Candlestick charts are arguably the most popular types of price charts in financial markets, as they offer a clean and appealing way of representing price movements. There are many advantages of candlestick charts compared to other chart types which will be covered in the following lines. In addition, we’ll explain what candlesticks are and how they’re formed, the best way to read candlesticks, and how they can be used to identify trend continuation patterns and reversals.
What are candlesticks in Forex?
Candlestick charts are OHLC charts, which stands for Open High Low Close. Just like bar charts, candlestick charts show the opening, closing, lowest, and highest prices for each trading session. The opening and closing prices are represented by a candlestick’s solid body, while high and low prices are drawn as upper and lower wicks respectively. The following graphic shows how a single candlestick is formed.
Candlesticks can be bullish when the closing price is above the opening price, and bearish when the closing price is below the opening price. This is important to understand once we come to the section about candlestick patterns and wicks.
Origin of candlesticks in Forex
Candlestick charts originate from Japan, where they were used by Japanese rice traders. Before Steve Nison brought them to the Western world, European and US traders mostly relied on bar charts, which show the same information about open, high, low, and close prices as candlestick charts. The main difference between bar charts and candlestick charts is that bar charts don’t have a solid body and represent opening and closing prices by small lines on the left and right side of the bar.
The name candlestick comes from the way they look. A candlestick closely resembles a candle, because of their solid body and upper wicks.
Types of candlesticks in Forex trading
Now that you know what a candlestick in Forex trading is, let’s move on to explain the different types of candlesticks. In essence, candlesticks can be either bearish or bullish. As we've already said, a bearish candlestick forms when the closing price is below the opening price, while a bullish candlestick forms when the closing price is above the opening price. The traditional color of a bullish candle’s body is white, while a bearish candlestick’s body is black. However, modern trading platforms such as MetaTrader 4 allow you to change the colours of candlesticks as you like.
If the closing and opening prices of a candlestick are located at the same level, then the candlestick is called a “doji”. A doji has no solid body at all and represents a single candlestick pattern which signals indecision on the market. If a doji forms at the top of an uptrend or at the bottom of a downtrend, there might be a high chance of a trend reversal.
Reading candlesticks in Forex
Forex candlesticks can be read in a variety of ways, depending on the size of their solid body, upper and lower wicks, and the way their surrounding candlesticks look. While we’ll cover some of the most important candlestick patterns in the following section, let’s quickly explain the psychological meaning behind individual candlesticks.
Forex candlesticks explained:
- Long solid bullish body with very short or no wicks – this candlestick suggests that the closing price is relatively far away from the opening price and that buyers are heavily under control. The absence of wicks shows that the buying momentum is extremely high.
- Long solid bearish body with very short or no wicks – this candlestick is quite similar to the explanation above, only that in this case sellers are in control.
- Long upper wicks with a small body – this candlestick signals that buyers were initially under control, pushing the price during the trading session higher, but sellers eventually jumped into the market and pressured the closing price to close well below the high price. This basically signals indecision on the market.
- Long lower wicks with a small body – long lower wicks suggest that sellers were initially in control, but buyers managed to push the price higher and close the trading near its opening price. Just like the previous type, this signals indecision on the market.
Candlestick patterns
Candlestick patterns are specific patterns of one or more candlesticks that can be used to anticipate trend continuations and reversals. We’ve already mentioned the doji candlestick, which is a single candlestick pattern that signals indecision on the market with its absence of a real body. In the following lines, we’ll cover three additional patterns: engulfing patterns, star patterns, and three soldiers/crows patterns.
Engulfing patterns
An engulfing pattern consists of two candlesticks. In a bullish engulfing pattern, the first candlestick is a small bearish candlestick while the second candlestick is a long bullish candlestick which completely engulfs the previous candlestick, signaling that buyers are taking control over the market. A bearish engulfing pattern forms with a small bullish candlestick, followed by a long bearish candlestick which completely engulfs the previous candle.
Star patterns
Star patterns are usually triple candlestick patterns which can be either bearish or bullish. In a bearish star pattern, also called an evening star, the first candlestick is strong and bullish, which is followed by a small, indecisive candlestick such as a doji or spinning top. The third candlestick is a strong bearish candlestick which closes below the opening price of the first candlestick, suggesting that sellers have taken control and that a price reversal may follow.
Three soldiers/crows pattern
A three soldiers pattern is also a triple candlestick pattern, just like the evening star pattern explained above. It consists of three very strong bullish candles which close near their high price, forming a candle without wicks or with very short ones. The three strong bullish candles suggest that buyers have been in control for the last three trading sessions, and that the price might continue to rise. If the pattern forms during a downtrend with three strong bearish candlesticks, it’s called a three crows pattern and suggests that the downtrend may continue.
Final words – understanding candlesticks in Forex
Candlestick charts in Forex are OHLC charts which show the opening, high, low, and closing prices for a trading session. Candlesticks are easy to interpret and graphically appealing, which makes them one of the most popular chart types in Forex trading.
Candlesticks can form so-called candlestick patterns, which are specific patterns used to identify potential trend reversals or continuations. However, bear in mind that candlestick patterns should only be used as a confirming signal to enter into a trade, as they can often create false signals if interpreted incorrectly. Understanding candlestick charts in Forex can make a real difference to your trading performance.