Best Candlestick Patterns for Traders

1. Doji Candle
Definition

A Doji candle is formed when the open and close prices are virtually equal, creating a candle with a small or non-existent body and long shadows. The Doji signifies indecision in the market. Neither buyers nor sellers have control, indicating a potential reversal or a continuation depending on context.

Types of Doji Candles

Standard Doji: Equal open and close prices with long upper and lower wicks.

Dragonfly Doji: Small body at the top, long lower shadow. Indicates bullish reversal if found at the bottom of a downtrend.

Gravestone Doji: Small body at the bottom, long upper shadow. Indicates bearish reversal if found at the top of an uptrend.

Long-Legged Doji: Long upper and lower wicks with a tiny body. Shows extreme indecision.

Trading Implications

Appears after strong trends to indicate potential reversals.

Confirmation is critical; traders often wait for the next candle to determine the market’s direction.

Risk management is essential because Doji candles alone do not guarantee a reversal.

Example

Imagine a strong bullish trend; suddenly, a Gravestone Doji appears. This could indicate that buyers are losing control, and a bearish reversal might follow. Traders might consider exiting long positions or preparing for a short opportunity.

2. Engulfing Pattern
Definition

The Engulfing Pattern consists of two candles:

Bullish Engulfing: A small bearish candle followed by a larger bullish candle that completely engulfs the previous candle’s body.

Bearish Engulfing: A small bullish candle followed by a larger bearish candle that engulfs the previous candle.

This pattern signifies a strong shift in market sentiment.

Characteristics

Bullish Engulfing:

Occurs at the bottom of a downtrend.

Indicates buyers taking control.

Bearish Engulfing:

Occurs at the top of an uptrend.

Indicates sellers taking control.

Trading Strategy

Look for significant volume during the engulfing candle for confirmation.

Place stop-loss below the swing low for bullish or above swing high for bearish setups.

Often paired with support and resistance levels for higher accuracy.

Example

During a downtrend, a small red candle is followed by a large green candle engulfing it. This signals that bulls are overpowering bears and a potential trend reversal is imminent.

3. Hammer and Hanging Man
Definition

These patterns have small bodies and long lower shadows. They often signal potential reversals but depend on their placement in the trend:

Hammer: Bullish reversal at the bottom of a downtrend.

Hanging Man: Bearish reversal at the top of an uptrend.

Characteristics

Body is small.

Lower shadow is at least twice the size of the body.

Upper shadow is minimal or absent.

Trading Insights

Hammer:

Appears after a downtrend.

Buyers start to gain momentum.

Confirmation comes from the next bullish candle.

Hanging Man:

Appears after an uptrend.

Sellers might be gaining control.

Confirmation comes from a bearish candle following it.

Example

In an uptrend, a Hanging Man appears. The next candle is red, confirming that sellers are exerting pressure. Traders may look to short or exit long positions.

4. Morning Star and Evening Star
Definition

These are three-candle patterns that indicate trend reversals:

Morning Star: Bullish reversal at the bottom of a downtrend.

Evening Star: Bearish reversal at the top of an uptrend.

Components

Morning Star:

First candle: Large bearish candle.

Second candle: Small-bodied candle (Doji or spinning top) indicating indecision.

Third candle: Large bullish candle closing at least halfway into the first candle’s body.

Evening Star:

First candle: Large bullish candle.

Second candle: Small-bodied candle showing indecision.

Third candle: Large bearish candle closing at least halfway into the first candle’s body.

Trading Approach

Confirm the pattern with volume.

Look for support/resistance levels aligning with the pattern.

Set stop-loss just below the lowest point (Morning Star) or above the highest point (Evening Star).

Example

In a downtrend, a Morning Star appears. The first candle is red, the second a small Doji, and the third a large green candle. This indicates a potential bullish reversal, signaling a long trade setup.

5. Shooting Star and Inverted Hammer
Definition

These patterns are opposite of Hammer and Hanging Man and indicate potential reversals based on trend location:

Shooting Star: Bearish reversal at the top of an uptrend.

Inverted Hammer: Bullish reversal at the bottom of a downtrend.

Characteristics

Small body.

Long upper shadow, at least twice the length of the body.

Minimal or no lower shadow.

Trading Implications

Shooting Star:

Appears after an uptrend.

Suggests bulls are losing control.

Confirmation comes from the next bearish candle.

Inverted Hammer:

Appears after a downtrend.

Suggests buyers are gaining momentum.

Confirmation comes from the next bullish candle.

Example

An uptrend sees a Shooting Star appear. The next candle is red, confirming sellers’ dominance, signaling potential short opportunities.

Conclusion

Candlestick patterns are invaluable tools in technical analysis, helping traders anticipate potential reversals, continuations, and market sentiment shifts. Among the myriad of patterns, the Doji, Engulfing, Hammer/Hanging Man, Morning/Evening Star, and Shooting Star/Inverted Hammer are considered the top 5 due to their reliability and simplicity.

Key Takeaways:

Always use candlestick patterns in context with trend and volume.

Confirmation is crucial; no single pattern guarantees a reversal.

Combine candlestick analysis with other technical tools like support/resistance, moving averages, and RSI for higher probability trades.

Risk management, stop-losses, and position sizing are essential for trading success.

By mastering these top 5 candlestick patterns, traders can gain a powerful edge in analyzing market behavior and making informed decisions.