Tyler Brooks
Candlestick charts are a cornerstone of technical analysis, offering a visual representation of price movements and patterns over a set period of time. Each candlestick represents four key pieces of information: open and close prices in the thick body, and high and low prices in the candle wick. Candlesticks are used to identify patterns and predict potential price changes, reflecting investor sentiment and the balance of power between bulls and bears. The colour of the candle also indicates the direction of market movement, with red or black indicating a price decrease, and green or white indicating a price increase.
| Characteristics | Values |
|---|---|
| Use | Used by traders and investors to determine possible price movement based on past patterns |
| Visuals | Candlesticks represent four important pieces of information: open and close in the thick body, and high and low in the "candle wick" |
| Colours | Black/red if the stock closed lower, white/green if the stock closed higher |
| Length of body | The longer the body, the more intense the trading |
| Length of wick | A short upper wick indicates the stock closed near the high of the day, a short lower wick indicates the stock opened near the high of the day |
| Bullish or bearish | If the price closes above the open price, the candlestick is bullish. If the price closes below the open price, the candlestick is bearish |
| Common patterns | Morning star, evening star, bullish harami, bearish engulfing |
| Timeframe | Each candlestick represents a specific time frame, e.g. a day, hour, or minute |
| Origin | Developed in the 18th century in Japan by rice trader Munehisa Homma |
| Other uses | Used in stock analysis alongside other tools such as Fibonacci analysis |
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What You'll Learn
Candlestick chart components: real body, shadows, and colour
Candlestick charts are a cornerstone of technical analysis, offering visual and analytical advantages over other chart types. They are used to determine possible price movements based on past patterns. Each candlestick represents a specific period, typically a day, and is made up of three components: the real body, shadows, and colour.
Real Body
The real body, or simply body, is the rectangular section of the candlestick. It represents the range between the opening and closing prices. Long bodies indicate strong buying or selling pressure, while short bodies suggest indecision. The body is thick and is usually accompanied by a line extending above and below it, called the upper shadow and lower shadow, respectively.
Shadows
The shadows, or wicks, extend above and below the real body, marking the highest and lowest prices reached during the period. The top of the upper shadow represents the high price, while the bottom of the lower shadow represents the low price. Long shadows indicate that much trading took place either far above or far below the opening and closing prices, and they often indicate that a trend may be ending.
Colour
The colour of the candle provides a quick indication of price direction. A bullish candlestick is typically green or white, indicating that the closing price is higher than the opening price. Conversely, a bearish candlestick is generally red or black, signalling that the closing price was lower than the opening price.
Candlestick charts were developed in the 18th century in Japan by rice trader Munehisa Homma. They are based on the idea that market prices are influenced by both trader psychology and the balance of power between buyers and sellers. By studying historical price changes, Homma identified patterns that signalled shifts in sentiment and market control, helping him predict price reversals and trends.
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Candlestick patterns: bullish and bearish engulfing patterns
Candlestick charts are a cornerstone of technical analysis, offering visual and analytical advantages over other chart types. They are used to describe the price movements of a security, derivative, or currency. Each candlestick represents four pieces of information: the open and close prices in the thick body, and the high and low in the "candle wick".
Candlesticks can be coloured or hollow. Coloured candlesticks are typically red and green. Red candles indicate that the current close price is less than the previous close price, while green candles indicate the opposite. Hollow candlesticks show whether the current close price is greater or less than the current open price through their solid or hollow fill respectively.
Bullish and bearish engulfing patterns are two-candle reversal patterns. They signal a potential trend reversal, indicating that the price has reached the bottom and is preparing to reverse the trend. A bullish engulfing pattern is a white or hollow candlestick that closes higher than the previous day's opening after opening lower than the prior day's close. The second candle completely 'engulfs' the body of the first, with the bulls taking over and pushing the price higher. This pattern can be a powerful signal when combined with the current trend, but it is not always accurate.
A bearish engulfing pattern is the opposite of a bullish engulfing pattern. It occurs after a price moves higher and indicates lower prices to come. The first candle is a bullish up candle, followed by a larger bearish down candle that engulfs the smaller up candle. The larger the timeframe on which the pattern appears, the stronger the reversal signal.
Traders can use these patterns to set up stop losses and minimise risk. However, it is important to note that these patterns are not always accurate and should be used in conjunction with other technical tools and indicators.
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Candlestick chart uses: visualising price movements
Candlestick charts are a cornerstone of technical analysis in finance, helping traders and investors to quickly assess price movements and short-term market sentiment. Each candlestick represents a specific time frame (e.g. a day, hour or minute) and four key pieces of information: the open and close prices (in the thick body) and the high and low prices (in the "candle wick").
The candlestick's colour and shape visually communicate the relationship between the open and close prices, as well as the highs and lows for the time period. For example, if the current close price is greater than the current open price, the candle will be hollow. If the stock closed lower, the candle will be red; if the stock closed higher, it will be green. The longer the body of the candle, the more intense the trading.
Traders can identify bullish or bearish patterns by analysing these four price points over multiple candlesticks, helping to predict potential price changes. For example, a small, bearish candle followed by a larger, bullish candle is a bullish engulfing pattern, suggesting the buyers have taken over. A morning star pattern, consisting of a bearish candle, a small indecisive candle, and a bullish candle, may signal a bullish reversal.
Candlestick charts are particularly useful for intraday trading, where traders buy and sell stocks within the same day, aiming to capitalise on small price movements. By understanding the candlestick patterns, traders can make more informed decisions about when to enter and exit trades.
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Candlestick chart history: origins in 18th-century Japan
Candlestick charts are a cornerstone of technical analysis, offering visual and analytical advantages over other chart types. They are used to describe price movements of a security, derivative, or currency, and are commonly used for equity trading. The charts are thought to have originated in 18th-century Japan, pioneered by rice trader Munehisa Homma (also known as Sokyu Honma).
Homma, who worked at the Dojima Rice Exchange in Osaka, was one of the first to understand the impact of emotion on settling prices. He identified that market prices are influenced by both trader psychology and the balance of power between bulls and bears. His research served as the foundation for Japanese candlestick analysis, and his approach and insights continue to help traders worldwide.
Homma published his findings in 1755 in a book titled "The Fountain of Gold - The Three Monkeys' Record of Money", which is now considered the first book on trading psychology. In it, he referred to the bull market as the Yin and the bear market as the Yang, detailing their interaction and rotation. One of his most famous adages, "when everyone is bearish, there is a reason for prices to rise", remains relevant today.
While candlestick charts have been used for over 100 years, they were not introduced to the Western world until the early 20th century by Japanese chartist Sokyu Honma. Steve Nison further popularised their use in the West with his 1991 book, "Japanese Candlestick Charting Techniques". Nison is credited with developing new candlestick patterns and refining their interpretation, thus modernising candlestick analysis outside of Japan.
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Candlestick chart analysis: predicting price trends
Candlestick charts are a cornerstone of technical analysis, offering traders a visually intuitive way to assess market sentiment and predict price trends. Each candlestick represents a specific period, typically a day, and conveys four important pieces of information: open, close, high, and low prices. The open and close prices form the thick body of the candlestick, while the high and low prices are represented by the "wick" or "shadow". The colour of the candlestick indicates the direction of price movement, with green or white usually denoting an increase and red or black a decrease.
Candlesticks form patterns that traders use to predict price trends and make trading decisions. For example, a small bearish candle followed by a larger bullish candle that engulfs the previous candle's body indicates that the bulls have taken over, and the price is likely to continue rising. This is known as a bullish engulfing pattern. Conversely, a bearish engulfing pattern, marked by a small bullish candle followed by a larger bearish candle, suggests a shift from bullish to bearish sentiment and a potential price decline.
Another bullish pattern is the hammer, which forms at the bottom of a downward trend. It is characterised by a short body and a long lower shadow, indicating that buying pressure ultimately drove the price up despite initial selling pressures. A variation of this is the inverted hammer, where the upper shadow represents bullish buying pressure pushing the price back towards the opening level. This pattern suggests that selling pressure may be exhausted, and a bullish reversal could occur.
The morning star is a three-candlestick pattern indicating a potential bullish reversal. It consists of a small candle between a long bearish candle and a strong bullish candle, marking the shift from bearish to bullish sentiment. The bearish equivalent is the evening star pattern.
While candlestick charts are powerful tools for predicting price trends, they have limitations and should be used alongside other forms of technical analysis for confirmation. They are best suited for short-term predictions and swing traders.
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Frequently asked questions
A candlestick chart is a style of financial chart used to describe the price movements of a security, derivative, or currency.
Each candlestick represents four important pieces of information: open and close in the thick body, and high and low in the "candle wick".
Candlestick charts are used to determine possible price movements based on past patterns. They are used by traders to decide when to enter and exit trades.
If the price closes above the open price, the candlestick is bullish. If the price closes below the open price, the candlestick is bearish.
Common candlestick patterns include the bullish engulfing pattern, the hanging man, the hammer, the harami, and the morning star. These patterns can indicate potential trend reversals or shifts in market sentiment.
