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. 

Despite the overshadow of trade tariffs, industrial stocks remain underpinned by a lower corporate tax rate (35% down to 21%), a push for increased infrastructure spending and a strengthening U.S. housing market. Economic data also shows increased industrial activity. Industrial production, which measures the value of output from manufacturers, mines and utilities, is up 5.1% year over year as of September 2018. The sector should additionally benefit from early investor rotation into value names, robust profit forecasts and increased buyback activity.

Senior analyst at Wolfe Research Nigel Coe told Barron’s that he believes industrial stocks can maintain strong growth momentum while the Federal Reserve’s policy remains loose and supportive of growth. However, he cautioned that companies in the sector need to grow into their earnings multiples – forward earnings currently sit at 16.7 times as of October 2018. Price action also suggests that industrial stocks are at key support levels. Three leading exchange-traded funds (ETFs) in the sector have all bounced at critical technical areas on their respective charts. Let’s further analyze each fund.

Launched in 2006, the iShares U.S. Aerospace & Defense ETF seeks to track the performance of the Dow Jones U.S. Select / Aerospace & Defense Index. The fund invests in companies that manufacture, assemble and distribute airplane and defense equipment. ITA charges investors an annual management fee of 0.43% and has returned 9.3% year to date (YTD) as of October 2018. The recent pullback found support on the uptrend line the connects the early May and late June swing lows. This $200 support level on the chart also finds support from the 200-day simple moving average (SMA), making it a high-probability buying area. A stop-loss order could be placed just below the candlestick that reversed on the trendline/moving average.

The Invesco DWA Industrials Momentum ETF, also created in 2006, aims to provide similar returns to the DWA Industrials Technical Leaders Index. The ETF’s portfolio holds U.S. industrial firms that are showing strong relative strength and price momentum. As of October 2018, the fund has a -4.69% YTD return and charges a 0.6% management fee. PRN’s chart appears to be forming a double bottom – the most recent swing low found support near the early May swing low at the $57 level. Short-term momentum looks to be moving back to the upside, with the relative strength index (RSI) crossing back above 30. Stops should be placed slightly below double bottom pattern to protect trading capital.

Formed in 2013, the Fidelity MSCI Industrials ETF attempts to replicate the performance of the MSCI USA IMI Industrials Index. It holds companies that cover the broad U.S. industrials sector. The fund has a low expense ratio of just 0.08%, well below the 0.5% category average. Performance wise, FIDU has returned -1.33% YTD. Although FIDU’s share price is trading below the 200-day SMA, it found strong support from the uptrend line that commenced in early May. The recent bounce at the $37.5 support level has moved the RSI out of oversold territory and occurred on above-average volume. Traders who take a long position should protect it with a stop below the most recent swing low.