Forex candlestick patterns are a popular tool to analyse price charts and confirm existing trade setups. They have been used for hundreds of years by Japanese rice traders and have made their way to the West through Steve Nison’s books. In this article, we’ll cover what Forex candlestick patterns are, how they’re formed, and how to trade on them.
Forex candle formations
Before we dig deeper into candlestick patterns, it’s important to understand how Forex candles are formed. Forex candles, or the candlestick chart, are OHLC charts, which means that each candle shows the open, high, low, and close price of a trading period. This is represented by the following picture.
The solid body of a candlestick shows the open and close prices of a trading period, while the upper and lower wicks of the candle represent the high and low prices of that trading period.
What are Forex trading candlestick patterns?
Forex Japanese candlestick patterns are specific candlestick patterns that can signal a continuation of the underlying trend, or a trend reversal. These patterns can be single candlestick patterns, which means that they’re formed by a single candlestick, or multiple candlestick patterns which are formed by two or more candlesticks.
Candlestick formations in Forex truly represent the psychology and sentiment of the market. They represent pure price action, and show the fight between buyers and sellers in a graphically appealing format.
While Forex candle patterns are a great way to confirm an existing trade setup, traders should be cautious when trading solely on candlestick patterns as there can be a significant number of false signals.
The most important candlestick patterns
- Bullish and bearish engulfing patterns
Bullish and bearish engulfing patterns are one of the best Forex candlestick patterns to confirm a trade setup. A bullish engulfing pattern forms when a green candlestick’s body completely engulfs the previous red candlestick, signalling strong buying momentum which breaks above the previous candlestick’s high. Bullish and bearish engulfing patterns are reversal patterns which include two candlesticks.
A bullish engulfing pattern is shown on the following chart.
Similar to bullish engulfing patterns, bearish engulfing patterns form when a large bearish candlestick completely engulfs the previous bullish candlestick’s body, signalling large selling momentum which goes beyond the previous candlestick’s low. A bearish engulfing pattern is shown on the following chart.
- Hammer and hanging man patterns
Hammer and hanging man patterns are also reversal patterns which form at the tops and bottoms of uptrends and downtrends. A hammer pattern forms at the bottom of a downtrend, with a small solid body and long lower wick, signalling that buyers had enough power to push the price back close to the opening price, hence the long lower wick. A hammer pattern is shown on the following chart.
A hanging man pattern looks similar to a hammer pattern, with the only difference being that it forms at the top of an uptrend. In this case, a hanging man pattern shows that selling pressure is growing – represented by the long lower wick - despite the uptrend. A hanging man pattern is shown on the following chart.
- Three inside up and three inside down patterns
Three inside up and down patterns are triple candlestick patterns, which means that they’re formed by three candlesticks. A three inside up pattern begins with a bearish candlestick, followed by a bullish candlestick which forms inside the first candlestick, and followed by a third bullish candlestick which closes well above the high of the first candlestick. A three inside up pattern is shown on the following chart.
Similarly, a three inside down pattern begins with a bullish candlestick, followed by a bearish candlestick which lies inside the first candlestick, followed by a second bearish candlestick which closes well below the first candlestick’s low. A three inside down pattern is shown on the following chart.
- Doji pattern
The final candlestick pattern which we are going to cover, and also one of the most important Forex chart candlestick patterns, is the doji pattern. The doji pattern is a specific candlestick pattern formed by a single candlestick, with its opening and closing prices at the same, or almost the same level.
A doji pattern signals market indecision. Neither buyers nor sellers managed to move the price far away from the opening price, signaling that a price reversal may be around the corner. A doji pattern is shown on the following chart.
As you can see, a doji pattern can form both during an uptrend and downtrend.
How to trade Forex based on candlestick patterns
Candlestick patterns are a great tool used by many Forex traders to confirm a trade setup. They should not be used to trade on their own, as they can produce a large number of false signals along the way. That’s why you need a trade setup already in place, based on tools such as chart patterns, channels, or Fibo levels, which is then only confirmed with a candlestick pattern, such as an engulfing pattern or hanging man pattern.
Forex candlestick strategy
As we've previously stated, the best Forex trading candlestick strategy is to use candlestick patterns for trade setup confirmations. Let’s take a look at the following charts, which show how to use candlestick patterns for day trading Forex the correct way.
1) Trading bullish pennants with engulfing patterns
The chart above shows a bullish pennant pattern which is confirmed by a bullish engulfing pattern. Once the engulfing pattern forms, a trade could enter in the direction of the pennant breakout.
2) Trading double bottoms with engulfing and hanging man patterns
The next chart shows a common double top pattern, followed by a pullback signalled by a hanging man pattern. Once the pullback is completed, a bullish engulfing pattern confirms the opening of a trade in the direction of the breakout. Bear in mind that these are only two examples of how to use candlestick patterns. You can combine them with all types of chart patterns and trading strategies.
Candlestick patterns are a great tool for trade confirmations. They represent the psychology of the market and the psychology of buyers and sellers who fight to move the price up and down. As such, candlestick patterns shouldn’t be used to trade on their own, but only to confirm existing trade setups.