- Candlestick charts have rectangular-shaped indicators that reflect the price range and direction in a given time frame
- Continuation patterns indicate that an existing trend may continue even if there is a short period of weakness.
- As such, they may offer indications on when traders should stay in, enter, or exit a position in order to benefit from the continuation of the same trend
- In this article, we are going to cover the continuous candlestick patterns and their most common formations, such as Doji, spinning top, and falling and rising threes
Traders are always looking for an edge when buying or selling a currency pair. One way to find that edge is to use candlestick patterns that reflect trend continuation.
And by using the continuation candlestick patterns to make trading decisions, you can place trades that pose a higher probability of securing a profit.
What are candlestick patterns?
A candlestick consists of a rectangular-shaped indicator with a maximum of two vertical lines on either side, also known as wicks or shadows.
Candlesticks can also form a single wick if the price is tipped to the bullish or bearish side, forming a hammer or a hanging man indicator. However, candlesticks cannot have more than two wicks, as each one represents maximum and minimum price movement in a given session. The top wick represents the highest traded price, while the bottom wick represents the lowest treaded price in the session.
Candlestick patterns are price charts formed by groups of one or more candlesticks. These formations sum up the total sentiment of the market, including the opening, closing, highest and lowest prices of a specific trading session.
There are a number of candlestick patterns in technical analysis that can be used to determine the overall trend and when or whether it will reverse.
Traders can use these patterns to establish a profitable trading strategy. However, they first must have an understanding of how these patterns work in order to use them effectively to make a profit.
The origin of candlestick charts
Traders have been using candlestick charts for centuries. The study of modern-day candlestick patterns is based on the work that Steve Nison did when he published his first book, ‘Japanese Candlestick Charting Techniques’, in 1991.
Nison is widely credited for introducing candlestick charting to the West. However, this form of price analysis has been around since at least the 1700s, being used in Japanese rice markets.
What is a continuation pattern?
Besides bearish and bullish patterns, candlesticks can also indicate a trend continuation. A continuation pattern can signal that the existing trend will continue and could be traded in the same direction even if it has suffered a short-term weakness.
In other words, if a trader is long on a currency pair and there is a bullish continuation pattern above the current market price, the trader should continue holding his position. If the trader is shorting the same current, hoping for a reversal, it is advisable to sell the asset to avoid short-term losses.
On the other hand, a bearish continuation pattern can help short sellers recognise trend continuation and help them hold on to the short positions despite price rallying for the time being. This is because bearish signs indicate downward price movement will continue throughout the current trend, or at least for some period of time.
Keep in mind that it usually takes more than one candlestick to confirm a trend continuation.
How to read candlestick patterns
Knowing how to spot when a certain pattern occurs in relation to the trend is the key to using the candlestick patterns effectively.
Each candlestick represents a price range (the body) as well as the opening and closing prices for that time period (the shadows or wicks). Candlesticks reveal six key pieces of information that reveal the current market sentiment.
Opening price: The top of a candle body denotes the opening price for bearish candles, while the bottom represents the opening price for the bullish candles.
Closing price: The candle top denotes the opening price for bullish candles, and the bottom represents the opening price for the bearish candles.
Highest price: Top wicks or sometimes the body represent the highest price traded in a given session.
Lowest price: Bottom wicks or sometimes the body indicate the lowest traded price for the given session.
Price direction: The price direction can be determined by the colour and the location of the candle.
Price range: The distance between wicks reflect the difference between the highest and lowest prices, providing the price range for a session.
Continuation candlestick trading strategies
Now that we have covered how to read candlesticks, the next step is to explore what a formation of candles into distinguishable patterns would mean for traders and investors.
Traders often observe other indicators alongside candlestick formations, including moving averages, to support their decisions when buying or selling.
A Doji candlestick pattern is a special type of price bar. It occurs when the candles show almost no difference between opening and closing prices for the given time period. This candle formation resembles a cross because the body is virtually non-existent but has two wicks on both sides.
Doji signals that there was little to no buying or selling pressure.
If the Doji is white, it means there was not enough buying power to push the price higher than where it opened. If it is black, then the market lacked selling pressure to push prices lower than their opening level.
The Doji candlestick pattern tells traders that even though there was no sufficient momentum, the market still expects prices to continue in the same trend.
Spinning top candlestick pattern
A spinning top is a candlestick pattern that resembles a cross, a similar one to the Doji candlestick. However, the wicks are much longer in the spinning top formation, signalling a much greater price range in a given period.
A spinning top candlestick is generally a sign that buyers and sellers are evenly matched at a given price level, which means that it will be difficult to confirm any future movement, and the price could linger around the same levels.
The spinning top candlestick also has two shadows, one on the bottom indicating the lowest price for the session and another appropriately located on top of the candle to represent the highest price.
Falling three pattern
A falling three pattern is a bearish continuation pattern that consists of a large bearish candlestick body followed by three consecutive price bars, each with a higher close than the previous. The bullish bars should not exceed the size of the first candlestick. One long bearish candlestick closing above the first candlestick is needed to close the pattern.
Rising three pattern
The rising three candlestick pattern is similar to the falling three.
This pattern signals a bullish trend continuation. It consists of a large bullish body followed by three consecutive price bars, each one closing slightly higher than the previous. Short bearish bars should not exceed the size of the first bullish candlestick. Finally, a long bullish candlestick has to close above the first one to signal the close of the rising three pattern.
Continuation patterns show that an existing trend may continue regardless of some temporary weakness. As such, they may provide clues to when traders should stay, enter or leave a position in order to capitalise on the continuation.
Sometimes it is difficult to imagine all these trading situations without trying actually to trade in real markets. It is important to remember that all forms of financial trading carry a degree of risk and nobody can guarantee profits, so it is advised to trade sensibly.
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