- Candlestick charts are financial indicators used in technical analysis to predict the direction of a future price movement
- Candlesticks originated from Japan’s 17th-century rice markets and are still widely used in all forms of financial trading
- Bearish candlestick patterns indicate a potential downward price movement
- In this article, we are going to cover the bearish candlestick patterns and their typical formations, such as hanging man, bearish engulfing star, and the shooting star pattern
Candlesticks are used in technical analysis to identify short-term price movements, price range, and overall market sentiment.
In particular, bearish candlestick patterns help traders identify a good market to short, catch a downward trend, and to reduce potential losses.
The origin of candlestick charts
The Japanese have been using candlestick charts since the 17th century by some accounts. However, the 18th-century Japanese businessman Munehisa Homma is widely regarded as the father of candlestick charts. He would draw candlestick charts to predict and trade rice contracts.
Rice trading was an attractive business at the time. The booming market gave birth to several financial inventions, most notably the first Futures exchange and Candlestick charts.
While the Japanese were already versed in financial trading, Munehisa approached the rice market from a slightly different angle. He sized up the extremely chaotic market by tracking the opening and closing prices alongside the highs and lows of the day. This gave him unique insight into the emotional state of the market.
By charting these elements under a single indicator, Homma created one of the price charts that is still used to follow price movements of liquid securities, currencies and derivatives.
Homma’s charts resembled rectangular shapes with tin wicks stretching from either side, hence the name ‘candlestick.’ Steve Nison later introduced this term to the Western world in his book, Japanese Candlestick Charting.
What are candlestick patterns?
The history of candlesticks is not just an intriguing trading tool but also offers an insight into why the candlestick charts are still frequently used today.
Candlesticks form into patterns. These formations are used to predict the future price movement. Because candlesticks provide context for market activity, they help technical traders evaluate current developments and decide on possible actions.
How to read candlestick patterns
Candlestick patterns represent price action. Each candlestick represents a price range (the body) as well as the opening and closing prices for that time period (the shadows or wicks).
The real bodies can show a range between open and close, while shadows highlight ups and downs beyond that range. Traders can choose an appropriate time frame for each candlestick, ranging from minutes to hours, days or even weeks and months. Candlesticks can form on any available timeframe in your trading dashboard.
As such, each candlestick offers six pieces of information:
Opening price: The top of a candle body represents the bearish opening price, while the bottom indicates the bullish opening price.
Closing price: The candle top indicates the opening price for bullish candles, and the bottom of the candle indicates the opening price for bearish candles.
Highest price: A top wick or the top of the candle’s body represent the highest price.
Lowest price: A bottom wick or the bottom of the candle’s body indicates the lowest traded price.
Price direction: Location and the colour signal the price direction.
Price range: The total distance between wicks reflect the difference between the highest and lowest prices, providing the price range for a session.
Bearish candlestick trading strategies
The next logical question for investors is to explore how candlesticks form into patterns that offer powerful trading signals.
Bearish candlestick patterns are formed when the market opens and then closes at a lower level than that of its previous session. This price action is largely caused by technical factors.
Your trading style would depend on your risk appetite, available capital and current market realities. For the sake of explaining the mechanisms of candlestick trading, we are going to explore some of the most established strategies to date.
Candlestick patterns usually form over a period of several days. Some strategies take longer, but most form over a period of 1-3 trading sessions (or candlesticks). For example, shooting star patterns form over a single session. Engulfing patterns require two trading candlesticks, and evening stars can take up to 3 sessions to form.
Hanging man candlestick
The hanging man pattern is a single candlestick chart pattern that forms during an uptrend and indicates a reversal of the current trend.
A Hanging Man consists of a single long upper shadow, small or non-existent lower shadow and a small real body near the top of the candle. This formation resembles the shape of a man hanging from gallows, hence the name.
The hanging man pattern is considered a bearish reversal candlestick pattern since it indicates that the prevailing uptrend has weakened or finished (at least for the moment). The colour of the candle (green or red) doesn’t matter in this case; only the shape matters.
Bearish engulfing pattern
Bearish Engulfing Pattern is a 2-candle pattern that forms over two trading sessions. The first candle is green. The second candle should open above the close of the previous session and trade within its body as it closes below the first candle opening position. The second candle formation completely engulfs the previous candlestick, hence the name engulfing pattern.
The bearish engulfing pattern is a bearish reversal candlestick pattern, indicating a possible change in market sentiment from bullish to bearish.
Evening star pattern
The evening star pattern represents a bearish reversal candlestick pattern that forms at the end of an uptrend. The evening star consists of three candles:
- A long bullish candle
- A short middle candle with little or no lower wick
- A long bearish candle that closes well into the first candle’s body or beyond
The colour of the middle candle does not matter since this is a reversal pattern. The evening star appears at the end of an uptrend, signalling a bearish reversal.
Shooting star candlestick indicator
The shooting star chart pattern represents a single candle with a long upper shadow, small or non-existent lower shadow and a small real body near the bottom of the candle. This formation resembles a star that shoots across the night’s sky.
The shooting star candlestick formation is considered a bearish reversal pattern since it indicates that the prevailing upward has lost its steam for the moment. Once the shooting star is confirmed, this formation can create an opportunity for short sellers to enter the market.
Candlesticks are used in technical analysis to calculate the potential price movement. These charts go centuries back and still make for one of the essential trading tools available to Forex traders.
With candlesticks chart formations, traders can tame chaotic markets and identify a viable trading opportunity. In addition, their ease of use and implementation makes for one of the most accessible chart patterns to learn.
With that said, it is crucial to note how all forms of trading includes a risk. Nobody can guarantee profits. But, with the right trading strategy in place, traders can make money with virtually unlimited upside potential.
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