Candlestick Analysis


Candlesticks originated in Japanese rice markets.
An underlying assumption in technical analysis is that price reflects all known information about the digital asset. Candlestick analysis looks at individual candles, pairs or triplets, to identify patterns and obtain clues as to where the market is going.

Engaging in candlestick analysis is less likely of necessity for a trend investor who takes three or four long positions a year. But for a trader working with shorter timeframes, let’s say a swing trader, a scalper or day trader, candlesticks provide great information on possible momentum changes, trend reversals, entry and exit points. Candlestick pattern complement price action trading, as well as the use of market indicators and chart patterns.

Candlestick Basics.
Each candle contains information about 4 prices: the high, the low, the open and the close of the day. That is traditionally true of candlesticks reflecting any stock market that opens sometimes in the mornings of a day and closes sometimes in the evening. If the candle is red, or black in black and white documents, that means that the open price is higher than the close. This would be a bearish candle. A green candle, or white in black and white documents, means that the close price is higher than the open. This would be a bullish candle.

In the stock market, the opening price of a stock may not necessarily coincide with the closing price of the previous day. There can be significant gaps between a stock’s closing and opening price. However, the Forex and crypto markets are continuous markets as they are open 24 hours during the week and 24/7, respectively! There are no afterhours or weekends in the crypto markets during which a trader’s sentiments may change and possibly causes gaps between close and open prices.

So, on weekly and daily crypto charts, a period’s closing price pretty much equals the following period’s opening price. The exception are possibly the combo of low-liquidity assets and faster intraday charts, those that run on hours or minutes. I see that closing and opening prices do not necessarily jive on TradingView charts then. In real time, price movements are not infinitely continuous, they do jump if ever so little.

Is that an issue for technical analysis in crypto? Candlestick analysis originated in the Japanese rice markets long ago. A lot of the current documentation on candlestick analysis relies on examples of the stock market. Some of the stock market’s candlestick patterns, involving two or three candles, account prominently for gaps between close and open prices. Some traditional candlestick formations, like the Morning Star or Evening Star, cannot occur identically in the slower charts of crypto markets because of the absence of timely gaps. In the crypto market, gaps – if you will – appear on slower charts as large candles.

To make matters worse, many reversal and continuation signals emitted by these candlestick patterns don’t work reliably in the modern electronic environment. Hedge fund managers use fast and fancy trading software to game retail investors like you and me by anticipating us to keep trading on textbook patterns. So, how does candlestick analysis work out in a fluent and volatile market for bitcoin and altcoins?

Candlesticks on a daily chart.
To be honest, I do not know. Accounting for 24/7 trading hours, most crypto analysts delimit days by simply utilizing Coordinated Universal Time (UTC), and otherwise improvise the best they can.

How does improvising work here? Well, every candlestick and every candlestick pattern of two or three candlesticks really speaks to the demand/supply issue, to the balance or imbalance between demand and supply during a particular timeframe in the market. A good trader does not simply buy or sell because s/he sees a candlestick pattern on a chart that exactly matches a candlestick pattern explained somewhere in someone’s website or textbook. A good trader tries to grasp the supply/demand scenario, and tries to get a sense of the mindset of the anonymous buyers and sellers or bulls and bears behind the chart patterns. Grasping and getting a sense for all that, however, is a skill which takes a bit of time to develop.

A long candle’s body with no or very short wicks indicates a definitive shift in this struggle for power, whereas a candle with a long upper wick beyond its body indicates a more contentious period with an effort by bulls to push price higher. Being unsuccessful, the price was pushed back by pressure from bears before the close of the candle. In other words, the length of the wicks versus the length of the body in combination with whether a candle is bullish or bearish can be used to determine a signal for the price action to come.

Candlesticks communicate a market’s sentiment during a particular timeframe. It’s important to keep in mind that the longer the duration of the candlestick, the more powerful its effect is on the overarching trend. That is, a hammer spotted in a hourly chart will have almost no impact on a 6-month long downtrend, whereas the reversal impact of a hammer formed on a weekly chart should be noted as much more significant.

Candlestick Formations

three line strike
Trend’s over, traders cover their shorts.
Candlestick patterns form comprised of two or perhaps three consecutive candles. These are short-term signals compared to chart patterns which take usually much longer to develop. Candlestick patterns work best within the time frame of the chart being reviewed. Their potency decreases rapidly after three to five additional bars have completed.

Some candlestick patterns still work well enough as they illuminate the price action moving one way, and then posit that price action may move in the opposite direction. These patterns imply that the emergence of long opposite-color candles rattle traders who were betting on the prior trend continuing, often forcing them out of their long or short positions as their stop-loss levels are hit. This helps fuel a continued move in the new direction.

These insights are usually put into context with support & resistance levels, volume and other chart indicators and patterns. While some traders may use candlestick patterns exclusively, I use them in my trading as an addition to price action.

Textbooks on candlestick analysis describe a considerable variety of candlestick patterns. Many of them are not significant enough or do not occur frequently enough to be kept in one’s memory. A few “stick” out, pun intended, and are elaborated on in many websites and cheat sheets. You’ll find that many similar-looking patterns are described under different names.

Naturally, traders might mostly be interested in reversal candlesticks and/or candlestick patterns.