal pattern that appears after a downtrend. It has a small body at the top and a long lower shadow, suggesting that sellers pushed prices down but buyers regained control by the close. This is a strong bullish candle pattern, often used as an entry signal for long trades.

Source: TradingView

3. Bullish Engulfing Pattern
This two-candle pattern consists of a small bearish candle followed by a larger bullish candle that completely engulfs the previous candle’s body. It signals a shift from selling to buying pressure, often marking the start of an uptrend.

Source: TradingView

4. Morning Star
A morning star is a three-candlestick pattern that appears at the bottom of a downtrend. It consists of a long bearish candle, a doji (or small-bodied candle), and a strong bullish candle. This pattern indicates that the downtrend is losing momentum and a reversal to the upside is likely.

Source: TradingView

5. Piercing Pattern
The piercing pattern is a bullish reversal signal formed by two candles. The first is bearish, and the second is a bullish candle that opens lower but closes above the midpoint of the previous candle’s body. This suggests a strong comeback by buyers.

Source: TradingView

How to Read a Candlestick Pattern?

Reading candlestick patterns involves more than just identifying shapes. Here’s how to interpret them effectively:

• Context Matters: Always analyse candlestick patterns in the context of the prevailing trend. For example, a hammer candlestick in an uptrend is less significant than one at the end of a downtrend.
  
• Volume Confirmation: Patterns accompanied by high trading volume are generally more reliable.
  
• Multiple Time Frames: Check for pattern confirmation across different time frames for stronger signals.
  
• Combination with Other Indicators: For more accuracy, use candlestick patterns in conjunction with moving averages, RSI, or support/resistance levels.
  

Conclusion

Candlestick charts and patterns are crucial tools for Indian traders aiming to decode market psychology and make informed decisions. Patterns like the doji candle, hammer candlestick, and other bullish candle patterns provide actionable insights into potential reversals and continuations. By mastering candlestick charts, you can enhance your technical analysis and trading outcomes in the dynamic Indian markets.

FAQs

1. What is the 5 candle rule?
   The 5 candle rule is a trading strategy where traders wait for five consecutive candlesticks to confirm a trend or reversal before entering a trade. This helps filter out false signals and provides more reliable entries.

2. Which is the most powerful candlestick pattern?
The bullish engulfing pattern and the hammer candlestick are considered among the most powerful candlestick patterns for signalling reversals, especially when confirmed by high volume and supportive market context.

3. What do the 7 candles stand for?
The “7 candles” concept often refers to analysing price action over a sequence of seven candlesticks to assess short-term market direction, momentum, or to identify specific multi-candle patterns.

4. What is the 9 candle rule?
The 9 candle rule is used in some trading strategies (like the TD Sequential indicator) where traders look for a sequence of nine consecutive candles in a particular direction to anticipate a potential reversal or exhaustion in trend.

5. How to confirm a candlestick pattern?
To confirm a candlestick pattern, look for:

• Higher trading volume during the pattern’s formation.
  
• Pattern alignment with support/resistance levels.
  
• Confirmation from subsequent candles (e.g., a bullish candle following a hammer).
  
• Additional technical indicators supporting the signal.