The Hustler's Digest StaffCandlesticks show you whether the price change in a market was good or negative, and to what extent. For day trading, learn how to read and comprehend candlestick charts. This guide covers top candlestick chart analysis tactics and tips.
A candlestick is a technical analysis price chart that shows the high, low, open, and closing prices of securities over time. Japanese rice merchants and traders developed hundreds of years ago to track market prices and daily momentum before becoming popular in the United States. The “true body” is the vast area of the candlestick that shows investors whether the stock closed higher or lower than it opened (black/red if the stock ended lower, white/green if the stock closed higher).
What is a candlestick chart?
A candlestick chart is a chart made up of individual candles that traders use to analyze market action. Candlestick price action entails determining the price highs and lows for a specific period, as well as where the price opened and closed for that period.
Traders in all financial markets can use price action to spot trends and reversals. For instance, groupings of candlesticks can build patterns that appear across currency charts and suggest trend reversals or continuations. Unique candlestick formations can also be formed, signifying market buy or sell entries.
The time frame chosen by the trader determines the length of each candle. The daily time frame is a popular one, and the candle will show the open, close, high, and low for the day. The many components of a candle can help you predict where the price will go in the future; for example, if a candle closes significantly below its open, it could imply additional price drops.
How to read candlestick charts
Do you know which cryptocurrencies to buy and when to acquire them? When researching crypto assets, you may come across a candlestick chart, which is a sort of price graph. So it’s a good idea to spend some time learning how these work.
Candlestick graphs are similar to line and bar graphs in that they display time on the horizontal axis and price data on the vertical axis. On the other hand, Candlesticks have more information than more straightforward graphs. You may display the asset’s peak and lowest prices, as well as its opening and closing prices, at a glance for any chosen timeframe.
What do candlesticks tell us?
Candlesticks can reveal more than merely price change over time. To evaluate market emotion and make forecasts about where the market could go next, experienced traders seek patterns. Here are a few examples of what they’re looking for:
A long wick on the bottom of a candle, for example, might indicate that traders are buying into an asset as prices fall, which could be a sign that the support is on the rise.
A lengthy wick at the top of a candle, on the other hand, could indicate that traders are eager to profit, potentially meaning a significant sell-off shortly.
Suppose the candle’s body fills practically the entire candle, with very short (or no visible) wicks on either side. In that case, this could signal a solid bullish (on a green candle) or bearish (on a red candle) attitude (on a red candle).
Understanding what candlesticks represent in the context of a specific asset or market conditions is one component of technical analysis, a trading approach in which investors seek to detect trends and potential future opportunities by analyzing past price movements.
How to read “one-candle signals”
Traders that trade in concise time frames may focus on just one candle at a time. Familiarizing yourself with these “one-candle signals” can benefit you as a newbie.
- A long upper shadow may signal a bearish trend, indicating that investors are ready to sell and profit. The stronger the indicator, the longer the upper shadow.
- A long lower shadow could be a bullish indication, indicating that investors are looking to buy and pushing prices higher. The signal is more reliable if the bottom shadow is longer.
- Because the open and close prices are the same, a Doji candle has nobody. These are usually regarded as market indecision, and they might be a precursor to a price reversal. (What is the significance of the term “Doji”? In the 18th century, Japanese rice traders were the first to employ candlestick charts. “Doji” means “mistake,” apparently because prices rarely open and close simultaneously.
- The bottom wick of an umbrella is unusually lengthy. A hammer is another name for a red umbrella. When you see a hammer, it usually signifies that the asset is seeing a lot of buyer interest, and the price is about to rise. On the other hand, green umbrellas are known as “hanging men.” They’re frequently a hint that sellers are ready to sell, reversing the uptrend. a similar location.)
It’s important to note that one-candle signals can be an important clue, but an accurate reading of the market requires understanding the broader context. And spotting trends and patterns in candlestick charts isn’t easy. If you’re not sure what investment strategy is right for you, check with a professional advisor.
There are many different types of candlesticks for reviewing a candlestick chart, but you only need to know a handful of them to begin understanding patterns and trends.
Different Candlestick types to know
- Big Candles
- Dojis
- Gravestone / Dragonfly
- Shooting Star / Hammer
- Morning Doji Star / Evening Doji Star
- Bearish Harami / Bullish Harami
- Engulfing Bullish / Engulfing Bearish
Why would we utilize a candlestick chart in the first place before we look at each form of the candlestick?
If you understand patterns and trends, candlestick charts may provide you with a wealth of information. Understanding the various types of candlesticks can assist you in piecing together patterns, resulting in more successful and potentially profitable decisions.
Why not use the Line chart?
When evaluating a stock’s history, the line chart is the most basic and straightforward chart accessible. It shows a line connecting a series of closing prices that can be seen by day, week, month, or year.
While its graph is straightforward and shows pricing and patterns over time, its data is limited. As a result, most experienced traders and professional brokers prefer candlestick charts to line charts.
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Types of candlesticks and their meaning
- Big Candles
- Dojis
- Gravestone
- Dragonfly
- Shooting Star
- Hammer
- Morning Doji Star / Evening Doji
- StarBearish Harami / Bullish Harami
- Engulfing Bullish / Engulfing Bearish
Let’s explore each type of candle and how it can help you predict patterns and trends.
Big Candles
Because they are enormous candles with significant price disparities, Big Candles are self-explanatory.
The small candle may have represented a $0.20 price drop, while the large candle could have been a $2.00 price drop. The crucial thing to remember is that large candles indicate price movements that increase or drop.
The candle’s lifetime notifies us about the present supply and demand. A large candlestick that falls in price indicates that supply was substantially larger than demand at the time. If the candle price rises, need is more significant than supply.
This chart, for example, has a substantial decline on this day, which is represented by a giant red candlestick. We can immediately see that supply was far greater than demand on this particular day, but why such a drastic drop?
We can assume that some news or information prompted such a significant price movement. Let’s take a look at another candlestick shape called a Doji.
Dojis
A doji is a candle that changes price over time but always opens and closes at the same price. It could be a day, an hour, or even a single minute. The gist of the story remains the same: the market is in a state of flux.
Buyers were winning at one point, and sellers were winning at another, but it ultimately closed at the same price as when it opened. When the candle wick is large, it simply signifies more indecision than when the candle wick is trimmed.
Dojis indicate that there is price ambiguity, but they don’t reveal much else. However, if you combine them with other candlestick patterns, you’ll get some exciting results.
You might learn more about how the stock price will go if you combine them with other candlestick patterns. The morning Doji star and the evening Doji star are two patterns.
Morning Doji Star and Evening Doji Star
The Doji is used in these patterns to indicate a likely trend reversal. The morning Doji star is formed when the candles travel down and then hit a Doji and move up. An evening Doji star is an inverse pattern when the Doji signifies a trend reversal going down.
The Doji stars in the morning and evening will not inform you which stocks to buy. You should not simply look at this pattern and decide to buy it. However, if you’ve already decided on a stock based on your approach, this pattern can help you figure out when the optimal time to enter the market is.
Also, don’t get too wrapped up in looking for a doji that exactly matches the opening and closing prices. It could also have a small body and similar pricing at both opening and closing. The aim is to have the ability to recognize market entry patterns.
This is an example of a clear entry point into the market. The little candle at the bottom indicates that the pattern is altering and a trend reversal is approaching. It would be an excellent opportunity to buy after the stock has bottomed out and shown signs of growth.
Gravestone and Dragonfly
These two types of candles are similar to Dojis in that they open and close at the same price, but they only move in one direction: up or down. They, like the Doji, aren’t beneficial on their own, but when combined with other candle types, they can help foretell a stock’s future.
Shooting Star and Hammer
A shooting star occurs when a stock opens at a specific price and then rises and falls to close just above that price. It’s nearly identical to the gravestone, except instead of closing at the same price, it closes slightly above the initial cost.
The hammer is in the same boat. The hammer is when the price opens, drops a little, and then rises again to close just below the opening price. The dragonfly candle type is closely linked to this motif.
Bearish Harami and Bullish candlestick patterns
A giant candle is followed by a smaller candle contained within the body of the first candle in these patterns. The bearish harami indicates a downward reversal pattern, whereas the bullish harami indicates upward.
This trend strongly signals that things will change shortly. Let’s look at how that may appear on a candlestick chart.
We can see that demand was more significant than supply for a decent streak. The purchasers had the upper hand. Then, once it had reached a particular price, the next opening price was lower, and the closing price was lower as well. This is a strong indicator that the stock will flip direction and revert to its previous trend.
This indicates that the stock was exhausted after reaching a specific price, allowing sellers to seize control of the market.
Engulfing Bullish and Engulfing Bearish
A little candlestick is followed by a larger opposite candlestick that completely engulfs the first one in this pattern.
Here’s an example of a bearish engulfing pattern.
We can see that the purchasers have been driving up the price for quite some time now. A massive red candlestick then engulfs the small green candlestick at the summit, suggesting a trend reversal. This is a significant indication since the sellers outnumber the purchasers by a large margin, as the previous candle is entirely engulfed.
Are these all the Candlesticks to know?
There are many more candlesticks with names on them, but they aren’t as important. You would be missing the point if you spent all of your time learning candlestick names and different varieties.
The purpose is not to memorize names. It’s all about figuring out how specific candles can predict behavior when arranged in a particular sequence.
Best candlestick patterns
Candlestick charts are technical analysis that consolidates data from many time frames into a single price bar. This distinguishes them from standard open-high, low-close bars or simple lines connecting the dots of closing prices. Candlesticks create patterns that, if completed, forecast price direction. This colorful technical instrument, which dates back to 18th-century Japanese rice dealers, gains depth with proper color coding.
In his acclaimed 1991 book “Japanese Candlestick Charting Techniques,” Steve Nison introduced candlestick patterns to the Western market. Hundreds of these patterns, with names like bearish dark cloud cover, evening star, and three black crows, are now recognized by many traders. Single bar patterns such as the Doji and hammer have also been used in many long- and short-side trading methods.
Candlestick pattern reliability
All candlestick patterns aren’t created equal. Their enormous popularity has diminished their reliability because hedge funds and their algorithms have evaluated them. These well-funded players rely on lightning-fast execution to compete against regular investors and traditional fund managers who use technical analysis tactics accessible in popular texts.
Hedge fund managers, in other words, utilize software to entice participants to search for high-odds bullish or bearish outcomes. Reliable patterns, on the other hand, continue to emerge, allowing for both short- and long-term profit chances.
Here are five candlestick patterns that work well as price direction and momentum predictors. Each predicts more incredible or lower prices in the context of the surrounding price bars. In two ways, they are also time-sensitive:
- They can only function within the parameters of the chart they’re looking at, whether it’s intraday, daily, weekly, or monthly.
- Three to five bars after the pattern is completed, their power rapidly diminishes.
Candlestick performance
This research is based on Thomas Bulkowski, who published the “Encyclopedia of Candlestick Charts” in 2008, including performance rankings for candlestick patterns. He provides data for two types of pattern outcomes that are expected:
- Reversal – Candlestick reversal patterns predict a change in price direction
- Continuation – Continuation patterns predict an extension in the current price direction.
The hollow white candlestick indicates a closing print higher than the opening print in the following cases, while the black candlestick indicates a closing pattern lower than the beginning print.
Three-line strike
The bullish three-line strike reversal pattern within a downtrend carves out three black candles. Each bar has a lower low and a close to the intra bar low. The fourth bar begins much lower but reverses into a wide-range outside bar that closes above the series’ initial high. The first print also marks the low of the fourth bar. This reversal, according to Bulkowski, predicts rising prices with an 83 percent accuracy rate.
Two-black gapping
After a significant top in an uptrend, the bearish two-black gapping continuation pattern occurs, with a gap down that gives two black bars posting lower lows. The slide will continue to lower lows according to this pattern, possibly sparking a broader-scale slump. This pattern, according to Bulkowski, predicts reduced pricing with a 68 percent accuracy rate.
Three black crows
Three black bars with lower lows close to intra bar lows form the bearish three black crows reversal pattern, which starts at or near the crest of an uptrend. The slide will continue to lower lows according to this pattern, possibly sparking a broader-scale slump. Because it traps buyers entering momentum plays, the most bearish variant starts at a new high (point A on the chart). This pattern, according to Bulkowski, predicts reduced prices with a 78 percent accuracy rate.
Evening star
A towering white bar initiates the bearish evening star reversal pattern, which carries an uptrend to a new high. The market gaps are higher on the next bar, but no new buyers materialize, resulting in a narrow range candlestick. The pattern is completed by a gap down on the third bar, indicating that the slide will continue to lower lows, possibly sparking a broader-scale slump. According to Bulkowski, this pattern has a 72 percent accuracy record in predicting decreased pricing.
Abandoned baby
After a sequence of black candles prints lower lows, the bullish abandoned baby reversal pattern develops at the bottom of a downtrend. On the next bar, the market gaps lower, but no new sellers materialize, resulting in a narrow range of Doji candlestick with identical opening and closing prices. The pattern is completed by a bullish gap on the third bar, indicating that the recovery will continue to higher highs, possibly initiating a broader-scale upswing. According to Bulkowski, this pattern has a 49.73 percent accuracy rate in predicting increased prices.
How to read candlestick chart for day trading
The candlestick’s shadows depict the day’s high and low, as well as how they compare to the open and close. The link between the day’s high, low, opening, and closing prices determines the shape of a candlestick.
Technical analysts use candlesticks to identify when to enter and exit trades since they indicate the impact of investor mood on security prices. Candlestick charting is based on a rice price tracking technique developed in Japan in the 1700s. Candlesticks can be used to trade any liquid financial instrument, including stocks, foreign exchange, and futures.
Long white/green candlesticks show significant purchasing pressure, indicating that price is likely to rise. However, rather than looking at them individually, they should be considered in the context of the market system. A long white candle, for example, is more likely to be significant if it forms at a substantial price support level. Long black/red candlesticks suggest that selling pressure is intense. This indicates that the price is declining. When the price drops significantly lower after the open then rallies to close near the high, a typical bullish candlestick reversal pattern known as a hammer occurs. A hanging man is the bearish candlestick’s equal. These candlesticks resemble a square lollipop and are frequently employed by traders looking for a good entry point.
The bottom line
Market participants are drawn to candlestick patterns; however, many of the reversal and continuation signals provided by these patterns do not work dependably in today’s computerized environment. Fortunately, statistics by Thomas Bulkowski demonstrate that a small subset of these patterns has extraordinary accuracy, providing traders with meaningful buy and sell recommendations.
A brokerage account is required to put the knowledge gained from candlestick patterns to use and invest in an asset-based on them. Investopedia has compiled a list of the finest online brokers to help you choose the proper broker for your financial needs and save time on your research.
