When analyzing stocks, futures, or foreign exchange, investors use several tools for charting and displaying information. Candlestick charts are commonly used, along with their brethren: line charts, bar charts, and point-and-figure charts.
There are key ways investors can use candlestick charts to make decisions. Learning how to read stock charts is an important step in becoming a successful trader.
Let’s examine the anatomy of candlesticks, the trading patterns associated with them, and how they are used in technical analysis.
What Is a Candlestick?
Candlesticks are price chart units that show the high, low, opening, and closing prices of a stock or security within a specified time period.
Candlesticks originated in Japan hundreds of years ago, when they were used to track rice prices and trends.
Most candlesticks consist of a body and upper and lower wicks, which are also known as shadows or tails.
Parts of the Candlestick
The part of the candle between the top and bottom borders is called the candle body, or real body. This represents the opening and closing prices of the time period that the candle depicts.
The candle body is more important than the wicks, because the wicks show high and low trades, which may be significantly different from the majority of the day’s trades. A longer candle body shows a stronger price trend in either direction.
The vertical line above the candle body is the upper candlewick. The top of the candlewick shows the highest price the security was traded at during the set time period. A long upper wick indicates a bearish price direction: It means traders are unsuccessfully attempting to increase prices.
The line below the candle body is the lower candlewick. The bottom of the candlewick marks the lowest price of the security during the set time period. If a wick is short, it means the opening or closing price was near the high and low trades.
The range is the difference between the highest and lowest points of the candlestick.
Types of Candles
Bullish vs. Bearish Candles
There are two types of candles, which show whether the security price increased or decreased during the set time period.
If the price increased between the opening and closing times, the candle body is marked in green or white. This is called a bullishcandlestick. The bottom of the candle body shows the opening price, and the top shows the closing price.
If the price decreased, the candle is red or black—a bearish candlestick. The top of the candle body shows the opening price, while the bottom shows the closing price.
If the price closes exactly where it opened, there is no candle body. This is called a doji and is marked with a horizontal dash. A doji can be a prediction of a price reversal.
The marubozu is essentially the opposite of the doji. It has a long candle body and almost no wicks.
Enlightenment Through Candles
Candlestick charts are composed of candles lined up next to one another, each of which shows price movement between the specified time period. Because candles show price changes in certain time periods, traders can use charts to see trends and try to predict price changes. Candlestick patterns can show that a negative or positive price continuation is likely, or that a price trend may reverse. Even a single candlestick can help traders decide whether to buy or sell.
Chart Time Frames
Traders can select the time frame that each candle represents. One commonly used time frame shows the opening price, closing price, and high and low for a single day. Each candle in the chart would show the price movement in one day. A trader could see that a stock price declined significantly over the course of the day, which could result in a continuing decline in the coming days.
The most commonly used time frames are:
• 1-minute (M1)
• 5-minute (M5)
• 15-minute (M15)
• 30-minute (M30)
• 1-hour (H1)
• 4-hour (H4)
• Daily (D1)
• Weekly (W1)
• Monthly (M1)
Shorter time frames essentially allow traders to zoom in on the price action of the chart. For example, an H1 chart would have four times the candles of an H4 chart, so traders can look more closely at price changes.
Bullish and Bearish Patterns
Certain candlestick patterns can help traders make short-term predictions about price movements. Although a single candle indicates whether buying or selling action is strong, it doesn’t necessarily mean that the long-term price will continue in that direction. This is why traders look at different time periods to get a sense for longer-term trends. There are many ways to read candlestick charts, depending on trading strategy and time frame.
At first glance, candlestick charts can appear pretty random. But there are many bullish and bearish patterns traders can identify in order to try to predict price movements. It’s important to remember that patterns are not guarantees of future price movement.
Below are some of the patterns traders can look out for.
Bearish Engulfing Pattern
If there are more sellers than buyers when a chart has been trending upward, traders will see a long red candlestick after a small green one. This can indicate that prices may decline.
Bullish Engulfing Pattern
The opposite pattern will occur if the price is trending downward but then a long green candlestick appears in the chart. This may indicate that prices will continue to increase.
Bearish Evening Star
If the last candle in a chart opens at a lower price than the previous day’s candle body, and the last candle closes deep into the candle body from two days before, this can show that buying is slowing down and more traders are selling. The pattern can form when the previous candle is either red or green.
If traders see a small red candle body that fits completely within the previous day’s candle body, buyers may well be undecided about whether to buy or sell. Price action continuing downward after the small candle could indicate a longer-term downward trend.
The opposite of a bearish harami is a bullish harami, which can indicate the prices will continue upward.
The harami cross is a harami pattern that has a second doji candle.
Bearish Falling Three
If there is one day with a strong downward trend, followed by three small green candle bodies that stay within the boundaries of the first candle, followed by another long red candle, the price may continue to decrease.
If the price significantly decreases but then makes a comeback and ultimately closes near the high, this is called a hammer. The hammer pattern has a small body and a long lower wick. It’s a bullish signal because it shows that the price was declining but then traders pushed it back up.
The hanging man pattern is the opposite of the hammer. It is also referred to as an inverted hammer. This pattern looks like a square lollipop. If traders are attempting to spot the top or bottom of a market, they often use hammer and hanging man patterns as indicators.
This pattern has three candlesticks. The first shows an uptrend, the second has a small body, and the third closes below the center of the first candlestick. It’s a bearish reversal pattern.
The reverse of the evening star is the morning star. The first candlestick in this pattern is long and red, the second is short and lower than the first, and the third is a long green candlestick that closes above the center of the first.
The shooting star is essentially the same as the inverted hammer. It can indicate a reversal toward a bearish trend.
A gap is a window of time in which there are no trade transactions. Gaps in a chart can indicate support and resistance levels, which can be followed by a further bullish or bearish trend.
Bar Charts vs. Candlestick Charts
Like candlestick charts, bar charts show security price changes over time. Many traders think candlestick charts are easier to read; the thicker candle bodies make it easy to see the distinction between the opening and closing price and the high and low. Bar charts are also often not color coded, making it more difficult to see price trends. However, some traders prefer the cleaner aesthetic of a bar chart.
Charting Your Investment Course
Now that you know more about how to read charts you can work on building your portfolio. There are tools available to help you research, track, and invest in stocks.
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