What are candlestick chart patterns?
A beginner’s guide to candlestick charts
For new traders starting out, trying to make sense of the volatile crypto markets can be incredibly difficult.
One minute, a cryptocurrency’s price rises only for it to drop sharply moments later, seemingly without warning.
Reacting to these movements can easily lead to repeated losses and bad trading habits, even among those more experienced.
So, how do successful traders avoid these scenarios and make better-informed decisions? A big part of it has to do with knowing how to read candlestick charts.
What are candlestick charts, exactly?
Candlestick charts offer a simplified way to visualize the price movement of an asset over a period of time.
Candlestick charts clearly display the changes between an asset’s opening price and closing price within a given time period, including the highest highs and lowest lows.
Each candle on the chart represents a segment of time. Traders can configure candlestick time periods so that each candle represents one minute or as long as one year’s worth of activity. This can be helpful for identifying short or longer-term trends, respectively.
Knowing how to read candlestick charts is an important part of technical analysis — the practice of identifying past market trends in an effort to predict future price movements.
While the concept of predicting the future might sound like voodoo, countless traders attest to its effectiveness when used correctly.
Like learning a language, mastering technical analysis using candlesticks requires dedication, time, and consistency.
The history of Japanese candlesticks
A Japanese rice merchant named Munehisa Honma created candlestick charts during the 18th century.
Rice markets played a huge role in fuelling Japan’s economy. Before his invention, rice was only traded according to the spot price. As a futures contracts market emerged, Honma took advantage of the new coupon trading market.
Homma was among the first people to recognise the dynamics of supply and demand, as well as how trader emotion and psychology impacted price movement. This inspired him to create candlestick charts in order to capture how rice prices change over time.
Over 200 years later, a 1991 book by Steve Nison entitled Japanese Candlestick Charting Techniques introduced the concept of Japanese candlestick charts to the western world.
You might ask — Why would an 18th century charting technique be useful for modern cryptocurrency trading?
It turns out that not much has changed in the last 200 years with regards to human emotions and market psychology. The same principles of fear and greed, supply and demand, still apply now just as they did back then.
How to read candlestick
In order to make the most of candlestick charts, it’s important to understand the anatomy of individual candlesticks.
Each candlestick displays four pieces of information:
- Open: the price at the beginning of the new time interval
- Close: the price at the end of the time interval
- High: the highest price reached during the time interval
- Low: the lowest price reached during the time interval
The asset’s open and close prices are displayed by the body of the candlestick (the rectangular blocks of color).
The wicks of the candlestick (the lines) extending from the top and bottom of the body display the highest high and lowest low price of the asset reached during that period.
When prices close higher than the opening price, it produces a green candlestick. These candlesticks are considered bullish, and show buyers took control of the market during that particular period.
When prices close below the opening price, it produces a red candlestick. Red candlesticks are bearish, and show selling activity was greater than buying activity during that time period.
Wicks above and below the candle bodies indicate sharp spikes and pullbacks in trading activity. In many cases, candles may not have any wicks at all. This is because the highest or lowest price of the asset during a given time period was reached at the start or end of the observed time period.
The size of the candle also illustrates the magnitude of the price change seen during a specific time period. Large green candles show strong buying pressure in the market, while large red candles indicate a lot of selling took place.
Conversely, small green candles indicate minor buying activity during that period of time. The opposite is said for small red candles.
Why candlestick charts are important in technical analysis
While individual candlesticks can provide a lot of information, they become infinitely more powerful when viewed together.
Across a section of candlesticks, traders can often see clear patterns or lines appear on a price chart. These might be areas of resistance, where prices have consistently failed to break above a particular level, or support lines where prices have repeatedly rebounded from.
Reducing the time frames of candlesticks to short intervals, such as five minutes or thirty minutes, can sometimes allow traders to identify these areas more precisely.
Alternatively, increasing time frames to much longer-term intervals, such as one week or one month, can be useful for identifying historically strong areas of support and resistance.
In some cases, situations can emerge where several candlesticks form a repeating pattern on a chart that produce a consistent result. This might be a bullish breakout or a bearish downturn. Traders might rely on these historical patterns to predict future movements.
Combining candlesticks with other indicators can help to confirm or reject your trading hypotheses. Using trading volume data, for example, can provide important supplementary information when predicting certain price movements.
Oftentimes, candlestick patterns produced during periods of high trading volume can lead to stronger price movements in either direction. Traders might wait for these moments to enter or exit a market, depending on their strategy.
In summary, understanding candlestick charts is vital for any serious trader looking to advance their skills.
With thousands of accompanying indicators and metrics available, it’s advisable to explore as many as possible to develop a strategy that best serves your risk tolerance and trading goals.
Time frame matters with candlesticks
When reading candlesticks, time frame matters.
While a candle on a 15 minute chart may look promising, it should not carry as much weight if a similar looking candlestick appears on a weekly chart.
A given traders' individual objectives will often dictate which time frames are important to them. But, no matter if they are starting out or a pro, the context of time frames matters when reading candlestick charts.
A handy reference for time frame order of importance is:
- 4 Hour
- 1 Hour
- 30 Minute
- 15 Minute
- 1 Minute
Additional trading resources
If you are interested in learning more about the different cryptocurrencies, you can visit Kraken’s Learn Center. There, you will find other guides on different trading concepts from hedging to derivatives.
If you want to spot trading opportunities, you can bookmark Kraken’s price page, which allows you to follow the state of the cryptocurrency market.
From there, you can start putting your new knowledge of candlestick patterns to work with our advanced trading platform Kraken Pro.
Buy, sell, trade and stake hundreds of cryptoassets like a pro using Kraken Pro today.