Candlestick charts are a type of financial chart for tracking the movement of securities. They have their origins in the centuries-old Japanese rice trade and have made their way into modern-day price charting. Some investors find them more visually appealing than the standard bar charts and the price actions easier to interpret.

Candlesticks are so named because the rectangular shape and lines on either end resemble a candle with wicks. Each candlestick usually represents one day’s worth of price data about a stock. Over time, the candlesticks group into recognizable patterns that investors can use to make buying and selling decisions.

How to Read a Single Candlestick

Each candlestick represents one day’s worth of price data about a stock through four pieces of information: the opening price, the closing price, the high price, and the low price. The color of the central rectangle (called the real body) tells investors whether the opening price or the closing price was higher.

A black or filled candlestick means the closing price for the period was less than the opening price; hence, it is bearish and indicates selling pressure. Meanwhile, a white or hollow candlestick means that the closing price was greater than the opening price. This is bullish and shows buying pressure.

The lines at both ends of a candlestick are called shadows, and they show the entire range of price action for the day, from low to high. The upper shadow shows the stock’s highest price for the day, and the lower shadow shows the lowest price for the day.

Bullish Candlestick Patterns

Over time, groups of daily candlesticks fall into recognizable patterns with descriptive names like three white soldiers, dark cloud cover, hammer, morning star, and abandoned baby, to name just a few. Patterns form over a period of one to four weeks and are a source of valuable insight into a stock’s future price action. Before we delve into individual bullish candlestick patterns, note the following two principles:

1. Bullish reversal patterns should form within a downtrend. Otherwise, it’s not a bullish pattern, but a continuation pattern.
2. Most bullish reversal patterns require bullish confirmation. In other words, they must be followed by an upside price move which can come as a long hollow candlestick or a gap up and be accompanied by high trading volume. This confirmation should be observed within three days of the pattern.

The bullish reversal patterns can further be confirmed through other means of traditional technical analysis—like trend lines, momentum, oscillators, or volume indicators—to reaffirm buying pressure. There are a great many candlestick patterns that indicate an opportunity to buy. We will focus on five bullish candlestick patterns that give the strongest reversal signal.

1. The Hammer or the Inverted Hammer

• The Hammer is a bullish reversal pattern, which signals that a stock is nearing the bottom in a downtrend.
• The body of the candle is short with a longer lower shadow. This is a sign of sellers driving prices lower during the trading session, only to be followed by strong buying pressure to end the session on a higher close.
• Before we jump in on the bullish reversal action, however, we must confirm the upward trend by watching it closely for the next few days.
• The reversal must also be validated through the rise in the trading volume.

The Inverted Hammer also forms in a downtrend and represents a likely trend reversal or support.

• It’s identical to the Hammer except for the longer upper shadow, which indicates buying pressure after the opening price.
• This is followed by considerable selling pressure, which wasn’t enough to bring the price down below its opening value.

Again, bullish confirmation is required, and it can come in the form of a long hollow candlestick or a gap up, accompanied by a heavy trading volume.

2. The Bullish Engulfing

The Bullish Engulfing pattern is a two-candle reversal pattern.

• The Bullish Engulfing pattern appears in a downtrend and is a combination of one dark candle followed by a larger hollow candle.
• The second candle completely ‘engulfs’ the real body of the first one, without regard to the length of the tail shadows.
• On the second day of the pattern, the price opens lower than the previous low, yet buying pressure pushes the price up to a higher level than the previous high, culminating in an obvious win for the buyers.

It is advisable to enter a long position when the price moves higher than the high of the second engulfing candle—in other words when the downtrend reversal is confirmed.

3. The Piercing Line

Similar to the engulfing pattern, the Piercing Line is a two-candle bullish reversal pattern, also occurring in downtrends.

• The first long black candle is followed by a white candle that opens lower than the previous close.
• Soon thereafter, the buying pressure pushes the price up halfway or more (preferably two-thirds of the way) into the real body of the black candle.

4. The Morning Star

As the name indicates, the Morning Star is a sign of hope and a new beginning in a gloomy downtrend.

• The pattern consists of three candles: one short-bodied candle (called a doji or a spinning top) between a preceding long black candle and a succeeding long white one.
• The color of the real body of the short candle can be either white or black, and there is no overlap between its body and that of the black candle before. It shows that the selling pressure that was there the day before is now subsiding.
• The third white candle overlaps with the body of the black candle and shows renewed buyer pressure and a start of a bullish reversal, especially if confirmed by the higher volume.

5. The Three White Soldiers

This pattern is usually observed after a period of downtrend or in price consolidation.

• It consists of three long white candles that close progressively higher on each subsequent trading day.
• Each candle opens higher than the previous open and closes near the high of the day, showing a steady advance of buying pressure.
• Investors should exercise caution when white candles appear to be too long as that may attract short sellers and push the price of the stock further down. 

Putting It All Together

The chart below for Enbridge, Inc. (ENB) shows three of the bullish reversal patterns discussed above: the Inverted Hammer, the Piercing Line, and the Hammer.

The chart for Pacific DataVision, Inc. (PDVW) shows the Three White Soldiers pattern. Note how the reversal in downtrend is confirmed by the sharp increase in the trading volume.

The Bottom Line

Investors should use candlestick charts like any other technical analysis tool (i.e., to study the psychology of market participants in the context of stock trading). They provide an extra layer of analysis on top of the fundamental analysis that forms the basis for trading decisions.

We looked at five of the more popular candlestick chart patterns that signal buying opportunities. They can help identify a change in trader sentiment where buyer pressure overcomes seller pressure. Such a downtrend reversal can be accompanied by a potential for long gains. That said, the patterns themselves do not guarantee that the trend will reverse. Investors should always confirm reversal by the subsequent price action before initiating a trade. 

A Bollinger Band® is a technical analysis tool defined by a set of trendlines. They are plotted as two standard deviations, both positively and negatively, away from a simple moving average (SMA) of a security’s price and can be adjusted to user preferences.

Bollinger Bands® was developed by technical trader John Bollinger and designed to give investors a higher probability of identifying when an asset is oversold or overbought.

How to Calculate Bollinger Bands®

The first step in calculating Bollinger Bands® is to compute the simple moving average (SMA) of the security, typically using a 20-day SMA. A 20-day SMA averages the closing prices for the first 20 days as the first data point.

The next data point drops the earliest price, adds the price on day 21 and takes the average, and so on. Next, the standard deviation of the security price will be obtained. Standard deviation is a mathematical measurement of average variance and features prominently in statistics, economics, accounting, and finance.

For a given data set, the standard deviation measures how far numbers are from an average value. Standard deviation can be calculated by taking the square root of the variance, which itself is the average of the squared differences of the mean.

Next, multiply that standard deviation value by two and both add and subtract that amount from each point along the SMA. Those produce the upper and lower bands.

Here is this Bollinger Band® formula:

$\begin{aligned} &\text{BOLU} = \text {MA} ( \text {TP}, n ) + m * \sigma [ \text {TP}, n ] \\ &\text{BOLD} = \text {MA} ( \text {TP}, n ) – m * \sigma [ \text {TP}, n ] \\ &\textbf{where:} \\ &\text {BOLU} = \text {Upper Bollinger Band} \\ &\text {BOLD} = \text {Lower Bollinger Band} \\ &\text {MA} = \text {Moving average} \\ &\text {TP (typical price)} = ( \text{High} + \text{Low} + \text{Close} ) \div 3 \\ &n = \text {Number of days in smoothing period (typically 20)} \\ &m = \text {Number of standard deviations (typically 2)} \\ &\sigma [ \text {TP}, n ] = \text {Standard Deviation over last } n \text{ periods of TP} \\ \end{aligned}$​BOLU=MA(TP,n)+m∗σ[TP,n]BOLD=MA(TP,n)−m∗σ[TP,n]where:BOLU=Upper Bollinger BandBOLD=Lower Bollinger BandMA=Moving averageTP (typical price)=(High+Low+Close)÷3n=Number of days in smoothing period (typically 20)m=Number of standard deviations (typically 2)σ[TP,n]=Standard Deviation over last n periods of TP​

What Do Bollinger Bands® Tell You?

Bollinger Bands® is a popular technique. Many traders believe the closer the prices move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold the market. John Bollinger has a set of 22 rules to follow when using the bands as a trading system.

The Squeeze

The “squeeze” is the central concept of Bollinger Bands®. When the bands come close together, constricting the moving average, it is called a squeeze. A squeeze signals a period of low volatility and is considered by traders to be a potential sign of future increased volatility and possible trading opportunities.

Conversely, the wider apart the bands move, the more likely the chance of a decrease in volatility and the greater the possibility of exiting a trade. These conditions are not trading signals. The bands do not indicate when the change may take place or in which direction the price could move.

Breakouts

Approximately 90% of price action occurs between the two bands. Any breakout above or below the bands is significant. The breakout is not a trading signal and many investors mistake that when the price hits or exceeds one of the bands as a signal to buy or sell. Breakouts provide no clue as to the direction and extent of future price movement.

Example of Bollinger Bands®

In the chart below, Bollinger Bands® bracket the 20-day SMA of the stock with an upper and lower band along with the daily movements of the stock’s price. Because standard deviation is a measure of volatility, when the markets become more volatile the bands widen; during less volatile periods, the bands’ contract.

Limitations of Bollinger Bands®

Bollinger Bands® is not a standalone trading system but just one indicator designed to provide traders with information regarding price volatility. John Bollinger suggests using them with two or three other non-correlated indicators that provide more direct market signals and indicators based on different types of data. Some of his favored technical techniques are moving average divergence/convergence (MACD), on-balance volume, and relative strength index (RSI).

Because Bollinger Bands® are computed from a simple moving average, they weigh older price data the same as the most recent, meaning that new information may be diluted by outdated data. Also, the use of 20-day SMA and 2 standard deviations is a bit arbitrary and may not work for everyone in every situation. Traders should adjust their SMA and standard deviation assumptions accordingly and monitor them.

The Bottom Line

Bollinger Bands® can be a useful tool for traders for assessing the relative level of over- or under-sold position of a stock and provides them with insight on when to enter and exit a position. Certain aspects of Bollinger Bands®, such as the squeeze, work well for currency trading. Buying when stock prices cross below the lower Bollinger Band® often helps traders take advantage of oversold conditions and profit when the stock price moves back up toward the center moving-average line.