Lessons 1 and 2 answered where a trade might make sense: in the direction of the structure, at a level that matters. Candles help answer when. A single candle shows whether buyers or sellers controlled a session and whether a price was accepted or rejected. Read alone, candle patterns are unreliable. Read at a strong level, in the context of the trend and with volume, they become one of the most practical timing tools in price action.
What a candle records
Each candle records four prices for its period: open, high, low and close. The body spans the open and the close; it is usually drawn green or hollow when the close is above the open and red or filled when it is below. The thin lines above and below the body, called wicks, shadows or tails, show prices that traded during the session but were not held at the close. Candlestick charts were developed by Japanese rice traders and became widely known among Western traders after Steve Nison's work around 1990.
Three readings matter more than the colour:
- Where it closed within its range. The close location, (close − low) ÷ (high − low), runs from 0 at the low to 1 at the high. Above about 0.7, buyers controlled the end of the session; below about 0.3, sellers did. A green candle that closes in the middle of a long range is weaker than its colour suggests.
- How large it was. Compare the range with ATR. A range of twice the ATR signals an event; half the ATR, a quiet session.
- Body versus wicks. A large body shows one side in control throughout. A long wick shows that prices in that direction were tested and rejected.
Keep the limits in mind. A daily candle compresses a whole session, and the same shape can come from very different intraday paths. The close is the most reliable piece of information, because it is the price at which the day's positions are marked and carried overnight.
The main patterns
Pattern names vary between books. The definitions below are precise enough to apply consistently:
- Pin bar (rejection tail). One wick at least twice the length of the body, typically two-thirds of the range or more, with the close in the opposite third. A bullish pin bar has a long lower wick and closes in the top third: sellers pushed price down and buyers rejected the lower prices. The traditional hammer, after a decline, and shooting star, after an advance, are pin bars.
- Engulfing. The second candle's body covers the whole body of the first and closes in the opposite direction. A bullish engulfing candle after a pullback shows that buyers have overwhelmed the previous session's selling.
- Inside bar. The high is below the previous high and the low above the previous low. It marks a pause and a contraction in range; the previous candle is often called the mother bar, and a move beyond its high or low gives the direction.
- Outside bar. The high is above the previous high and the low below the previous low. Range expands in both directions, and the close shows who won: an outside bar that closes near its high after a decline is bullish.
- Doji. The open and close are equal or nearly so, with a body of about a tenth of the range or less. It shows balance and indecision, which matters after a strong run into a level and means little in the middle of a range.
These patterns overlap. A bullish engulfing pair on a daily chart often forms a pin bar on a two-day chart. The names describe the same few events: rejection of a price, a shift in control, or a pause before the next move.
Location matters more than the pattern
Independent tests of candle patterns across large samples of US stocks have generally found that, taken in isolation, most patterns offer only a small and unstable edge over the following days. What turns a candle into a signal is where it appears. Three questions decide that:
- Where is it? At a support or resistance zone that grades well, at the edge of a range, or at a level visible on the higher timeframe. A pin bar in the middle of a range, with no level nearby, carries little information.
- Which way is the trend? A bullish signal at support in an uptrend works with the larger flow of orders. The same candle in a downtrend is a counter-trend bet and needs more confirmation.
- What came before it? A rejection after an orderly three- to five-bar pullback into support is a cleaner signal than one after a steep, ten-bar decline, which often only pauses before falling further.
Volume confirmation
Volume shows how much participation stood behind a candle. Compare a session's volume with its 50-day average; the Learn article unusual volume explains this relative measure.
| Candle and location | Volume | Reading |
|---|---|---|
| Rejection at support | 1.5× average or more | Heavy selling met heavier buying; demand absorbed supply |
| Rejection at support | Below average | Few sellers showed up; weaker evidence |
| Engulfing or outside bar at a level | Above average | A genuine shift in control |
| Inside bar or narrow day | Below average | Quiet contraction, often before an expansion |
Heavy volume needs the close to interpret it. Very heavy volume after a long decline, with a close near the high, can mark sellers exhausting themselves; the same volume with a close near the low shows supply still in control. The Wyckoff lessons that follow build this reading of effort and result into a full method.
How to apply it
Rules for a long trade on a rejection candle at support:
- Context: a daily uptrend, or the lower edge of a range, and the weekly chart not in a downtrend.
- Location: price is inside a support zone that grades well (lesson 2).
- Signal: a bullish pin bar, bullish engulfing or bullish outside bar that closes in the top third of its range, preferably on volume at or above the 50-day average.
- Entry: a buy-stop order a few cents above the signal candle's high. If it is not filled within two sessions, cancel it.
- Stop: a few cents below the signal candle's low or the zone's lower edge, whichever is lower.
- Target: the next resistance zone, at least twice the risk.
- Invalidation: if price trades below the signal candle's low before the entry fills, the signal has failed; cancel the order.
For an inside bar, the buy-stop goes above the mother bar's high and the stop below the mother bar's low, or below the inside bar's low for a tighter but less forgiving stop.
Worked example (illustrative numbers). In a daily uptrend, price pulls back into a support zone of $47.50 to $48.20. A pin bar forms with a high of $49.10, a low of $47.30 and a close of $48.90, on 1.8 times average volume. ATR is $1.40, and the next resistance is at $53.20.
| Item | Price | Basis |
|---|---|---|
| Entry | $49.15 | Buy-stop above the pin bar's high |
| Stop | $47.25 | Below the pin bar's low |
| Target | $53.20 | Next resistance |
Risk is $1.90 per share and reward $4.05, about 2.1 times the risk. The candle's range of $1.80, about 1.3 ATR, keeps the stop at a normal distance; a pin bar three or four ATR long would force a much smaller position.
Common mistakes
- Pattern hunting without location. A textbook candle in the wrong place is noise.
- Acting before the close. A hammer at 2 p.m. can be a full bearish candle by 4 p.m. The pattern exists only once the candle is complete.
- Trading every doji. Indecision in the middle of a range is the normal state of a range.
- Ignoring size. A signal candle several ATR long puts the stop far away; reduce size or pass.
- Ignoring scheduled events. A signal on the day before earnings can be erased by the opening gap.
- Bending the definitions. Calling a candle a pin bar because the trade looks attractive defeats the purpose of having rules.
Candle patterns in Clear Tape
In trading systems, the NR7 / Inside-Day Breakout preset turns this lesson's inside bar into fixed rules. The setup day is either the narrowest range of the past seven sessions (NR7) or an inside day, in an uptrend where the close is above the 50-day average and the 50-day is above the 200-day. The buy-stop is one cent above the setup day's high, and the entry comes when the next session closes above that high. The stop is one cent under the setup day's low, and the trade exits at twice the risk or on an ATR trailing stop. The preset is based on narrow-range patterns published by Toby Crabel in 1990, and its rulebook notes that it produces many false triggers, which is why the trend filter matters. Members can also build their own systems with conditions on price, averages and volume, for example volume above 1.5 times its 50-day average. Building systems is free; backtests are available to Tools and Pro members.
Summary
- Read a candle through its close location, its range against ATR and the balance of body and wicks.
- Define patterns precisely: pin bar, engulfing, inside bar, outside bar and doji each have objective rules.
- Location, trend and what came before decide whether a pattern is a signal; volume shows how much conviction stood behind it.
- Enter on a move beyond the signal candle, place the stop beyond its other end, and cancel if the low breaks first.
Next: Lesson 4: breakouts and false breakouts.
For educational purposes only. Not investment advice.