A Full Guide to Forex Candlestick Analysis and Candle Pattern Trading Strategies
Forex technical analysis is a very wide spread concept that includes various components: from several analytical approaches to take, to specific charts and tools to work with. Just like anything else about the currency trading market, the technical analysis can be mastered by virtually anyone. However, it is also fair to say that becoming a successful analyst will definitely require some time and energy. The best way to go about it is to break down all the information into segments and go through them one by one. This way you can ensure that all of the necessary information is covered and you have an appropriate amount of knowledge to do your own analysis and productively trade based on its results. In this guide we are going to focus our attention on a very specific part of technical analysis - understanding and trading with candlestick charts. We will cover the following:
Main principles of technical analysis
The most and least popular types of market charts
What is candlestick in Forex trading including its origins, structure and formation
Some of the common chart patterns, both simple and complicated
Basic candlestick trading strategy guidelines
The best way to practice candlestick analysis for free
What is Forex technical analysis and how does it work
For starters, it is important to take a couple of moments to discuss the idea behind technical analysis altogether. It is a well known fact that professional traders pay a large portion of their attention to the part that comes before the actual trading process. This preparation includes the analysis of the market and the development of an action plan that will cover the steps the trader is looking to take in order to achieve the set target. Trading action plans, also known as trading strategies, vary on a number of factors to fit each trader’s personal trading style and capabilities. The same goes for choosing the correct market analysis approach to accommodate special needs and resources.
There are two major types of Forex analysis: fundamental and technical. Fundamental analysis is considered more tricky and far more subjective compared to the technical one. The basis of fundamental analytics is taking place outside of the market itself, more specifically this kind of analysis focuses mainly on what affects the market to begin with. This can include political situation in the countries that control major currencies, social events and economic trends around the world. Very obviously, you need to be an expert in all of the above mentioned to have a clear understanding of what is going on. That is why traders who base their Forex strategy on fundamental analysis, aka the traders who prefer trading on news, choose to find a reliable source of fundamental analytics and stick to it. Having the results just presented to you with the easy to follow interpretation saves a good deal of time and lets you avoid the overcomplicated analysis process.
On the other hand, there is a more approachable and therefore more popular type of market analysis - technical. Technical analysis of the Forex market is purely mathematical and takes origins in theories like Dow theory and Elliot wave principle, and focuses primarily on the price itself. By studying the course a single currency pair takes, traders can both understand the nuances of its behavior and predict the upcoming changes. As mentioned before, there are many ways to perform technical analysis. And there are also a lot of tools to do it. Some of the handy support instruments for this kind of analysis are technical indicators: trading platform add-ons designed to extract all sorts of statistics from the chart and assist traders with building the strategy. As you have probably figured, in technical analysis, all the data you might possibly need is presented on the chart. And proper understanding of charts is always a foundation for a productive analysis.
The types of Forex market charts
The new traders often get overwhelmed when taking a first look at the chart. However, the market experts might even say that there is a certain beauty to the way price forms a graph. In Forex trading, a market chart is simply an expression of price movement at a specific period of time. Depending on the trading strategy and the analytical approach, traders tend to use various timeframe settings and chart types to have the information presented to them in the most convenient way. Some of the most popular chart types are: line, bar and candlestick. The line charts are expressed as a broken line that connects closing price values over the selected time period. This kind of chart is considered a good way to observe the big picture and notice major trends, but it is also widely advised to combine the line chart analysis results with a different graph like bars or candles for a more thorough overview.
The bar chart is a step further from simplified line chart. Here the information about the price is expressed through bars - vertical lines of different lengths with smaller horizontal markings on top and bottom. The top and the bottom of each bar represent the high and the low values respectively. The marking to the left indicates the price value during the opening of the chosen period and the marking to the right is the closing value. If on the taken bar closing value is above the opening one we can read it as the price increasing signal, and this type of bar will be called bullish. And on the opposite, if the opening value is higher than the price is decreasing and the bar in front of us is bearish. The words bullish and bearish will come up quite often during your Forex journey, so concentrate on getting them right.
We are going to go into the third most popular type of charts a bit later. Just before doing that, let’s quickly look over the two least popular chart types which are still sometimes used by the currency traders: renko charts and point and figure charts.
Renko charts are somewhat similar to the bars and candles, but they form a little differently. The renko graphs consist of bricks which can look like either vertical boxes or vertical lines. All bricks are going to be the same size, and differ in color based on their bullishness or bearishness. The new brick forms when the price surpasses the current low or current high on the existing brick, the new arrival will go either slightly higher (if the price is increasing) or slightly lower (if the price is going down), but never on the same line. When trading on this kind of charts traders pay attention to the amount of bricks prior and after reversals, as well as the pace of their formation. Unlike the majority of Forex market charts, point and figure graphs do not focus on the time but rather on the direction and significance of the price movement. The visualisation in this type of chart can resemble a video game of Tic Tac Toe - a bunch of O’s and X’s forming columns of various heights. The main characteristic of this chart is that it can be drawn differently by each separate trader, because here the traders themselves choose which information they want to include and what they want to disregard.
Now that we have covered the Forex market charts in general it is time to move on to the main focus of this guide - candlestick Forex analysis and how to read Forex candlestick charts.
What is candlestick in Forex trading
Candlesticks are often referred to as Japanese candles, because they are believed to take origin in 18th century Japan. This was a way for ancient rice traders to keep their books, and the method has proved so effective that now this type of chart is used globally across every market including currency, stocks and commodities. In Forex, candlesticks are the visualization of the theory that price describes everything you need to know. The currency exchange market is driven by so many things like economy, time of the day and purely human factors like greed and stress. All of this is conveniently described through candlesticks for the trader to decide what actions should they take next.
As we move along to the structure, let’s break down each element of the candle. The first thing you notice as you look at one separate candle is its body - a vertical box that might differ in height and color. Just like the bar each candle can be either bullish or bearish and depending on your Metatrader visualization setting they may be different colors. More often than not, the bullish candles are green and the bearish - red.
As bullish candles appear when the closing price is higher than the opening one, in the bullish candle the top line of the body will represent the closing value and the bottom will stand for the opening. The two vertical markings on the top and the bottom of the body are called the witch and the shadow respectively. The peak of the wick represents the highest value throughout the chosen time period and the shadow represents the lowest.
On the contrary, in bearish candles the opening price stands above the closing one, therefore the price is going down. So in the bearish candle the top stands for the opening price value and the bottom for the closing one. The wick and shadow remain the same - the highest and lowest values accordingly.
Depending on the chosen time period each candle can hold different values. This way on the daily chart every candle will represent an hour, while on the 60 minute chart it will can represent as low as one minute of the time at the market. Based on this candles vary in size - the more the difference between closing and opening values the longer the candle is going to appear. In order to successfully learn how to read Forex candlestick chart every trader has got to start by getting comfortable with determining what each particular candle represents on its own. And then it will be time to explore a fun candlestick chart concept - the chart patterns.
Technical Analysis in Forex trading with candlesticks and patterns
We already know that there is plenty of information we can get from each individual candle. Depending on the period of time expressed at the chart every candle can show at what value the price opened and closed a specific time segment as well as what were the highest and the lowest values during that period. Now, what takes the technical analysis to a whole other level is to understand and master candlestick pattern trading.
Trading experts like Charles Dow believed that the price moves in patterns, meaning that each particular move has its designated meaning and what’s more, each pattern is bound to occur from time to time since the market proves to constantly fluctuate. This way when one candle or a set of candles form a distinguishable shape we can make certain judgements about the situation at the market and build the trading process accordingly. There are definitely a lot of patterns to learn about, but as long as you keep an eye out you will quickly notice that every chart is nothing more than a set of patterns and this will make your trading life much easier. Plus, the fun part about getting to know the various patterns is that most of them have very memorable and quirky names which make them simpler to spot and remember. Next we will cover some of the simple and some of the complex patterns that you will come across most often.
Simple candlestick Forex analysis patterns are the one consisting of just one candle, however they are capable of carrying enough information to form a decision. Here are some of them:
Regular candles indicate either a bullish or bearish pattern and are formed the way described above. As previously mentioned, they can differ in color based on the MT4 settings.
Big red/green candle. Disregarding of what color it is the big candle has an unusually long body with short wick and shadow. This type of candles usually appear on long term charts where each period can have a significant difference between open and close. Depending on what color it is this candlestick indicates either a bullish or bearish pattern.
Doji candles look like plus signs and occur when the opening and closing values are so near each other they are practically the same. However, the lengths of the wick and shadow may vary. Doji with extremely long wick and shadow are called long legged doji and can point to the strong pushes from opposite sides of the market.
Dragonfly Doji looks like a tall capital T and occurs when the opening and closing prices were near the highest value. The longer the shadow the higher is a chance for an upcoming bullish trend. It can also be read as a reversal signal if found at the bottom of the chart.
Gravestone Doji looks like the dragonfly doji turned upside down and means the opposite accordingly: the opening and closing prices were near the low, the long wick indicates a bearish trend and if located at the top of the market can be considered a reversal signal.
Hanging Man is a candle of either color with a small upper body and the shadow up to three times its size. This candle can indicate a bearish pattern in the middle of an ongoing up trend.
Marubozu candle is a regular or long candlestick with neither a wick nor a shadow. It appears when the opening and closing values matched the highest and lowest values and can be read as a continuing trend pattern.
Spinning Top candle has a small body and the lengths of the wick and shadow can differ. It is mostly considered a neutral pattern but can serve as a part of more meaningful complex formations.
Complicated or complex candlestick patterns are formed out of two or more simple candles and depending on the positioning can indicate different things. Here are some of them:
Bearish Harami is a combination of a large body bullish candle followed by a small bullish candle contained within the range of its bigger partner. This pattern can indicate a bearish trend if comes at the end of an upwards movement.
Bullish Harami is a large body bullish candle with small bearish one contained within its range. The meaning is the exact opposite from bearish harami - it can be read as a signal for a bullish trend if comes after a downwards movement.
Evening Doji Star is a formation of three candles: a large bodied bullish candle followed by a doji start at the top and then a large bodied bearish candle located higher than the bottom of the first candle. This can be easily interpreted as a reversal signal when found at the top of the chart.
Falling Window is a pattern when the candle appears significantly lower than the one prior to it. This gap between them referred to as window usually indicates the high amount of resistance.
Three White (Green) Soldiers are three large bullish candles appearing one higher than the prior. This is a strong upward pattern and indicates a reversal when located at the bottom of the chart.
As you get to know most of the patterns you would have no problem indicating them and utilizing them for successful technical analysis in Forex trading with candlestick patterns. Let’s now briefly go over some of the popular trading strategies directly related to candlestick patterns.
How To Use A Forex Candlestick Chart In The Trading Process
Now you have a good understanding of what is candlestick Forex analysis and how to read a candlestick chart, so it is time to put this knowledge to good use and apply it to the real market trading. What is important to remember here is that each trader has a different strategic approach, and therefore one particular pattern can be used in a number of ways depending on what kind of signal the trader expects. This is why here we are going to go over a few guidelines how candlestick patterns be used during the trading process:
Learn to differentiate the trend patterns from continuation ones. Depending on the specific formation of candlesticks and the overall situation on the market a certain pattern can indicate either that the trend is continuing and will keep going in the same direction or if the reversal is about to take place. You can look out for reversal signals using the patterns we have discussed above. And if before you is a formation of candles that create a string upward movement path followed by a number of candles that slightly lean towards the low, almost as sure as day you have a consolidation flag in front of you which indicates that the ongoing trend is currently on pause but will strike towards new heights later on. The exact opposite goes for downward trends.
Pick a set of patterns to work with. This will allow you to focus your attention in the same direction and not get sidetracked by any occasional confusing patterns. Additionally, due to the repetitive nature of Forex, by being persistent you can guarantee yourself with the slowly but surely type of success. A good example of this is a triple top pattern: when the bearish candles’ wicks on three candles reach the same height within one segment of fluctuating chart the upcoming downward movement is most likely to occur. By promptly spotting this pattern the tarder can avoid major setbacks in case they are going long.
Set rules for dealing with each pattern. In most cases the strategy you choose will indicate how are you to behave in certain situations. But in case you are creating your own course of action, stick to doing the same actions in relation to the same patterns. Again, consistency is the key and by mastering as little as one pattern you can reach great amounts of productivity.
At this point you already know a great deal about candlestick Forex analysis and can certainly begin to implement this knowledge in your trades. However, before you go on to the real market it is also good to practice the newly gained skills in the risk free environment. In the following short section we will briefly cover the way to practice candlestick analysis for free without risking any of your personal funds.
How to practice candlestick Forex trading for free
Practice always makes perfect, but when it comes to risky areas such as currency trading funding the right way to practice can get tricky. Some traders get trained in their analytical skills by analyzing the charts but not trading based on this analysis, and while this a good way to really learn how to interpret Forex charts, it will not give you even the slightest idea of would this analysis prove itself effective in the conditions of an actual market. One of the solutions here is to make small trades based on the analysis results and see how they play out. But for the new traders having to risk their money no matter how small just to practice is highly irresponsible and simply not an option.
This is where Forex demo accounts come in extremely useful. A demonstration account is an exact copy of a real online trading account with the one difference being - all the trades in practice mode are simulated and have no real repercussions on the market. This way both market newbies and professionals can benefit from experimenting with various analysis approaches and working out the right strategies for their future real trades. As for the candlestick analysis in particular, trying it out in demo mode first can be beneficial for a number of reasons:
The setup of a demo account is the same as in the real account. The trader can take their time to get to know both the platform and the charts. It is also a good idea to try different visualization options and set up to save yourself adjustment time once you are ready to trade for real.
All of the trading indicators are available in demo mode, so you can try each and single one of them to see how they work and choose the ones that serve your chosen strategy most effectively.
Besides practicing identifying the patterns you can also try out different ways to act around them. By seeing how a certain action plays out in relation to specific patterns you will get a good understanding when you should act fast and when you should ignore the entire signal altogether. Since all of the market data in demo is taken from an actual market you will see the precise outcome of each experiment without risking any actual money.
Summary of technical analysis Forex with candlestick and patterns
Candlestick trading has its followers and you might become one of them as you get more comfortable with the matter. The best thing is when it comes to technical analysis in general and candlestick pattern trading in particular - anything is possible and with the right mindset you will definitely achieve even the highest goals. Take in as much knowledge as possible and do not hesitate to practice your skills in demo mode. It will not be long before you are ready to open and activate a live Forex trading account and start getting a steady income flow like a pro.