Understanding a Candlestick Chart

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Understanding a Candlestick Chart

Candlestick graph The bar and point-and-figure charts were invented in Japan over 100 years before the West. In the 1700s, a Japanese man called Homma recognized that, although there was a relationship between rice price and supply and demand, the markets were heavily impacted by merchants’ emotions.

Candlesticks convey emotion by graphically showing the magnitude of price movements with various colors. Candlesticks are used by traders to make trading choices based on frequently recurring patterns that assist estimate the price’s short-term direction.

Key Takeaways

  • Traders use candlestick charts to forecast price movements based on prior patterns.
  • Candlesticks are important in trading because they display four price points (open, close, high, and low) across the time period specified by the trader.
  • Many algorithms rely on the same price data that is shown in candlestick charts.
  • Trading is often influenced by emotion, which may be seen in candlestick charts.

Click Play to Learn How to Read a Candlestick Chart

Candlestick Components

A daily candlestick chart, like a bar chart, displays the market’s open, high, low, and closing prices for the day. The candlestick features a broad section known as the “true body.”

This genuine body depicts the price range between the day’s open and closing. When the true body fills in or becomes black, it indicates that the close was lower than the open. If the actual body is empty, it indicates that the close was greater than the open.

Image by Julie Bang © Investopedia 2019

These colors may be changed on the trading platform. A down candle, for example, is often tinted red rather than black, while an up candle is frequently shaded green rather than white.

Candlestick vs. Bar Charts

The “shadows” or “wicks” are located just above and below the main body. The shadows represent the day’s high and low prices. If the top shadow on a downcandle is short, it means that the open that day was around the day’s high.

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On an up day, a brief upper shadow indicates that the close was near the high. The daily candlestick’s appearance is determined by the connection between the day’s open, high, low, and close. Real bodies might be short, dark, or white. Long or short shadows are possible.

Bar charts and candlestick charts display the same data in various ways. Candlestick charts are more visually appealing owing to the color coding of the price bars and thicker actual bodies that show the difference between the open and close.

The chart above depicts the same exchange-traded fund (ETF) throughout the same time frame. Colored bars are used in the bottom chart, while colored candlesticks are used in the top chart. Some traders want to observe the thickness of the actual bodies, while others like the clean appearance of bar charts.

Basic Candlestick Patterns

Candlesticks are formed by price fluctuations up and down. While these price changes may look random at times, they may also develop patterns that traders can utilize for study or trading. There are numerous different candlestick patterns. Here’s a little to get you started.

Bullish and bearish patterns are distinguished. Bullish patterns suggest that the price will climb, while bearish patterns suggest that the price will decrease. No pattern works 100% of the time since candlestick patterns depict price movement trends rather than promises.

Bearish Engulfing Pattern

When sellers outweigh purchasers in an upswing, a bearish engulfing pattern forms. A long redreal body devouring a little green genuine body reflects this action. The pattern suggests that sellers have regained control and that the price may continue to fall.

Image by Julie Bang © Investopedia 2019

Bullish Engulfing Pattern

When buyers outnumber sellers, an engulfing pattern forms on the bullish side of the market. The chart depicts this as a lengthy green real body enveloping a little red real body. The price might rise now that the bulls have gained some grip.

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Image by Julie Bang © Investopedia 2019

Bearish Evening Star

A toppingpattern is an evening star. The final candle in the pattern opens underneath the previous day’s little actual body, identifying it. The little true body might be red or green. The final candle shuts deep into the candle’s true body two days before. The pattern shows the buyers delaying and then the selling seizing control. More selling may occur.

Image by Julie Bang © Investopedia 2019

Bearish Harami

A bearish harami is a little real body (red) that is totally contained inside the previous day’s real body. This is not a trend to act on, but it is one to keep an eye on. The pattern demonstrates the purchasers’ hesitation. If the price continues to rise after that, the uptrend may continue, but a down candle after this pattern predicts a further down.

Image by Julie Bang © Investopedia 2019

Bullish Harami

The bullish harami is the inverse of the bearish harami. A downtrend is in effect, and a little real body (green) occurs within the previous day’s huge real body (red). This indicates to the technician that the trend has come to a halt. If it is followed by another up day, additional gains may be on the way.

Image by Julie Bang © Investopedia 2019

Bearish Harami Cross

In an uptrend, a bearish haramicross happens when an up candle is followed by a doji—the session in which the candlestick has a nearly equal open and close. The doji is inside the previous session’s true body. The ramifications are identical to those of the bearish harami.

Image by Julie Bang © Investopedia 2019

Bullish Harami Cross

In a downtrend, a bullishharamicross happens when a downcandle is followed by a doji. The doji is inside the previous session’s true body. The ramifications are same to those of the bullishharami.

Image by Julie Bang © Investopedia 2019
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Let’s take a look at some additional black and white patterns, which are very popular colors for candlestick charts.

Bullish Rising Three

This pattern begins with what is known as a “long white day.” The price then falls during the second, third, and fourth trading sessions, but it remains within the price range of the long white day (day one in the pattern).The pattern’s fifth and final day is another lengthy white day.

Image by Julie Bang © Investopedia 2019

Despite the fact that the price has been declining for three days in a row, a new bottom has not been reached, and bull traders are preparing for the next move up.

A little variant of this pattern occurs when the second day follows the first lengthy up day with a tiny gap up. Everything else about the design is the same; it simply has a different appearance. When that happens, it’s referred to as a “bullish mat hold.”

Bearish Falling Three

The trend begins with a significant down day. This is followed by three little real bodies that rise but remain within the range of the first major down day. When the fifth day makes another major downward move, the pattern is complete. It indicates that sellers have regained control and that the price may fall further.

Image by Julie Bang © Investopedia 2019

The Bottom Line

As Japanese rice dealers found centuries ago, the emotions of investors around the trading of an asset have a significant influence on its movement. Candlesticks assist traders in gauging the emotions around a stock or other asset, allowing them to make more accurate forecasts about where that stock may be heading.

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