How to Read Candlestick Charts for Trading: A Beginner’s Guide
How to Read Candlestick Charts for Trading: A Beginner’s Guide
18 October 2022
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A candlestick chart is one of the popular technical analysis instruments used by investors to visualize asset price information. It has gained widespread adoption and become an integral element of many trading platforms being an efficient tool to analyze market sentiment and the direction of the price trend. In this guide, we will explore everything you need to know about candlestick charts, from their core features and patterns to ways to read and apply them to your trading portfolio.
What is a Candlestick Chart?
A candlestick chart is a type of price chart often used by traders to identify potential trading opportunities based on price patterns. It provides investors with a wide range of trading data and is considered to be relatively easy to read and understand.
This chart is represented by candles which provide investors with 4 data points and consist of a “real body” and wicks (also called shadows).
The real body offers information about the open-to-close price range.
Upper wick stands for the high price.
Lower wick represents the low price.
Every candle offers price data during a particular time frame set by an investor. It means that, if a trader chooses a time period of 15 minutes, a new candlestick will be formed every 15 minutes. Thus, the open and the close price of such a candle will stand for the prices of the beginning and the end of this 15-minute trading period.
As it can be seen from the example of the chart above, candlesticks can be of different colors, usually green and red (depending on the settings of the trading platform).
A green candle implies that an asset’s closing price was higher than the opening price.
A red candle means an asset’s closing price was lower than the opening price.
Candlestick charts can be used to trade a wide variety of securities, including stocks, futures, CFDs, and forex pairs. They could provide valuable information about market sentiment and potential price movements when interpreted correctly.
Interpreting a Candle on a Candlestick Chart
Each candlestick provides investors with a considerable amount of trading information. Let’s have a look at how to read the main features and components of this technical tool.
The body is the main part of the candlestick. It represents the range between the opening and closing prices, which, in turn, can be located either at the bottom or at the top of a candle, depending on its color. A red-colored body denotes a market situation when the close price was lower than the open price. Conversely, a green-colored body means that the close price was over the open price. Traders should also pay attention to the size of a real body. A long-bodied candlestick denotes a strong trend in either direction while a short body indicates little price action or a possible reversal. Candlesticks with no bodies at all are called dojis and are often considered by traders as a sign of market indecision or a potential change in the trend direction.
Wicks, also known as shadows, are lines that protrude from the body of a candle. The upper shadow shows the highest price point that was reached during the candlestick’s time interval while the lower shadow indicates the lowest price throughout this particular period. By analyzing the shadows traders could get an idea of how much buying or selling pressure was in the market and whether candlesticks are bullish or bearish.
The open is the first price traded at the beginning of the trading period. It could be located at the top or the bottom of the real body, depending on the direction of the price. If the asset price starts to trend upwards, the open price will be located at the bottom and the candlestick itself will be colored green. Conversely, if the asset value drops, the open will be located at the top and the candlestick will be colored red.
The high price throughout the particular trading interval is represented by the upper wick, the length of which could give investors a clearer understanding of market sentiment. For example, a long upper shadow could be interpreted as a bearish sign, meaning that bullish traders were trying to take control of the market but didn’t succeed so the price closed below the high. A candle with no upper wick but the real body at the high is called a shaven head. It could be interpreted differently. For example, if found at the bottom of the downtrend it could be read by some traders as a bullish reversal signal. However, if found in the middle of an uptrend, it could indicate the continuation of the existing trend.
The low price of the candlestick is indicated by the lower wick. Just as with the upper shadow, traders can analyze its length to form a better picture of the market situation. Some investors tend to interpret this technical indicator as a potential market reversal in either direction. For example, when the long lower wick is found at the bottom of a downtrend it is called a hammer and could be considered a bullish reversal signal. However, when spotted at the top of an uptrend, it is known as a hanging man and may be interpreted by some traders as a potential bearish reversal sign.
The close is the most recent price traded throughout a particular trading period. Just like the open price, it can be located either at the top of the real body (if the candle is green) or at the bottom of it (if the candlestick is red).
It’s relatively easy to determine the direction of the price. All you need to do is to analyze the color of the candlestick. If it is green, the candle is considered bullish since its closing price is over the opening one. Conversely, red candlesticks are considered bearish since their price closed below the open.
A bullish candlestick indicates that during a certain time frame, buyers were in control of the market and pushed the prices higher. A bearish candlestick, conversely, would indicate that sellers had momentum on the market.
What Do Candlesticks Tell Us?
Apart from the price action during a certain time frame, candlestick charts could offer much more useful information, especially if traders know how to correctly interpret it. For example, some seasoned investors pay attention to the size of the real body. A longer body of a candlestick tells that there is more conviction behind the move. A real body with almost no wicks is often read as a strong bullish sign (for green candles) and a strong bearish sign (for red candles).
Another data point to take into account is the shadows. For instance, if the candle has long wicks (usually twice more than the size of the body), it means that the prices were pushed in one direction but couldn’t sustain, and quickly dropped back. This could be a potential reversal indicator.
Putting it all together, you can get a pretty good idea of what’s going on in a market by looking at candlesticks. However, it’s crucial to remember that no single indicator is perfect, thus it’s always better to use candlesticks in conjunction with other technical indicators to confirm its signals and, this way, avoid substantial losses.
Candlestick Chart Patterns
Some investors get sufficient trading information from analyzing candle formation while others look for various chart patterns. Now that you know how to read a candlestick, let’s take a look at some of the most common and useful bullish and bearish patterns.
Bullish chart patterns usually occur at the bottom of a downtrend and could indicate a potential change in the price direction. Thus, traders who spot it tend to open buying positions to benefit from a potential rise in the asset price.
The hammer is a single candlestick pattern that has a small real body and a long lower shadow, which makes it look like “T”. It happens because the bears are entering the market while it’s dropping, but at the end of the trading period bulls gain the momentum and push the asset price closer to its open.
A hammer candle is usually spotted at the bottom of the downward price movement and is considered a potential reversal signal to the upside. However, just as with any pattern it’s recommended to confirm this chart signal with other technical indicators. For example, traders could analyze the following candlestick and make sure it continues moving up, closing above the low of the hammer.
There is another similar pattern, known as the inverted hammer. As well as a usual hammer it has a small body, however, it stands out with a long upper wick. The inverted hammer is also usually found at the end of a downtrend and is considered a potential bullish reversal indicator.
Bullish Engulfing Pattern
A bullish engulf is a two-candle pattern. It consists of a red candlestick with a small body that is followed by a green candle with a significantly longer body. It means that bullish traders took control of the market, thus the asset price could head higher. However, it’s important to analyze not only 2 candles of this pattern but also take into account the previous candlesticks. Some experienced traders believe that the possibility of a reversal increases if the bullish engulfing pattern is preceded by at least four bearish candles.
Morning star is a three-candle price pattern that is represented by two long-bodied candles, one red and one green, and one short-bodied candlestick in between them. It usually occurs at the end of the bearish trend and indicates the beginning of an upward price movement. The second candle informs traders about the indecision on the market while the third one confirms the reversal and may start a new trend.
This is another common bullish pattern used by traders to identify a potential reversal in the asset price. It is usually formed during a bearish trend when a small-bodied green candlestick occurs, thus indicating that the downward price movement is paused. If the reversal is confirmed by the next green candle, traders could expect a further price increase.
Bearish price patterns usually appear at the top of an uptrend and may indicate a potential reversal in the price direction. In this case, investors tend to close their buying trades or open selling positions.
The hanging man is a bearish pattern opposite to the hammer. These two indicators are identical in their appearance, the only difference between them is the location within the trading interval. While the hammer appears during a downtrend, a hanging man is usually formed after an increase in an asset price.
The shooting star is a bearish equivalent of an inverted hammer. It also has a short body with a long upper shadow but is usually formed at the top of an uptrend. It indicates that the market was growing at the beginning of the trading period, however, at the end of it, the price fell dramatically, almost to the open.
Bearish Engulfing Pattern
This two-candlestick chart pattern is considered a strong bearish reversal indicator. It usually occurs during a downtrend and signals that the buyers are expected to lose momentum while the sellers’ move may come shortly. As well as the bullish engulfing, it consists of a red and green candle, yet in this market situation, the bearish candle engulfs the bullish one.
The evening star is the opposite pattern of the morning star. It consists of 3 candlesticks: long-bodied green, short-bodied green, and long-bodied red candles. For a stronger signal, the third candle is supposed to cover at least half the body size of the first candle. This pattern can be spotted during bullish trends and signals a potential downside reversal.
Bearish harami is the opposite of bullish harami. It is represented on the chart by a small-bodied bearish candle spotted after a continuous bullish trend. This pattern provides investors with a sign of market indecision. It’s important to analyze the following candlesticks to get a better picture of the market direction. If a short-bodied red candle is followed by a green candle, traders may expect the continuation of the uptrend. However, if the price continues to drop after this candle, it could indicate the beginning of the bearish trend.
How to Read a Candlestick Chart
There are different ways to interpret a candlestick chart. Some traders get the necessary information from analyzing candle formation, while others try to spot and understand various candlestick chart patterns. The choice is up to every trader. However, when opting for one of these techniques, it’s crucial to ensure it complies with your trading strategy and risk management plan.
How to Read “One-candle Signals”
While trading within short time frames, investors often have to take faster decisions. Thus, it would be particularly helpful for them to know how to interpret one-candle patterns. Here is some brief information to keep in mind:
Long lower wick could be an indicator of a potential reversal to the uptrend. It means that more buying traders are opening positions, thus pushing the asset price higher. The longer the wick the stronger the signal of a reversal.
Long upper wick could be a sign of a potential reversal to the down. It implies that more traders are looking for selling opportunities, making the asset price decline. Just as with the upper wick, the longer it is the more accurate signal it provides.
Doji is a type of candlestick that has a tiny or no real body, meaning that its open and close prices are almost equal. Doji comes in different variations (such as dragonfly, gravestone, long-legged doji, etc.), thus can be interpreted slightly differently, depending on its type. In general, this pattern is considered a sign of market indecision, yet it could also indicate a potential reversal or continuation of the market trend.
Candlestick vs. Bar Charts
Japanese candlesticks and bar charts have much in common. They provide traders with the same information about the asset open, close, high, and low, yet in a slightly different way. While on the bar chart the close and the open are represented by left and right horizontal lines on the candlestick chart this information is shown by a real body. The high and the low on the bar chart are introduced by the vertical line, on the candlestick chart they are represented by upper and lower shadows.
Both of these instruments are in wide use among traders. However, candlesticks are believed to be more visually appealing and make it easier to see trends. It’s worth noting that both charts are more effective when used in combination with other technical analysis indicators and patterns.
The Bottom Line
Candlestick charts are one of the most popular trading instruments applied to a wide variety of financial markets. They provide investors with important trading information about the open, close, high, and low asset prices, thus helping them to form a clearer market picture and analyze the direction of the trend. While some traders base their strategies on candle formation, others are seeking to recognize price patterns, such as hammer, shooting star, bullish and bearish engulfing, and others.
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