Candlestick charts are a fundamental tool in technical analysis, providing traders with visual insights into price movements over specific periods. By understanding candlestick patterns, traders can identify potential trends and reversals, making them invaluable for analysing most tradable asset classes and financial instruments.
Originating in Japan over 200 years ago, these charts have helped traders better understand market trends and make informed trading decisions and are now an essential part of modern trading strategies amongst market professionals. In this article, we will explore what candlestick charts are, how to read them, and why they are essential for traders. Additionally, we’ll explore common candlestick patterns, their significance, and how they can be integrated with other technical analysis tools.
What are candlestick patterns?
Candlestick patterns are graphical representations created by the movement of prices for a given asset over a specified period on a candlestick chart. Each candlestick represents four key pieces of information: the Opening price, High price, Low price and Closing price during that time (e.g., one day, one hour), also known as OHLC. Candlesticks consist of a body and wicks (or shadows) that extend above and below the body. This method provides a more comprehensive view of price action than traditional line charts.
Basic Structure of a Candlestick
How do I read a candlestick chart?
Reading a candlestick chart involves understanding the individual candlesticks and their patterns. Each candlestick provides information about the market sentiment during a particular time frame.
Knowing how to read candlestick charts can help you to identify or predict market movements. You read a candlestick by looking at its colour, body and wick:
The Body: The candlestick's body equates to the range between the opening and closing prices.
The Wick (Shadow): The lines extending above and below the body are known as wicks or shadows. The upper wick ‘extreme’ represents the highest price during the period, while the lower wick ‘extreme’ represents the lowest price. A candlestick with a long upper wick and a short lower wick indicates that buyers were highly active during the trading period, pushing prices up significantly. However, sellers were dominant and drove the prices down from their peak, resulting in the market closing below the high point, which is reflected in the long upper shadow.
On the other hand, a candlestick featuring a long lower wick and a short upper wick shows us that sellers initially pushed prices down, but buyers entered the market at lower prices, leading to a recovery. This buying activity caused the market to close higher, as evidenced by the long lower shadow.
The Color: The colour of the candlestick body helps traders quickly identify whether the price moved up or down during the period. If the closing price is higher than the opening price, the body is typically coloured green (or white), indicating a bullish period. Conversely, if the closing price is lower than the opening price, the body is coloured red (or black), indicating a bearish period.
What is the difference between a bullish and a bearish candlestick?
A bullish candlestick suggests that buyers were in control during the period (typically green or black), pushing prices higher and closing higher than the opening price of that timeframe. Conversely, a bearish candlestick indicates that sellers dominated (typically red or black), driving prices lower to close below the opening price.
Why are candlestick patterns important in trading?
Candlestick patterns can help traders identify potential market reversals or continuations. By analysing these patterns, traders can make more informed decisions about when to enter or exit trades. There are many candlestick patterns which act as valuable indicators for traders looking to make price movement predictions.
What are some common candlestick patterns I should know, and how do I identify a possible trend or reversal?
Several candlestick patterns can signal possible future market movements. Here are a few common ones:
1 - Doji: A Doji candlestick, which typically looks like a cross, inverted cross, or plus sign, shows that the opening and closing prices for a trading period a