Forex Candlesticks: A Complete Guide for Forex Traders

Forex candlesticks explained

There are three specific points that create a candlestick, the open, the close, and the wicks. The candle will turn green/blue (the color depends on the chart settings) if the closing price is above the open. The candle will turn red if the close price is below the open.

If you have the chart on a daily setting, each candle represents one day, with the open price being the first price traded for the day and the close price being the last price traded for the day.

Open price: The open price depicts the first traded price during the formation of a new candle.

High price: The top of the upper wick. If there is no upper wick, then the high price is the open price of a bearish candle or the closing price of a bullish candle.

Low price: The bottom of the lower wick. If there is no lower wick, then the low price is the open price of a bullish candle or the closing price of a bearish candle.

Close price: The close price is the last price traded during the formation of the candle.

The image below shows a blue candle with a close price above the open and a red candle with the close below the open.

Why forex traders tend to use candlestick charts rather than traditional charts

Candlestick charts are the most popular charts among forex traders because they are more visual. Candlestick charts highlight the opening and closing of different time periods more distinctly than other charts, like bar charts or line charts.

Candlestick charts have certain advantages:

Forex price movements are perceived more easily on candlestick charts compared to others.

It is easier to recognize price patterns and price action on candlestick charts.

Candlestick charts offer more information in terms of price (open, close, high, and low) than line charts.

However, there are some disadvantages to candlestick charts:

Candles that close green or red may mislead amateur forex traders into thinking that the market will keep moving in the direction of the previous closing candle.

Candlestick charts may clutter a page because they are not as easy as line charts or bar charts.

How to trade forex using candlestick charts

Candlestick formations and price patterns are used by traders as entry and exit points in the market. Forex candlesticks individually form candle formations, like the hanging man, hammer, shooting star, and more. Forex candlestick charts also form various price patterns like triangles, wedges, and head and shoulders patterns.

While these patterns and candle formations are prevalent throughout forex charts they also work with other markets, like equities (stocks) and cryptocurrencies.

Trading forex using candle formations:

The hanging man:

The hanging man candle is a candlestick formation that reveals a sharp increase in selling pressure at the height of an uptrend. It is characterized by a long lower wick, a short upper wick, a small body and a close below the open.

It is a bearish signal that the market is going to continue in a downward trend. Learning to recognize the hanging man candle and other candle formations is a good way to learn some of the entry and exit signals that are prominent when using candlestick charts.

The chart below shows the GBP/USD on a weekly timeframe. This means that each candle depicts the open price, closing price, high, and low of a single week. The hanging man candle below (circled) is a bearish signal. Traders use bearish signals like this to enter short trades, a bet on the GBP depreciating relative to the USD.

If a trader uses the hanging man to execute a short trade, he/she should then place a stop loss and a take profit with a positive risk-reward ratio.

The Shooting Star

A shooting star candle formation, like the hangman, is a bearish reversal candle that consists of a wick that is at least half of the candle length. The long wick shows that the sellers outweigh the buyers. A shooting star would be an example of a short entry into the market, or a long exit.

Traders could take advantage of the shooting star candle by executing a short trade after the shooting star candle has closed. Traders could then place a stop loss above the shooting star candle and target a previous support level or a price that ensures a positive risk-reward ratio. A positive risk-reward ratio has been shown to be a trait of successful traders.

The Hammer

The hammer candle formation is essentially the shootings stars opposite. It is a bullish reversal candle that signals that the bulls are starting to outweigh the bears. It is characterized by its long wick and small body. A hammer would be used by traders as a long entry into the market or a short exit.

The image below is an example of how a forex trader would use the hammer candle formation to enter a long trade, while placing a stop-loss below the hammer candle and a take profit at a high enough level to ensure a positive risk-reward ratio.

What is a Hammer Candlestick？

The hammer candlestick is found at the bottom of a downtrend and signals a potential (bullish) reversal in the market. The most common hammer candle is the bullish hammer which has a small candle body and an extended lower wick – showing rejection of lower prices. The other pattern traders look out for is the inverted hammer, which is an upside-down bullish hammer.

Bullish Hammer Candlestick

The hammer candlestick appears at the bottom of a downtrend and signals a bullish reversal. The hammer candle has a small body, little to no upper wick, and a long lower wick - resembling a ‘hammer’.

The pattern indicates that the price dropped to new lows, but subsequent buying pressure forced the price to close higher, hinting at a potential reversal. The extended lower wick is indicative of the rejection of lower prices.

Inverted Hammer Candlestick

The inverted hammer candlestick, like the bullish hammer, also provides a signal for a bullish reversal. The candle is, as the name suggests, an inverted hammer. The candle has a long extended upper wick, a small real body with little or no lower wick.

The candle opens at the bottom of a downtrend before the bulls push price upwards – reflected in the extended upper wick. Price does eventually return down towards the opening level but closes above the open, to provide the bullish signal. Should the buying momentum continue, this will be seen in the subsequent price action moving higher.

Advantages and Limitations of the Hammer Candlestick

Hammer candles have their advantages and their limitations; therefore, traders should never rush into placing a trade as soon as the hammer candle has been identified.

Advantages

Reversal signal: The pattern indicates the rejection of lower prices. When found in a downtrend, it could signal the end of selling pressure and begin to trade sideways or reverse to the upside.

Exit signal: Traders that have an existing short position can view the hammer candle as an indication that selling pressure is subsiding, presenting the ideal time to close out of the short position.

Limitations

No indication of trend: The hammer candle does not take the trend into consideration and therefore, when considered in isolation, can provide a false signal.

Supporting evidence: In order to enter into high-probability trades, it is important for traders to look for additional information on the chart that supports the case for a reversal. Such confluence can be found by assessing whether the hammer appears near a major level of support, pivot point, or significant Fibonacci level; or whether an overbought signal is produced on the CCI, RSI, or stachastic indicator.

Using Hammer Candles in Technical Analysis

The following example of how to trade the hammer candlestick highlights the hammer candle on the weekly EUR/USD chart.

Traders can make use of hammer technical analysis when deciding on entries into the market. Looking at a zoomed-out view of the above example, the chart shows how price bounced from newly created lows before reversing higher. The zone connecting the lows acts as support and provides greater conviction to the reversal signal produced by the hammer candlestick.

Stops can be placed below the zone of support while targets can coincide with recent levels of resistance – provided a positive risk-to-reward ratio is maintained.