Candlesticks are also referred to as Japanese Candlesticks or the concept of “candlesticks charting”. It was developed by a Japanese rice trader named Munehisa Homma. By analyzing the rice market, he understood that candlesticks are formed after traders’ emotions while affecting the supply and demand of the price. Japanese candlesticks or candlesticks in short are the first thing a trader will look at to start the technical analysis.
Candlesticks are displayed in a stock’s chart and determine the direction of the price. The most common colors to use are green and red or white and black. A red/black candlestick indicates a bearish movement in the price whereas a green/white candlestick indicates a bullish movement in the price. Candlesticks can be adjusted in the period frame the trader wants to use. For example, if you choose the 1-hour chart every candlestick will represent a 1-hour movement. Likewise, if you choose a 1-day chart you will see that candlesticks will be different, representing a price movement per day.
Starting with the basics. A single candlestick looks like this:
As you can see in the above image, the body of the candlestick is red if the price is declining and white if the price of a specific asset is inclining. Then the upper tail/highest high of the candlestick represents the highest price the asset went to. Whereas, the lower tail/lowest low represents the lowest price of the day (If it’s a 1day chart) that the price went to. According to the movement, the closing or the opening price is determining. So, if it is a green candle (price going up) the opening price will start from below and will finish at the top. If it is a red candle (price going down) the opening price will start from above, going downwards.
Candlesticks are only making life easier for traders and investors. It is the core to more detailed and accurate information about the price movement compared to bar charts. Candlesticks represent the supply and demand behind each stock for a given period of time.
Body: As we explained above, each candlestick includes a central portion that shows the distance or change in price from the opening price and the closing price of the security being traded.
Upper tail: The upper tail is the top price the asset reached from the body distance.
Lower tail: The lower tail is the lower price the asset reach from the body distance.
Opening price: The opening price is the price that the candlestick had when it started forming. So we can say that if the candlestick has a price of $20 but the opening price was $10, the stock price went up. The candlestick will be white or green.
Closing price: The closing price is determined after the candlestick is formed. For example, if the opening price of a candle was $20 but the closing price was $10 it means that the price fell. In this case, the candlestick will be red or black. Likewise, if the opening price of a candle was $20 but the closing price was $30 it means that the price raised. The candlestick will be green or white.
Note: Traders have the ability to choose the colors they want when using their electronic trading platform.
As mentioned above candlesticks provide more accurate and detailed information compared to bar charts. Overall, both candlesticks and bar charts provide the same information about a stock price but in a different graphical structure. Japanese candlesticks are more visual and clearer which helps traders see the price movement better.
Traders usually look at both the body and the tails of the candlestick. Both lengths are important to help identify the price action or the potential direction of the asset. Candlesticks form patterns that allow traders to speculate on the next movement.
Let’s learn some candlesticks patterns that can enhance your trading decision making. Candlesticks patterns can show three directions: No movement/Indecision/reversal in the market, Bullish (price going up), or Bearish (price going down).
Bullish patterns are formed after a downtrend and are showing a reversal in the price movement. When traders see the following patterns, they may decide to open a buy position and benefit from the bullish movement.
Let’s start with a bullish marubozo. A bullish marubozo shows the expectation of bullishness that will continue over the next few trading sessions. The absence of upper and lower tails/shadows as shown below implies that the low is equal to the opening price and the high is equal to the closing price. Therefore, you see the tails missing.
The opening marubozo applies when the opening price occurs and is no longer disappearing. When the opening price is equal to the high of the day it is a bearish signal and when the price is at the low of the day it is a bullish marubozo.
Tweezer bottoms are part of the dual candlesticks pattern. As shown in the image below, the two candlesticks should have the same lows. The bearish candlestick should be followed by a bullish candlestick that has the same length of low. In this way, it indicates a bullish movement and a potential buy signal.
The hammer candlestick has a very short body with a longer lower tail. Sometimes it can have a very small upper tail or no upper tail at all like the image below. It is usually formed at the bottom of a downward trend, which is why it gives a reversal signal since the price will reverse from downward to upward. The hammer shows that although there were selling pressures during the day, ultimately a stronger buying pressures drove the price back up.
A similarly bullish pattern is the inverted hammer. The only difference between the two is that the longer tail appears to be the upper one. Like the hammer above, it can also have no lower tail at all or a very small one compared to the upper one.
It is also indicating the buying pressure that is followed by selling pressure. However, the selling pressure was not strong enough to drive the market price down. The inverse hammer suggests that buyers will soon have control of the market.
The bullish engulfing pattern is a dual candlestick pattern. The first candle is a short red/bearish body that is completely engulfed by a larger green/bullish candle. The bullish market will eventually push the price up, culminating in an obvious win for buyers.
The piercing line is also a dual candlestick pattern. It is formed by a long red candlestick that is then followed by a long green candlestick. In order for traders not to confuse it, they need to make sure that the second candlestick has its closing price higher than the half of the red candle. A piercing line is a very strong reversal signal. It indicates a strong buying pressure, as the price is pushed up to or above the mid-price of the previous day (if it’s a 1-day chart).
The morning star candlestick is considered a sign of hope in a bleak market downtrend. It is a three-stick pattern: a long red candle, a shorter body candle in the middle, and lastly a long green candle. Traditionally, the ‘star’ will have no overlap with the longer bodies, as the market gaps both on open and close. It signals that the selling pressure of the first day is subsiding, and a bull market is on the horizon.
The three white soldiers pattern occurs over three days (if we are looking at a 1-day chart). It consists of consecutive long green (or white) candles with small tails, which open and close are progressively higher than the previous day. It is a very strong bullish signal that occurs after a downtrend and shows a steady advance of buying pressure.
Bearish candlestick patterns are usually formed after an uptrend. In comparison to bullish signals that show a reversal, bearish candles signal a resistance. Heavy pessimism about the market price often causes traders to close their long positions and open a short position to take advantage of the falling price.
Tweezer tops are part of the dual candlesticks pattern. The two candlesticks should have the same highs and the bullish candle should be followed by a bearish candle with the same length of high to indicate a bearish movement and a potential sell signal.
Whenever a bearish marubozo arises the expectations is are bearish and this bearishness will continue over the next few trading sessions. The absence of upper and lower tails/shadows implies that the high is equal to the open and the low is equal to the close. Therefore, the tails do not appear in the chart.
The hanging man is the bearish equivalent of a hammer. It has the same shape but forms at the end of an uptrend instead of a downtrend.
It indicates that there was a significant sell-off during the day, but that buyers were able to push the price up again. The large sell-off is often seen as an indication that the bulls are losing control of the market.
The shooting star has the same shape as the inverted hammer but is formed in an uptrend. In other words, it has a small lower body and a long upper tail. As you can see in the below image, the shooting star will go slightly higher than the previous candle but will close just above it. (Since it is a bearish move the opening price started from above and closed at the bottom). The movement is like a star falling to the ground, thus the name.
A bearish engulfing pattern occurs at the end of an uptrend which is why it can be viewed as a resistance signal. The first candle has a small green body that is engulfed by a subsequent long red candle. It signifies a peak or slowdown of price movement and is a sign of an impending market downturn. The lower the second candle goes, the more significant the trend is likely to be.
The evening star is a three-candlestick pattern and is equivalent to the bullish morning star. The short candle is in the middle of the long white candle and a red candle that is also longer than the middle evening star. It is a very strong resistance indicator especially when the fourth candle is longer than the first long candle. Traders who enter a sell signal are looking to benefit from this downtrend in the price.
The three black crows’ candlestick pattern is composed of three consecutive long red candles with short or non-existent tails. Each session opens at a similar price to the previous day (if looking at a 1-day chart), but selling pressures push the price lower and lower with each close. Traders take this pattern as a confirmation to enter a strong bearish movement that will follow.
The dark cloud cover is the candlestick pattern that indicates a bearish reversal is approaching. Thus, the name “a black cloud over the previous day’s optimism”. It comprises two candlesticks: a red candlestick which opens higher than the previous green candle and is followed by a small green candle (usually taken as the confirmation of the pattern). This means that the bullish movement was taken too high for sellers and jumped in to sell back to normal.
Lastly, let’s learn about the continuation of candlesticks patterns that do not indicate the next movement and show indecision. When the following four candlesticks are formed traders understand that the buyers and the sellers in the market cannot determine the next price movement. In other words, the market is neutral or indecisive.
Doji candlesticks are the most common signal of indecision. They show that the market might signal an impending change of trend or market reversal. The unique feature of a Doji candlestick is that the opening and closing prices are identical. Therefore, the candlestick body is a simple flat line or a very tiny body. In addition, when the upper or lower “tails” are longer, the market indecision is stronger. This can lead the price to a possible reversal. This is how Doji candlesticks look like:
In the image below you can see what forms the Doji can be. Since you have already noticed the names of each candlestick represent well the movement that follows it. This is also the case with the Dojis.
The Long-legged Doji is the most common one and you will see it appear more frequently than the rest. As the name suggests, both tails are long and the opening and closing times are in the middle without a body being formed. The visual appearance clearly indicates indecision in the market. It can also tell us that the same number of buyers and sellers enter the opposite trades.
Whenever this Doji appears following an uptrend or a downtrend, traders take it as a signal of a reversal. For example, if the price is bearish and this Doji appears it is very possible that the market will take direction and become bullish. The same is true for the opposite.
The Dragonfly Doji emerges after an extended downtrend in the price. The dragonfly has a significantly long lower tail and the opening and closing prices are at the top. This Doji shows the resistance of the price to stay low which is why the price ‘recovers’ at the highest point. It is clearly rejecting to go down and indicates a reversal upwards.
The Gravestone Doji, as its name hints, is a ‘gravestone’ for investors and traders. This Doji is the exact opposite of the dragonfly. It shows the resistance and refusion of pushing the price upwards. This is why the opening and closing prices are at the bottom, indicating a potential downtrend is about to take place.
This is the rarest Doji of all four. The four price Doji does not have any tails and shows very strong indecision in the market. When this Doji appears traders cannot identify when the next price will go. This can happen when the market just opens, closes, and in-between carry out buying and selling at the exact price within the same period. It is very rare because the buyers and the sellers cannot just be the same in number at the exact same period.
The spinning top candlestick pattern has a short body centered between the tails that are of equal length. The pattern indicates indecision in the market, resulting in no meaningful change in price: the bulls sent the price higher, while the bears pushed it low again. Spinning tops are often interpreted as a period of consolidation, or rest, following a significant uptrend or downtrend.
The falling three-method formation patterns appear when the current falling market will continue to fall. In the picture, we can see that the falling three methods are formed in between two long red candlesticks. The green candles are not exceeding the two red candles. The first green candle has its opening price at the same height as the first red candles’ closing price. Likewise, the last green candle has its closing price at the same height as the second red candles’ opening price.
This pattern tells us that buyers did not manage to change the direction of the falling market.
The rising three methods are the exact opposite of the above one. This appears in a bullish market that will continue to be bullish even if sellers are trying to change the direction. The same thing is true for this pattern. The red candles are formed in between two long green candles and do not exceed them.
Candlesticks are difficult to understand if you do not first understand the basic candlestick that is shown in the first image. Once you understand the opening and closing prices the rest of the patterns will just make sense! Well done for learning so many patterns in such a little time. Now try to test yourself on a demo account.