One of the legendary figures who greatly influenced the trading world is Munehisa Homma (moo-ne-hee-sa ho-ma), who was known as the “god of the markets” of his time.
Originally a rice merchant from Sakata (sa-ka-ta), Japan, Homma became an expert rice futures trader at the world’s first formal futures exchange — the Dojima (do-jee-ma) Rice Exchange — in the 18th century.
Homma came up with a system that spots repeating patterns and trends in rice commodities pricing, which was instrumental to his success. Today, that system is referred to as the “candlestick”.
A candlestick chart is a type of financial chart that describes the price movements of an asset. Each candlestick represents all four pieces of information. This includes the market’s open, high, low, and close price for the day.
This part — called the “real body” — shows the price range between the open and close of the day’s trading.
The lines above and below the real body are called shadows, tails or wicks. They represent the low and high price ranges of the day. However, remember that not all candlesticks have wicks.
Black or green candlestick indicates that the close is higher than the open. When the close is lower than the open, the candlestick will be shown in white or red instead. Keep in mind that not all candlestick charts use black and white, and some trading platforms allow colour customisation.
Before we go over the candlestick patterns, we must first understand what bullish and bearish patterns mean. A bullish pattern indicates that there is a good chance that the price will rise. If you see a bearish pattern, buckle up because it indicates that the price is likely to fall.
This is a Bearish Engulfing pattern. You can see that the real body of the green candlestick is engulfing the red candlestick’s real body. This pattern occurs when there are more sellers than buyers, which implies that the price could continue to fall as the sellers are back in control.
It also has a bullish counterpart called — you guessed it — the Bullish Engulfing pattern. This time, it is the red candlestick that is engulfing the green candlestick. As the buyers outpace the sellers, this could signal an eventual price hike.
The Evening Star pattern consists of three candlesticks. The first candlestick has a large red body, followed by a second candlestick with a small green or red body gapping above it, and then finally ending with a green body candlestick that closes somewhere in the middle of the first candlestick’s body. This bearish pattern is often an indication that the price uptrend is nearing its end.
The bullish counterpart of the Evening Star pattern is the Morning Star pattern. The first large green candlestick precedes a short green or red candlestick gapping below it, followed by a third large red candlestick that closes well into the first candlestick. Much like the Evening Star pattern, this is an indication of a price trend reversal. Be prepared to witness a price rebound.
If you’re seeing a pattern consisting two candlesticks where the first one is larger than the second one, this is what we call the Harami (ha-ra-mee) pattern. Its name means “pregnant” in Japanese since it resembles a mother carrying a child in her womb. These two candlesticks are never the same colour. If it’s bullish, the first candlestick is green while the bearish one has red for its first candlestick. Much like the Evening or Morning Star pattern, it is a sign of an impending changing trend.
If the second candlestick is a Doji (do-jee) — which means that the candlestick has opening and closing prices that are virtually the same — it is a Harami Cross pattern. It’s similar to the Harami pattern as it also signals a possible trend reversal.
Finally, the Bullish Rising or Bearish Falling Three are five candlesticks patterns where three small candlesticks are sandwiched between two longer candlesticks. If it’s bullish, there will be three falling green candlesticks trading above the low and below the high of the first red candlestick. If it’s bearish, the colours are reversed and the three candlesticks will be in the rising formation instead. These are considered trend continuation patterns.
However, do note the market moves in random steps ultimately. So, as much as a pattern signifies a higher probability that something is going to happen, it may not.