For a lot of people, the stock market appears utterly chaotic. Numbers go up and down, seemingly beyond anyone’s control or ability to predict. And to a certain extent, that is true. 

No one can perfectly predict exactly what will happen with any particular stock, much less the whole stock market.

If you ask two economists, whose job it is to study these things, where the economy will be in a year, they are likely to give you two completely different answers.

So, if people who stare into the abyss for a living can’t tell whether it’s staring back or not, what hope does an ordinary person have of just trying to make some money? More than you’d think.

You see, the thing about the stock market is that you do not need to know exactly where it’s going. You just need to know whether it’s going to go up or down. 

How do you do that? Well, whether you are talking about analysing things for the long-term or the short-term, one of the most popular ways to determine what will likely happen next is by reading charts, and the patterns that commonly form within them. But there are some things you need to learn first.

Table of Contents:

• Which Charts Do Traders Read
• The Chart Patterns You Need to Know
• Patterns that Apply Over a Week or More
• Patterns that Apply Over the Course of a Day

Which Charts Do Traders Read? 📊️

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There are lots of charts associated with the stock market. There are bonds, futures, currency values, options chains, volume, moving averages, and so on and so forth. You can make yourself sick trying to read and understand them all. Fortunately, the kind of chart we are talking about is much simpler.

In order to be a successful trader, all you need to learn to read is the price chart—specifically, the candlestick chart. Don’t know what a candlestick chart is? That’s fine, I’ll teach you. The first step is understanding the difference between a common line chart and a candlestick chart.

The Line Chart

If you use Google to search for a stock price right now, what you’ll see is a line chart. This chart shows how the price of the stock has changed over time. But how does it get those prices? Well, it varies from place to place. Most places use “five-minute charts”, meaning that each point in their line chart is the average price of the stock within a five-minute period

So, to recap: search the price of Apple’s stock. Mouse over a point on the line chart. It will give you a price at that given time. If you mouse over what the price was at 10 AM, for example, it will show you the average price Apple’s stock traded at from 10:00 AM to 10:05 AM on that day.

That one number does not tell the whole story, however. Hundreds of trades are made every minute, and thousands can be made within a five-minute window like that. These trades can include prices that are much higher or much lower than the price shown on the line chart. That is where the candlestick chart comes into play: It is a chart designed to show both the average price and the extreme range of trades in a time period.

The Candlestick Chart

To understand a candlestick chart, you have to understand the candlesticks that make it up.

A candlestick is a symbol with a solid body and up to two “wicks”, one on top and one on bottom. The body will either be red or green, while the wicks are always a neutral colour like white, grey, or black.

Find a candlestick chart of Apple’s stock price and you will see candlesticks with highly varying lengths of both their bodies and their wicks, as well as the colours alternating between red and green. So, what are we even looking at here? Let’s start with the lengths of the candlesticks’ bodies.

The Length of a Candlestick

The length of a candlestick shows the difference between the opening price and the closing price of the stock in a given period. Similar to a line chart, a candlestick chart will usually measure in five-minute increments. 

That means a long candlestick at 10 AM shows that the price of the stock changed a lot between its average at 10:00 AM and its average at 10:05 AM. If the candlestick is short, then the price did not change all that much.

The Colour of a Candlestick

Now let’s look at the colour. A candlestick can either be red or green. A red candlestick means that the price change was negative. A green candlestick indicates that the price change was positive. 

Is it really that simple? Well, mostly. You have to be careful of how you read the different coloured candlesticks. A green candlestick should be read “bottom to top”, as the price started low, at the bottom of the candlestick, and then went up. A red candlestick should be read “top to bottom”, as the price started high at the top of the candlestick and then went down.

The Wicks of a Candlestick

In addition to the length and colour of the candlesticks, you will notice little lines coming out of the top and bottom. These are the wicks, and they represent the variance in trades during the time that the candlestick encompasses. What does that mean? Well, consider that calculating the average price within a five-minute period also means calculating the outliers. This is what a line chart excludes.

These wicks on a candlestick will show you the extremes of how high people were selling and how low people were buying in this time period. This is important, as it shows you whether or not more people are buying low or selling high.

Technically speaking, the wicks show all transactions outside the bounds of the price change. Someone might have bought high and someone else might have sold low. But a vast majority of the trades being signalled by a wick will be purchases of a stock under the candlestick and sales of the stock over it.

What is the Meaning of a Candlestick and its Wicks?

Now that you know what a candlestick is, you are probably wondering what to do with this information.

Well, look at your candlestick chart of Apple’s stock again. Somewhere in there you will find a candlestick with an absurdly long wick going one way or another. You might find a candlestick with a tiny body, either red or green, and much larger wicks. You will definitely find candlesticks with a long body and a long wick on top or bottom, while the opposite wick does not go very far at all.

All of these individual candlesticks tell a story about what the stock did. And taken alongside the adjacent candlesticks, you can start to see what is going on with the stock at a given time and perhaps where it is headed next.

That is what it means to read a candlestick chart. And this is what many stock traders, from day traders to swing traders, read in order to make their money.

The Chart Patterns You Need to Know 💡️

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Only once you understand these candlesticks can you expect to understand the patterns they form. But once you do, the patterns are the next step to maximising your trades.

I am going to go over the 10 candlestick patterns that you absolutely need to know. What you will find is that some chart patterns concern how a stock’s candlesticks look over the course of a day, while others can be applied to as long as a week, and others only concern themselves with three consecutive candlesticks within a 15-minute period. All of them are valid, however.

I will separate the chart patterns into two different categories: First are the patterns that are usually applied over the course of a week or more. And second are the patterns that can really only be applied during the middle of the day, usually by day traders and scalpers. 

Patterns that Apply Over a Week or More 🔎️

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1. The Head and Shoulders Pattern

When you find this pattern during the day, the head and shoulders pattern is something you will notice in a stock with a lot of price action. People will find it much more common during a week, but it is an important pattern to be able to spot because it can be applied to so many different timescales.

The idea is simple: First, you establish a neckline. This neckline is where the price of a stock refuses to fall beyond. The wicks of candlesticks can pass the neckline, but ideally all the price action of a stock reaches a hard stop at this neckline. Any time the price comes down to this neckline, it should “bounce” off of it and go back up again.

The head and shoulders pattern consists of six big price movements. The first is the move up from the neckline, and then the second is after the highest point of that neckline is reached and the stock moves back down. These two actions form the first “shoulder” of the head and shoulders pattern.

The third action will be another rise in the stock price, resulting in a high that exceeds the high set by the first action. Then, the fourth movement will bring the price back down to the neckline again. The last two actions will be a rise to the high of the first shoulder, followed by a fall that completes the pattern.

Why is this Pattern Important?

What you are identifying when you notice a head and shoulders pattern is that a stock’s price rose for the head of the pattern but is not necessarily on an upward trend. In fact, once a head and shoulders pattern is complete, the stock price will usually fall down below that neckline.

Identifying this pattern can alert you to when a stock does not have the energy to go into that upward trend and is therefore “owed” a downward trend due to the natural entropy of the market.

And of course, you can also read an inverse head and shoulders pattern. A normal head and shoulders pattern will tell you when a stock is about to fall. An inverse head and shoulders pattern will tell you when a stock is about to rise.

2. Cup and Handle

Whenever you see a stock reach an impressive high and then drop, you should look for the signs of a cup and handle pattern. The pattern can be made of many different price actions, but there are five that are the most important. The first is the big climb up. As we said, you will see this before anything else, as the stock price will usually reach a new high for a period of time. The second action is it falling down.

This fall should not bring the price of the stock down below where it was before the climb. If it does, it is not a cup and handle pattern. What it should do is enter the price into a period of “consolidation”. That means that the price will go up and down a ton, struggling to either rise or fall. This is the “cup”.

When I mentioned that there are many different price actions associated with this pattern, it is because periods of consolidation like this will have potentially dozens of tiny rises and falls, all amounting to the price not moving much. A lot of action, but no significant movement. 

That is until the price suddenly climbs up in the third important price action of the pattern. It will usually not reach the high of the first price action at this point. What it will do is enter another, much shorter period of consolidation. This fourth action is the “handle”, and it precipitates the last action: A rise above the price reached at the height of the first action.

Why is this Pattern Important?

Everyone is going to run into a moment where a stock of theirs rises in price, and then falls before they sell. What this pattern does is tell you whether or not holding is worth it, as a cup and handle pattern is one of the most consistent indicators of a stock’s ability to recover from such a fall.

But even if you were not invested in the stock beforehand, seeing a stock rocket upwards and then fall down into consolidation might get you interested in it. This pattern lets you know that the stock still has upside potential even if it seems to be struggling to rise.

3. Rounding Bottom

One of the most difficult times to commit to a trade is when a stock’s price is in a rounding bottom pattern. But at the same time, this pattern is also one of the best times to commit to a trade.

The rounding bottom is unique in that there are only two price actions of any significance within it. First, the price of the stock will fall. It might fall suddenly, it might have been consolidating, it might have even plummeted into this position. But the first price action will be a steep fall into a slowdown of movement.

What comes next will appear to be a ton of consolidation. This is what makes the pattern so hard to commit within. If you read the pattern as it happens, you will probably see a lot of tiny actions that amount to a downward slope. But eventually, that consolidation will appear more and more positive. In fact, eventually it will begin to trend upwards. This is how you know you’re in a rounding bottom.

This trend upwards will, again, not appear convincing. But it is a good sign, because it means that there is a build-up of energy within the stock. The fact that it is slowly crawling out of its decline also means that it’s resisting the entropy that brought it down. And eventually, it will begin to rise much faster.

Why is this Pattern Important?

Lots of stocks go through periods of minor price action. Even huge companies with high-volume stocks, like Coca-Cola, will have slow and steady movements. But trading those slow movements is difficult and not very lucrative. A rounding bottom pattern will help you turn a slow and steady movement into something that is sharp, dramatic, and highly profitable at the moment it leaps upwards.

4. Double Top

It is important to notice when a stock price has reached its peak. Pardon me for being obvious, but it’s easy to think that there is no way of really knowing. But a double top pattern is a pretty safe way of telling when the top has been hit, and that a new bottom is on the way.

There are four very simple price actions involved with a double top pattern. First, a stock’s price will rise. Second, the stock’s price will fall to a trend line. Third, the stock’s price will rise again and fail to surpass the first price action’s rise. And then finally, the price will fall below the trend line.

It’s rather simple when you think about it, but it’s critical that you understand what is going on here: The first and third price actions will see the price of the stock touch the same level, while the second and fourth actions will see it bounce off that level. 

Why is this Pattern Valuable?

There are two angles that you can approach this from: Taking a long position and taking a short position. 

If you are expecting to buy a stock and hold it as it goes up, the double top pattern will clearly indicate to you that it has the potential to go up once or twice, but no more than that.

This can save you from being stuck holding it after it fails to establish an upward trend. 

If you are expecting to sell a stock before it drops or short it in any way, then it literally pays to know when those peaks are (which will represent the most profitable shorts) and when you can expect to see the stock drop. 

A long position will want to sell at the first peak but will usually sell at the second. A short position will want to buy at the first peak but usually buy at the second. 

5. Wedges

One of the most fundamental patterns is known as “wedges”, though in practice it will usually either be called “upward wedges” or “downward wedges”. The reason is that wedges can’t exist without a direction. They also can’t exist without “trend lines”, which I have mentioned before.

A trend line is similar to the neckline of the head and shoulders pattern. But while the neckline of a head and shoulders pattern is flat, a trend line will usually be angled. Every stock that is rising or falling (which is most stocks, as long as they are not stuck in consolidation) will have two trend lines.

The first is a line that connects all the highest highs of a given period, and the second is a line that connects all the lowest lows. Between these two lines you should see repeated price action of the stock going up and down. Whether or not the stock is trending up or down is determined by whether or not the subsequent highs are higher, or the subsequent lows are lower.

Why is this Pattern Important?

As we said, this is the fundamental behaviour of most stocks. It usually takes something pretty dramatic to make a stock do something other than this. Being able to read upward wedges and downward wedges will help you identify trend lines, and also spot where you can expect a stock to peak and bottom. But perhaps most importantly, because this pattern is so normal, you can spot abnormalities.

If the stock breaks through either trend line in either direction, then you have good cause to look for other patterns. If a stock sticks between two trend lines for a while, an unexpected event might unmoor the stock from those trends. So, you can never get too comfortable with a trend line. 

Patterns that Apply Over the Course of a Day ➡️

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While patterns over a week or more are quite valuable, not everyone trades in those time frames. Especially during rough economies, lots of people hold 90% of their assets in cash and only invest when they think they can get something spicy out of trading in the middle of the day.

Here are a few chart patterns for trading in those time frames.

6. The Hammer

This is one of the few “patterns” that is created by a single candlestick. Here, the candlestick will have a small green body and a lower wick that is longer than the body, with no upper wick.

Although the hammer by itself is the “pattern”, you will usually only find a hammer during a period of consolidation after a fall. That means you can get really technical and say that the pattern includes the fall, the consolidation, and actually ends on the hammer. The issue with saying that is that hammers can happen when a stock price is going up, it is just not all that common.

A hammer can also come after any kind of fall. Whether it’s the fall after a double top, a head and shoulders pattern, or right before the handle of a cup and handle pattern. The hammer is unique because it stands alone within patterns while other patterns pivot around it.

Why is this Pattern Important?

As I’ve mentioned before, the key to maximising the value of a trade is finding the reversals. When you are trading over days or weeks, the reversals can be spotted by looking back and seeing the first half of a pattern, and then making an educated guess as to whether a stock can support the second half.

When you are trading in the middle of a day, however, you need something a lot more decisive. The hammer can be that indicator that you need to make a decisive purchase right then and there.

7. Bullish Engulfing Candlestick

This one is another simple pattern, though it requires a keen eye to find and quick reactions to capitalise on it. While most patterns occur in an obvious fashion at the beginning or end of periods of consolidation, this pattern comes about during consolidation, particularly at the very end of the day.

You will see the terms “bears” and “bulls” thrown around the market a lot. A bear is someone who is in the market and expects it to go down, while a bull is in the market and expects it to go up. Therefore, a bullish candlestick is a candlestick that indicates that a given stock is due for a turnaround for the better.

So, what is an engulfing candlestick? Simple: That means that the second candlestick between two candlesticks is larger than the other. Specifically, the bottom of the second candlestick is lower than the bottom of the first, while the top of the second is higher than the top of the first as well.

What this indicates is that the price of the stock started lower in that five-minute period than it ended in the previous five-minute period but ended higher than that previous period started. 

As a side note, the wicks of the candlesticks do not matter in this pattern.

Why is this Pattern Important?

Imagine that a stock does nothing but drop all day. Drops are exciting. Everyone wants to “Time the bottom” and buy a stock right when it is at its lowest. But timing the bottom is kind of like catching falling knives: It’s really impressive when it happens but hurts a ton if you mess it up.

For that reason, most people trying to figure out the direction of a stock wait until the end of the day. If they buy in the last one to five minutes, then they can sell the next day when sentiment has changed.

A bullish engulfing pattern is a great way of seeing how much strength this strategy has. If there is a micro-rally at the end of the day, then that shows that there is a good number of traders interested in seeing the stock go up. And that interest can compound if it is able to go up even a little.

8. Morning Star Pattern

Finally, a candlestick pattern with three candlesticks. While the general rule is the fewer data points you have to read, the easier a pattern is to read, the disadvantage of low-datapoint-patterns is that they can sneak up on you. One minute you’re shorting the market, and then bam! Engulfing bullish candlestick.

The morning star pattern is named for the second candlestick in the pattern. Its first candlestick will be a solid red candlestick with little to no wick. Its third will be a solid green candlestick that also lacks much of a wick. Its middle candlestick will be what’s called a “Doji”. 

This is a candlestick with a short, green body and two long wicks that are about the same size. This Doji will also start below the low of the first candlestick, indicating a bounce off of a low point.

Generally speaking, a candlestick with long wicks indicates a lot of uncertainty in the market. It means that within a five-minute period, lots of people are buying low and selling high. In fact, their purchases and sales are so scattered that the average price of the stock does not move much, hence its small body.

While the middle candlestick is the fulcrum of the pattern, it would not be a morning star pattern without the other two components: First, there has to be a red candlestick on its right, indicating a drop, usually from a negative period of consolidation, though it can also come from a steep fall.

Second, the Doji itself needs to be green. If it is not green, then it might actually indicate things are about to fall further. And last, the third candlestick needs to be green too. Even if it is not that large, as long as it is larger than the Doji, it indicates an incoming rise in price.

Why is this Pattern Valuable?

The reason why this is a three-candlestick pattern is that it is a pattern you can detect during long periods of consolidation. You might see it during a rounding bottom indicating that the bottom is about to gently curve upwards. You might also see it during that trend back up, indicating that a red candlestick’s drop is invalid, and that the stock is actually going to continue upwards.

The fact that this gives you an idea of when and how a stock will reverse is justification enough to use it. But the real special thing about it is the fact that because the Doji starts so low, you can set a stop loss at its lower end if you think the stock might go back down. 

9. The Dark Cloud

The dark cloud is a pattern formed by two candlesticks, and it is easily one of the hardest to spot in the moment. It is sneaky, as nothing about it screams that it is anything but part of consolidation.

How the dark cloud pattern works is that a green candlestick is followed by a red candlestick. The red candlestick starts higher than the green one, following on from the support the first candlestick gave it, but trending downwards. But the most important part is where the second candlestick ends.

It is only a dark cloud pattern if the second candlestick ends lower than the middle of the first candlestick. Its wick can go as low as it wants. What matters is the body of the candlestick.

This indicates that the price action of the first candlestick is being undone.

Why is This Pattern Important?

This is our first truly bearish pattern, and it indicates why bearish patterns are important: They correct overvaluations of a stock’s price. A dark cloud pattern requires a stock to be increasing in some amount. It might be bumping up and down during consolidation, but it also might be a gradual walk upwards.

If you’re already in the business of catching falling knives, then you are probably also in the business of selling right at a stock’s highest price. That requires some patience and foresight, as there will be a lot of brief moments of downturn on the way to that high. This is a moment of downturn you can’t ignore.

10. Evening Star

A mirror of the morning star, the evening star is basically exactly the same, but in reverse. That means it is also made up of three candlesticks, but this time the first is green and the second two are red. 

It also has a middle candlestick that is much shorter than the other two, though that middle candlestick is higher than the first rather than lower. However, you will notice that an evening star is similarly small with long wicks, indicating the same period of uncertainty that the morning star does. 

If there is one thing that makes this candlestick pattern unique from the morning star pattern, it is the fact that it signifies a downturn rather than an upturn. That doesn’t just mean it will reverse though. It also means that the third candlestick in the pattern is a lot more likely to engulf the first.

If the third candlestick does not engulf the first, then you have a lot more room to be sceptical of this pattern than normal, as downturns are usually harsher than upturns are helpful.

Why is this Pattern Important?

Again, we find ourselves in the realm of trying to take profits off of the highest highs. This pattern, however, is much easier to spot than the dark cloud pattern due to the distinctive shape of the middle candlestick (this time called a “Spinning Top” rather than a Doji).

This is fortunate, since obvious signals are exactly what you want in the case of an incoming reversal to the downside. It also means that you might have bumped into a trend line on the top. If you bounced off of it and didn’t sell, you might set a limit order to sell when you get at or near where the Spinning Top was. It is not likely it will get back up there, but it gives you a place to say it won’t go any higher.

Conclusion 🤔️

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It takes a lot of patience and discipline to make use of these trading patterns. The issue that a lot of traders run into is that they get so antsy to trade that they end up snatching up the first pattern they see. The moment they see a dark cloud, they sell. The moment they see a Doji, they buy.

But it is better to sell a few minutes after you see a Doji, once you have confirmed it, rather than get stuck with a stock that might hurt you if you were wrong about where it was going.

It is also better to sell a little after a peak (or even a little before a peak) rather than trying to snatch up the maximised profits of a transaction. Even if you catch a falling knife, that doesn’t mean you need to do a backflip afterwards. Trying to stack tricks on top of tricks will just leave you open to mistakes and losses.

But perhaps most importantly, remember that these patterns can happen incredibly quickly. For that reason, reacting to them is optional. You can always just use them for stop orders and limit orders instead, which will allow you to play much safer. And staying safe is what the market is all about.

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