Stockbrokers, traders, and investors rely on technical analysis charts to understand and predict the movement of stock prices for a given period. The market trends are represented by drawing straight, vertical lines on the chart that aim to capture movement in stock prices. The trend lines are also called candlesticks.
The idea behind technical analysis of stocks is that all participants in the market – buyers and sellers – are acting based on their perceptions about a stock and aware of the relevant information regarding the security.
Technical traders believe that past movements of a stock’s price can indicate the future performance of the security.
In this blog post, we take a look at some of the candlestick patterns that are commonly used for technical analysis of stocks.
Candlestick vs. Chart Pattern
Both line and candlestick charts can be used for technical analysis. However, the candlestick chart is more common these days.
The line chart displays the price movement of a stock over a period of time. The chart displays information in a series of data points that are connected by lines in a series.
The candlestick chart shows price movements by displaying the price at an exact moment in time. Prices at different adjacent times are displayed side by side for comparison. Some popular time frames include the 5-min, 15-min, hourly and daily charts.
Understand Candlestick Chart Patterns
There are dozens of candlestick patterns that are used by traders for understanding and predicting stock prices in the future. The stronger candlestick patterns are very useful for understanding the underlying market sentiment about a stock. This is information that you simply cannot get with fundamental analysis alone. Technical analysis of stocks can help you formulate a profitable trading strategy for your portfolio.
A candlestick size is determined by the time and level of changes in price for the upward and downward movement. When there is greater fluctuation in price, it leads to a bigger candle. When the price of a stock is more stable for a longer duration, it lowers the size of the candle.
Some of the more popular and easily recognized technical patterns include the following.
The Doji pattern is identified as a transitional candlestick. It shows that there is equality between the bulls and bears in the market. If the bulls try to buy the stock and make an upward push on prices, it is equally offset by a pull from the bears or vice versa. The result is that the opening and closing prices are the same in a Doji.
A long-legged Doji is identified when the upward and downward movement continues for a much longer period of time.
The Hammer trend appears in a candlestick analysis when a stock’s open, high and close are roughly the same price. Generally, there is a long lower shadow, at least twice the size of the actual body of the candlestick. This pattern is considered one of the most reliable candlestick patterns to help understand the movement of the price for a shorter period of time.
The Hanging Man
This trend occurs when certain conditions are met during a period of stock trading. The first condition is that the stock has been on an upward trajectory, with a long lower shadow. There should also be a smaller upper shadow. The candle is quite small in size.
Three Line Strike
This is a reversal pattern in technical analysis. It is used when the candlesticks are in an upward trend with a downward push by the bears of vice versa.
The first candlestick is usually big with a smaller high point and longer lower shadow. The second candlestick has a smaller low but continues in a decline. The third candle is positioned much lower on the candlestick chart with a very small lower shadow and a big upper shadow. It shows that there is a likely reversal in the future.
Three Black Crows
This is a bearish pattern that is similar to the three-line strike discussed above. The first two candlesticks show a decline with lower shadows getting shorter. The main difference is in the third candlestick where the lower shadow becomes bigger at the end. It means that the bears are in firm control and there is not going to be a reversal in the short term.
Technical Analysis Of Stocks can be very useful for traders as it helps improve their understanding of how the markets are expected to behave in the near-future. There are dozens of candlestick patterns that have been identified by brokers that help improve trading strategy.
We suggest that all traders should learn how these trends work as they can be effective for improving short term trading gains in the market.