Candlestick Patterns
Common candle formations that signal potential reversals or continuations.
Candlestick patterns are specific formations of one, two, or three candles that suggest what price may do next. Developed by Japanese rice traders centuries ago, they remain one of the most popular tools in technical analysis. Each candle shows the open, high, low, and close for a period. The shape, color, and relationship between consecutive candles create patterns that signal potential reversals, continuations, or indecision.
Why It Matters
Candlestick patterns provide early visual warnings of potential price changes. For options traders, a reversal pattern at a key support or resistance level can be the final confirmation needed to enter a trade. A bullish engulfing candle at support might trigger a bull put spread. A bearish shooting star at resistance might confirm a bear call spread. Patterns turn ambiguous price action into actionable signals.
The patterns are especially useful for timing entries. Knowing which direction to trade is only half the battle — knowing when to enter determines whether you buy premium at a good price or a bad one. Candlestick patterns provide that timing edge.
How It Works
Bullish reversal patterns (appear after downtrends):
- Hammer: Small body at the top, long lower wick. Sellers pushed price down but buyers recovered by the close. Bullish when it appears at support.
- Bullish engulfing: A large green candle completely engulfs the prior red candle's body. Strong shift from selling to buying pressure.
- Morning star: Three-candle pattern — a red candle, a small-body indecision candle (gap down), then a large green candle. Classic bottom reversal.
- Doji at support: A candle with almost no body (open equals close) at a support level signals indecision that often resolves upward.
Bearish reversal patterns (appear after uptrends):
- Shooting star: Small body at the bottom, long upper wick. Buyers pushed price up but sellers drove it back down. Bearish at resistance.
- Bearish engulfing: A large red candle engulfs the prior green candle's body. Buying momentum has been overwhelmed.
- Evening star: Opposite of the morning star — green candle, small-body candle, large red candle. Classic top reversal.
Continuation patterns:
- Three white soldiers: Three consecutive green candles with progressively higher closes. Strong uptrend continuation.
- Three black crows: Three consecutive red candles with progressively lower closes. Strong downtrend continuation.
Important rules:
- Context matters more than the pattern itself. A hammer at support is meaningful; a hammer in the middle of nowhere is just noise.
- Volume confirmation strengthens any pattern. A bullish engulfing candle on double average volume is far more reliable than one on light volume.
- Higher timeframes produce more reliable patterns. A daily chart engulfing candle carries more weight than a 5-minute chart one.
Quick Example
A stock drops from $80 to $68 over two weeks and approaches its 200-day SMA at $67. At $67.50, a bullish hammer candle forms on heavy volume — long lower wick, small green body. The next day, a bullish engulfing candle confirms the reversal. You buy a call spread with 30 days to expiration. The stock rebounds to $73 over the next week, and the candle pattern at the moving average gave you the confidence to enter.