Candlestick charts are a way to show how prices change. They were first used in Japan in the 18th century. Traders and investors use these tools to study a lot about the patterns and trends of different financial instruments, such as stocks, currencies, commodities, and indices.
Individual candles that make up candlestick charts display the opening, closing, high, and low prices for a particular time period, as well as the direction and size of the price movement. Traders can spot numerous formations and signs that suggest potential future market behavior by mixing different candles.
In a Nushell
- Popular and useful for visualizing price changes and pinpointing trading opportunities are candlestick charts.
- Each period’s open, close, high, and low prices are displayed on candlestick charts, along with the body and wick’s color and form.
- The body color and shape of the candlesticks show if and how much the price changed during the period.
- The candlestick’s wick’s length and position reveal the range of price swings and the degree of volatility over the course of the time period.
- Candlestick charts can show a variety of patterns and formations, including reversal, continuation, consolidation, and breakout signals, that represent the psychology and sentiment of market players.
Candlestick Components
Like a bar chart, a daily candlestick shows the opening, high, low, and closing price of the day. The candlestick has a wide part, which is called the “real body”.
This real body represents the price range between the open and close of that trading day. When the real body is filled or black, it means that the close was lower than the open. If the real body is empty, it means that the close was higher than the open.
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Traders can modify these colors on their trading platform. For example, a bearish candlestick is often shaded red instead of black, and bullish candlesticks are often shaded green instead of white.
Candlestick vs Bar Charts
Just above and below the real body are the “shadows” or “highlights.” The shadows show the high and low prices of that day’s trading. If the upper shadow of a bearish candlestick is short, it indicates that the opening of that day was near the high of the day.
A short upper shadow on a bullish day indicates that the close occurred near the high. The relationship between the open, high, low, and close of the day determines the appearance of the daily candlestick. True bodies can be long or short and black or white. Shadows can be long or short. Bar charts and candlestick charts show the same information, but in a different way. Candlestick charts are more visual due to the color coding of the price bars and the thicker real bodies, which better highlight the difference between the open and close.
The above chart shows the same exchange traded fund (ETF) over the same time period. The lower chart uses colored bars, while the upper chart uses colored candlesticks. Some traders prefer to see the thickness of the actual bodies, while others prefer the clean look of the bar charts.
Basic Candlestick Patterns
Candlesticks are created from up and down price movements. Although these price movements sometimes appear random, at other times they form patterns that traders use for analysis or trading purposes. There are many candlestick patterns. Here is a sample to get you started.
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Patterns are divided into bullish and bearish. Bullish patterns indicate that the price is likely to go up, while bearish patterns indicate that the price is likely to go down. Neither pattern works every time, as candlestick patterns represent trends in price movement, not guarantees.
Bearish Engulfing Pattern
A bearish engulfing pattern develops in an uptrend when sellers outnumber buyers. This action is reflected in a long, red real body wrapping around a small, green real body. The pattern shows that sellers are in charge again, and the price could keep going down.
Bullish Engulfing Pattern
On the bullish side of the market, an engulfing pattern forms when there are more buyers than sellers. This is reflected on the chart with a long green real body wrapping around a small red real body. With the bulls having established some control, the price could be headed higher.
Bearish Evening Star
An evening star is a ceiling pattern. It can be seen when the last candlestick of the pattern opens below the small real body of the day before. The small, real body may be red or green. The last candlestick closes deep inside the real body of the candlestick from two days earlier. The pattern shows a stalling of buyers, and then sellers take over. More selling could occur.
Bearish Harami
A bearish harami is a small real body (red) completely inside the previous day’s real body. It is not a pattern to act on, but it could be one to watch. The pattern shows indecision on the part of buyers. If the price keeps going up after this pattern, the uptrend may still be going strong. However, a bearish candle after this pattern shows that the price will go down further.
Bullish Harami
The bullish harami is the opposite of the bearish harami. A downtrend is in play, and a small real body (green) occurs within the large real body (red) of the previous day. This indicates to the technician that the trend has paused. If another bullish day follows, there could be further upside.
Bearish Harami Cross
When a bullish candlestick is followed by a doji, the session in which the candlestick has an almost identical open and close, a bearish harami crossover occurs in an uptrend. The doji is within the real body of the previous session. The implications are the same as those of the bearish harami.
Bullish Harami Cross
A bullish harami crossover occurs in a downtrend when a bearish candlestick is followed by a doji. The doji is inside the real body of the previous session. The implications are identical to those of the bullish harami.
Let’s look at some more black and white patterns, which are also common colors on candlestick charts.
Bullish Rising Three
This pattern begins with what is called a “long white day”. Then, in the second, third, and fourth trading sessions, small real bodies move the price down, but still stay within the price range of the long white day (day one in the pattern). The fifth and final day of the pattern is another long white day.
Although the pattern shows us that the price is falling for three days in a row, a new low is not seen, and bullish traders are preparing for the next move higher.
A slight variation of this pattern is when on the second day there is a slight gap up after the first long day to the upside. The rest of the pattern is the same, it just looks slightly different. When that variation occurs, it is called a bullish mat hold.
Bearish Falling Three
The pattern starts with a very bearish day. Three small real bodies that are moving upward but staying within the first significant bearish day’s range follow it. The pattern is complete when the fifth day makes another big bearish move. It shows that sellers are back in control and that the price could move lower.
Wrap Up
For traders and investors who wish to understand the dynamics and direction of the market, candlestick charts are a potent and useful tool. They can be used to pinpoint probable entry and exit locations, support and resistance levels, risk/reward scenarios, and the strengths and weaknesses of price movements.
Candlestick charts can be used in conjunction with other technical tools and indicators to strengthen analysis and decision making. Candlestick charts are a useful tool for traders, but they are not a guarantee of success. Traders should always use them with restraint and test their techniques first before implementing them in actual trading scenarios.
FAQs about Candlestick Charts
Compared to other chart formats, such as line, bar, or area charts, candlestick charts provide more information and insight into price fluctuations. They can clearly and intuitively display direction, size, volatility, and market mood.
A candlestick chart is composed of distinct candlesticks that show price movement over a specific time period, such as a day, hour, or minute.
There is a wick and a body on each candlestick. The wick displays the high and low prices of the time while the body displays the opening and closing prices of the period. The body’s color and shape reveal if and how much the price changed throughout the course of the time.
Combinations of candlesticks known as candlestick patterns and formations provide insight into the psychology and sentiment of market players as well as potential future price direction. Typical patterns and formations include:
Reversal patterns, such as the hammer, shooting star, engulfing, harami, morning star, and evening star, are indicators that the current trend is about to shift.
Continuation patterns: These patterns, such as the marubozu, spinning top, doji, three bullish and bearish ways, three white soldiers, and three black crows, are indicators that the current trend is about to continue.
Consolidation patterns, including rectangles, triangles, wedges, flags, and pennants, are indicators that the price is going sideways inside a range.
Breakout patterns, such as the gap, window, and thrust, are indicators that the price is emerging from a consolidation or a resistance or support level.
You can use candlestick charts to determine the probable entry and exit points, support and resistance levels, and risk/reward situations, as well as the strengths and weaknesses of price movements.
Candlestick charts can be used to validate or refute your trading hypotheses, identify opportunities and dangers, and modify your approach and tactics as necessary. Candlestick charts should always be used in conjunction with other indicators and technical tools, including as trend lines, moving averages, oscillators, and volume, and you shouldn’t rely completely on them.
You may learn more about candlestick charts and how to utilize them well by consulting a variety of online and printed publications. Several instances are:
Books: Many experts and professionals in candlestick charting have authored books on the subject, including Steve Nison’s “Japanese Candlestick Charting Techniques,” Gregory Morris’ “Candlestick Charting Explained,” and Adam Grimes’ “The Art and Science of Technical Analysis.”
Courses: You can learn about candlestick charting’s fundamentals and more complex ideas by enrolling in one of the many courses that reputable institutions and organizations offer.
A few examples include “Candlestick Charting for Beginners” from Investopedia Academy, “Candlestick Patterns to Master Forex Trading Price Action” from Udemy, “Candlestick Analysis for Professional Traders” from Trading Campus, and “Candlestick Trading Masterclass” from Trading with Rayner.
Websites: Numerous websites, like “Candlesticker.com,” “Candlecharts.com,” “Stockcharts.com,” and “Tradingview.com,” provide important resources and information on candlestick charting.
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- Alan Northcott | Candlestick Charts – The Complete Guide to Using Candlestick Charting: How to Earn High Rates of Return – Safely
- Investopedia – What Is a Candlestick Pattern?
- IG – 16 Candlestick Patterns Every Trader Should Know
- Morpher – Candlestick Patterns: The Complete Guide (2023)
- En.wikipedia.org – Candlestick pattern
- Incrediblecharts – Candlestick Chart Patterns
- Babypips – Single Candlestick Patterns
