Basics of Candlestick Charts
How to Read Candlestick Charts
A candlestick chart is used to determine the price movement of an asset or security in the financial world. Candlestick chart was introduced by the Japanese rice trader Munehisa Homma. He discovered that the price of the rice fluctuates during the period due to the emotions of the trader and also the supply and demand of rice. Here in this article, we will try to cover the basics of candlestick charts, how candlestick charts are formed, how to read candlestick charts, various candlestick patterns, and how to analyze them.
What is a Candlestick Chart?
Candlestick charts are the graphical/visual representation of the price fluctuation over the period (1 min, 2 min, 30 min, 1 hour, 1 day, 1 week, 1 month, etc.). This price fluctuation is due to the changes in demand and supply of a particular stock or an entity based on the performance of the company or any news related to the company.
It also depends on the emotions of the investors/traders and some macroeconomic news/indicators. These charts are popular among the traders to do technical analysis, as they are easy to read and analyze.
How are Candlestick Charts formed?
Candlestick Charts are formed based on the price fluctuation mentioned above. Candlestick Charts consist of various candles. Here now we will see how one can represent each candle.
Open: First traded price
Close: Last traded price.
High: Highest traded price
Low: Lowest traded price
Each candle consists of the body and the wick. Wick is the tail, above and below of the rectangular body. Wick of the upper part is also called an upper shadow and the lower wick is also called a lower shadow.
Now we will see two types of candles, represented based on the colors and the direction in which price movement happened.
- Green Candle: If the color of the candle is green that means the stock price closed higher than the opening price of that time duration.
The top of the upper wick is the highest of the time duration and the bottom of the lower wick is the lowest price of the time duration.
- Red Candle: If the color of the candle is red that means the stock price closed lower than the opening price of that time duration.
How to Read Candlestick Charts?
There are various ways to interpret candlestick chart patterns. If there is no upper wick in the green candle that means stock price closed at the highest price of the mentioned time duration.
Similarly, if a red candle has a shorter upper wick that means the opening price was close to the highest price of the time duration of the candlestick chart.
Candlestick Chart Patterns
Now we will go through some of the most used candlestick chart patterns by the traders.
Bullish Engulfing Pattern
This pattern shows how a bearish trend can be converted into a bullish trend. This pattern is formed when a green candle is formed after the red candle. Green candles should close higher than the previous day’s opening and opening lower than the previous day’s close. The red candle should be completely engulfed by the following green candle.
One shouldn’t look at just two candles. Generally, when this green candle is formed after 4 such red candles and also looking at some other technical indicators, trend reversal may happen.
This is also one of the trend reversal candlestick chart patterns, one of the bearish indicators. On the first instance, a large green candle is formed, followed by another small green or red candle that shows moderate growth or moderate shrink in the price of the stock, and on the third day stock price opens below the previous day and ends up as a red candle, closing at somewhere around the half of the first day. These candlestick chart patterns have relatively high accuracy.
There is also a candlestick chart pattern called the morning star pattern which is exactly the opposite of the evening star pattern. It is used to predict an uptrend and has one large red candle, followed by a small red or green candle, and lastly, it will form a large green candle.
Three Black Crows
This candlestick chart pattern predicts the downturn of the stock price. The pattern consists of three consecutive red candles, which seem like a staircase. These three red candles show how bears have overtaken bulls. Initially, bulls will take the stock price higher but they can’t withstand the selling pressure of the bears and the price of the stock ends up to be in the red.
In order to confirm the downtrend, volume is the key feature. The volume of the stock will be moderate but when these three candles are formed there is a high volume of selling created by the bears.
Hammer or Inverted Hammer
Hammer candlestick pattern is found at the bottom of the downtrend and it shows the bullish reversal. Hammer candle will have a small body but a large wick. This proves that bulls are taking over bears. There are some conventions followed by traders that the wick of the candle should be at least two times the body in order to have more accuracy in the trade.
An Inverted Hammer pattern will be the same as a hammer pattern with a selling pressure which will lead to lower price during the time frame but end up in green, due to more buying pressure of the bulls.
Candlestick chart patterns are used by almost every trader to make profitable trades. Candlestick charts show the price movement of the security in the market for the given period. Various patterns are mentioned above which helps to predict the uptrend or downtrend.