Learning Lab: Chart Analysis
How to Read Candlestick Charts
Trading and investing decisions must be taken with a lot of consideration. From public sentiment, to inherent asset value, to global economic and political circumstances – there are a multitude of factors deciding the course of an investment. But more directly, the valuation and depreciation of an asset are decided by people as they buy and sell that specific asset. Therefore, it’s safe to say that the market reflects everything.
If we want to figure out where the market is going, a good idea can be to understand where it is coming from. And for that – charts provide the story of what people think and how they act. The valuation of a coin or token in time is clearly visible when we look at its time chart.
Whether it is long-term investment or day trading you are interested in, charts can help you identify market trends and predict future price movements. While there are several types of charts used in trading, this article will focus on the most common one used in crypto – the candlestick chart. Read on to get familiar with some of the most common and important chart patterns.
In this article you will learn about:
How to Read Candlestick Charts
Bullish and Bearish Patterns
- Dark Cloud Pattern
- Evening Star & Morning Star
- The Doji Pattern
The Market Reflects Everything
Candlesticks are one of the most popular charting tools used by technical traders. Depending on your desired settings, charts can display longer time frames – like days, weeks, months, or shorter intervals that are necessary for day trading and scalping (a trading strategy making high volumes off small profits).
Each candlestick indicates the opening and closing price of a certain cryptocurrency during a specific time frame. The candlestick is made up of two parts: the body, which shows the closing price during that time period, and the upper and lower wicks (also known as shadows), representing the opening and closing prices for that time period, respectively. You can use candlesticks to see patterns or trends in price movements, as well as determine support and resistance levels in the market.
What do support and resistance mean? This refers to the critical points at which people are willing to buy and sell respectively. A candlestick chart can give you a good indication in regards to what is the approximate price at which people will start selling the asset to take profits (resistance), as well as what is the lower margin that will attract people to buy, pushing the price back up (support).
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Bullish and Bearish Patterns
Did you know that price patterns form on the charts and fall into two main categories, Bullish Reversal Patterns and Bearish Reversal Patterns? It is not difficult to identify the Bullish Reversal Pattern. It has a short body representing the head of the hammer, while the longer wick is a sign that sellers were driving prices lower during that trading session, followed by strong buying pressure to end the session on a higher note. The upward trend must be confirmed by watching it closely for a couple of days (in case of a longer time frame analysis) and the reversal should also be validated by an increase in trading volume before you invest or buy options based on this information.
On the other hand, bearish patterns are formed when you see a small green (bullish) candle followed by a larger red (bearish) one with the second one engulfing the first on top of the price chart. Bearish reversal patterns indicate that selling pressure overwhelmed buying pressure for one or more time intervals, but it remains unclear whether or not sustained selling or lack of buyers will continue to push prices lower.
⏱️ The same logic applies if you are trading shorter time intervals. If one candlestick represents a 5 minutes time frame – the dynamics have the same principle, only that everything is happening faster.
Dark Cloud Pattern
The Dark Cloud Cover pattern is a bearish reversal pattern that looks similar to that of the Bearish Engulfing pattern. The difference between the two relates to the second candlestick. The Bearish Engulfing pattern has the second candlestick opening above the closing of the first, while the Dark Cloud Cover opens above the high of the first candle and closes below its midpoint. It occurs during an uptrend and needs to form on at least 2 consecutive bars. The pattern is significant as it shows a potential shift in the momentum from the upside to the downside.
Morning Star & Evening Star
The Evening Star and Morning Star candlesticks are two reversal patterns that tend to occur at the end of an upward trend or downward trend respectively. Both patterns consist of three candles – two candles in the same direction as the trend are followed by a bullish or bearish candle with a small body. The third candle is seen in the direction of the reversal, ideally closing past the halfway point of the first candle.
If confirmation signals are strong enough, traders can build a reliance on the reversal candlestick pattern. For example, traders will look for a bearish candle after the Evening Star signal. This is simple to use and can be very effective when applied correctly.
The Doji Pattern
A Doji is a candlestick pattern that looks like a cross as the opening and closing prices are almost the same – not something that you see very often. This candlestick appears when bullish traders push prices up while bearish traders reject the higher price and push it back down. This might be an indication that there’s indecision in the market: traders are waiting for a new direction to develop. Indecision could mean a potential reversal of the current trend or consolidation and can be a good moment to take advantage.
If you want to have an edge, it’s not enough to identify the market trend. To get a more accurate picture of what is happening with a given asset, it’s a good idea to pay attention to the market volume as well. Cryptocurrency volume is a key indicator of the health of any cryptocurrency ecosystem. It represents the total amount that has been traded over a given time, in monetary terms. Be aware that the total volume traded for a given cryptocurrency has a direct relationship with how volatile it is. ⚠️
Volume indicators are one of the most important tools when trading crypto. An increasing volume on several currencies can be an indication that a market is going up and the trend is more likely to continue. For instance, when there is a sharp increase in volume, then it might indicate an entry point for short-term trading.
On Balance Volume (OBV) is one of the most common volume indicators. It is a momentum indicator measuring positive and negative volume flow. The OBV formula is relatively straightforward: the current OBV is simply the previous OBV adjusted for today’s trading volume. If today’s closing price of an asset is higher than yesterday’s, then today’s trading volume is added to the previous OBV value. If today’s closing price is lower, then trading volume is subtracted from the previous OBV.
The smart trader can use volume to give clues as to where price might be heading and how much momentum a move has. Rising prices on declining volume point towards a declining momentum and potential reversal. On the other hand, falling prices on declining volume can equally signal a shift in direction.
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Learn to Read the Markets
While some chart patterns like the ones described above might indicate a certain market trend, we must understand that the market is actually made up of millions of people trading at the same time. There is no tool or method by which you can precisely anticipate what they will do at any given time.
However, sometimes clear patterns form and it helps in making a decision. Other times, a lot of the market display will be just random trades pushing the asset up or down. Some call it “background noise” – meaning, erratic market behavior not easily discerned. If what you’re looking for is not there, then the smartest decision could be to wait for a stronger signal. Trading and investing are closely related to timing. For both buyers and sellers, acting at the right time is of critical importance and implies much of the success or failure of a trade.
Learn to watch the markets objectively, without projecting your desires, expectations or fears upon them. This will allow you to see clearly and act at the right time. Learn to wait for a good opportunity and you will find out that trading and investing are very much a waiting game.
Do you want to strengthen your understanding of charts and market information? Read more in this blog – Learning Lab: Best Indicators for Swing Trading.
Keep an eye on our Learning Lab for more educational articles about crypto and blockchain. At Coinmetro, your crypto journey is fulfilling and meaningful, having all the tools and resources you need.
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