Candlestick Analysis: The Art of Reading Charts and Recognizing Reversal Points

When we talk about candlestick analysis in cryptocurrency markets, we mean one of the most effective methods for forecasting price movements. Japanese candlesticks allow traders to quickly understand the dynamics of the battle between buyers and sellers over a specific time period.

Structure of a Candlestick: Basic Understanding

Each Japanese candlestick consists of several elements that tell what happened in the market. The broad central part is called the body — this is the area between the opening and closing prices of the trading session. If the closing price is lower than the opening price, the body is colored red, signaling selling pressure. Conversely, when the closing price is higher than the opening, the body is green, indicating buyer strength.

Thin lines extending above and below the body are called wicks or shadows. They show extreme points — the maximum and minimum prices reached during the session. Shadows often tell the most interesting story about how the trading day developed.

It’s important to remember one crucial principle: the higher the timeframe you analyze, the more reliable the signals from candlestick formations become. Hourly and daily charts provide much more confidence in identified patterns than minute charts.

Main Reversal Patterns

Hammer and Its Bearish Twin

One of the most powerful reversal formations is the hammer and hanging man. The paradox of these candles is that the same shape can be both bullish and bearish signals — it all depends on the context.

When a hammer appears after a downtrend, it signals weakening selling pressure. If such a candle forms at the top of an upward move, it becomes a hanging man — a warning of a possible reversal downward.

Recognizing these candles is easy by three signs. First, the body is located in the upper part of the range. Second, the lower wick is twice as long as the body. Third, the upper wick is nearly absent or very short. The longer the lower wick and the shorter the body, the higher the potential for a bullish hammer.

Absorption: Signal of Power Shift

The absorption pattern belongs to the most important trend reversal signals. It consists of two contrasting-colored candles, where the second “absorbs” the first. For this formation to be valid, three conditions must be met.

First, there must be a clearly expressed trend in the market. Second, the absorption is formed by exactly two candles, with the second definitely covering the first with its body. Third, the bodies must contrast in color.

The likelihood of a reversal sharply increases when the first candle has a very small body and the second is large. This indicates that the old trend is losing strength, and the new one is gaining momentum. If absorption occurs after a prolonged or sharp move, and the second candle is accompanied by high trading volume, the probability of a market turn approaches maximum. The strongest signal is when the second candle absorbs several previous bodies immediately.

Cloud Cover: Warning at the Top

Cloud cover is a clear sign of a possible reversal at the top. The formation consists of two candles appearing after an uptrend. The first is a strong green candle with a substantial body. The next day, the price opens above the previous candle’s high, initially seeming like continuation of the rise. However, the price quickly reverses downward, closing near the minimum, covering a significant part of the green body.

The lower the close of the second red candle, the higher the likelihood that the market is already at the top. The signal is even stronger if the second candle closes near the level of the first green candle’s open — indicating that buyers have completely lost control.

Particularly significant is the so-called “Black Day with a Cut-off Top and Bottom” shape — when a long green candle opening at the minimum and closing at the maximum of the daily range is followed by a long red candle opening at the maximum and closing at the minimum. This is one of the most powerful bearish signals.

Break in the Clouds: Hope in Darkness

The break in the clouds is the bullish opposite of the cloud cover — a formation appearing in a falling market. It consists of a red candle and a subsequent long green candle, partially overlapping the previous one. The green body should close above the midpoint of the red candle for the formation to be considered strong.

The strength of this pattern depends on how deeply the green candle penetrates into the red area. In the basic case, the green candle closes near the minimum of the previous session. Medium strength occurs when the close is slightly above the red’s close. The weakest variant — a “push” — when the green candle does not surpass the middle of the red.

Star Patterns: Complexity and Reliability

Morning and Evening Star

Star — this is a candle with a small body, forming a price gap relative to the previous candle with a large body. Star patterns occur at both tops and bottoms and have several varieties.

Morning star appears at the bottom of the market. It consists of a long red candle, followed by a small-bodied candle with a gap down. On the third day, a long green candle appears, covering a significant part of the first red body. This pattern indicates a takeover of initiative by buyers.

Evening star — the bearish counterpart. The first two candles have long green bodies, followed by a star. The formation is completed by a red candle that covers the green body of the second candle.

The strength of these models increases when there are price gaps between all elements, with the third candle covering most of the first, and when the trading volume is low at early stages but sharply increases on the final candle.

Doji Star: Uncertainty as a Signal

Doji star is a doji forming a price gap with the previous candle. In an uptrend, the doji gaps upward; in a downtrend, downward. This indicates uncertainty, often preceding a reversal.

It’s important to wait for the next candle for confirmation. If at the top after a doji star a long red candle appears, it confirms a reversal at the bottom, forming a Evening doji star. At the bottom, a green candle overlapping the red body indicates a Morning doji star.

The most powerful signal is the “Abandoned Baby”, when the doji has gaps before and after without shadows intersecting, followed by a gap in the opposite direction. This is one of the strongest reversal signals overall.

Falling Star and Inverted Hammer

Falling star warns of a possible end to the rise. It has a small body in the lower part of the range and a long upper shadow. The body color is not crucial. Ideally, it forms a gap with the previous candle.

Inverted hammer looks similar but gives the opposite signal — it indicates a possible reversal at the bottom after a downtrend. Confirmation requires the next green candle with an upward gap or at least a close above the inverted hammer’s body. The larger the gap, the stronger the bullish signal.

Internal and Sequential Patterns

Harami and Harami Cross

Harami — a small-bodied candle located inside the previous candle with a large body. The name translates as “pregnant” — the large candle is the “mother”, the small one is the “child”.

The key feature is that the small candle must be entirely within the previous candle, regardless of shadow lengths. The smaller the “child”, the more significant it is. Harami is not a powerful reversal signal but rather a “stop” signal for the previous trend, indicating a pause.

Harami Cross — a variation where instead of a small candle, a doji appears. This formation is much more significant than the previous and belongs to the most important reversal signals, as the doji indicates maximum uncertainty.

Engagement: Sign of Power Shift

Engulfing — a single long candle opening at the minimum of the previous candle and moving upward (bullish variant) or spreading downward (bearish). The candle’s length is critical — the longer, the more it influences market development.

If the next close surpasses the bearish engulfing candle, it often signals a recovery in upward movement. Conversely, if the close is below the bullish candle, it reinforces selling pressure.

Sequential Bearish and Bullish Patterns

Two Crows and Tailing

Two Crows — a bearish formation with a gap between a small red candle and the previous body. It consists of two red candles, with the second opening higher but closing lower, signaling weakening upward momentum.

Tailing — extends this idea, adding a fourth red candle or more. However, if afterward a green candle with a gap to the previous high appears, it transforms the formation into a bullish continuation pattern, suggesting buying.

Three Black Crows — three consecutive decreasing red candles. This pattern is especially significant when occurring in high price zones after a prolonged rise. Each subsequent candle should open within the previous one and close near its lows. Ideally, the first in the series drops below the previous green candle’s high.

Practical Conclusions

Candlestick analysis is both an art and a science. To apply these patterns effectively in cryptocurrency markets, practice and patience are essential. Remember, no single candle provides an absolute signal — always look for confirmation through volume, support/resistance levels, and additional indicators.

The most important thing is to start with basic patterns like hammer and engulfing, then gradually develop the skill to recognize more complex formations. Regularly reading charts across different timeframes will train your visual analysis and help you make faster, more accurate trading decisions.