how to read candlestick charts Archives

One of the primary tools used in technical analysis is price charts. A chart is a graphical representation of data. In this article, we take a deeper look at what price charts and candlestick patterns are.

What is a Price Chart?

A price chart is a graphical representation of the price and volume data of a stock/security. It helps us visualise the price movement to understand it better. Before price charts, participants had to watch the screen for hours and try to remember the important price levels at different points in time which was practically impossible. This led to the use of price charts.

What are Line Charts?

Line charts are the oldest form of price charts. It is a simple graphic display of price trends over time. Line charts are typically drawn with closing prices as the data points. The closing price refers to the price at which the last trade of the trading session occurred. Many consider it one of the most important data points as it signifies the financial decision for the trading session or period. The closing prices can be of any time frame such as hourly, daily, weekly, monthly, or yearly.

The vertical axis or Y-axis represents the price level and the horizontal axis or X-axis represents time.

The line chart above shows the previous 6-month price data of Tata Motors. Each data point represents the closing price of 2-hour timeframes. If we observe, the price of Tata motors fell from 490 in mid-august. This chart shows the trend of prices in the last 6 months.

Even though a line chart portrays the data in a simple way, it only considers a single data point, the closing price. The Japanese invented an alternative to the line chart known as the Candlestick Chart, which utilises four different data points.

What are Candlestick Charts?

The Japanese invented candlestick charts, and they have been utilising technical analysis for centuries. A candlestick chart is a type of price chart that provides four prices per data point, the opening and closing prices and the high and low prices during a period. These prices can be called OHLC data in short which stands for Open, High, Low, and Close, respectively.

In addition to the four prices, the candlesticks also portray the emotions of the investors and traders, which we will learn how to interpret later in this chapter. The greatest advantage to using candles on your charts is that single candle lines and multiple candle patterns offer more reliable, earlier, and more effective reversal signals.

Candlesticks form candlestick charts. A candle shows the price movement of a security during a fixed period through the OHLC data. Bullish (green) candles and Bearish (red) candles are the two types of candles.

Structure of Candle Sticks

A Candlestick Shows Four Prices:

Open – The price at which the asset started trading at in the timeframe.
High – The highest price at which the asset was traded.
Low – The lowest price at which the asset was traded.
Close – The price at which the asset was traded at the end of the time frame. The LTP of the timeframe will be the closing price.

The Three Parts of a Candlestick Are:

The central real body – It is a rectangular shape that connects the opening and closing prices.
Upper shadow – Indicates the high
Lower shadow – Indicates the low

A candlestick is in the form of a rectangle with wicks at both ends. The rectangle is called the central real body and connects the opening and closing price. The upper shadow (wick) indicates the high, and the lower shadow (wick) indicates the low. Both the wicks are connected to either side of the central real body.

A candle only reaches its final form once the timeframe ends. A 5-minute candle starts forming at the beginning of the 5 minutes, and the close of the candle keeps changing depending on the price fluctuations. The price at which the last transaction in the 5 minutes took place will be the closing price. The two types of candles are based on the opening and closing price of the candle.

What are Bullish Candles?

If the closing price is higher than the opening price, it is known as a Bullish or green candle. The closing price will only be higher than the opening price only if buying takes place. Therefore, a green or bullish candle symbolizes buying, which means there will be an increase in the price of the security.

What are Bearish Candles?

If the closing price is lower than the opening price, it is known as a Bearish or red candle. The closing price will only be lower than the opening price only if selling takes place. Therefore, a red or bearish candle symbolizes selling, which means there will be a decrease in the price of the security.

Let us look at some bullish and bearish candles in action:

Timeframe refers to the duration of each candle. You can change it from the menu on top of the window. The chart will display the OHLC data of the highlighted candle at the top. Here, the highlighted candle is the first 5-minute candle of 25th October 2022. You can move the cursor to select and highlight a candle, allowing you to view its OHLC data. The time and date are shown at the bottom of the chart.

If you look at the opening candle, you can see that the candle has no upper wick. This means that the opening price of the candle is the same as the high that the price made in that time frame and hence no upper wick. It says that the price fell as soon as the candle opened.

As an exercise, you can load up a chart on TradingView or in your broker’s terminal and try to understand the candlesticks by checking its OHLC data. Also, try changing the timeframes to see how the price action was in a selected timeframe.

Types of Single Candlestick Patterns

As you may have noticed, each candle is unique but of similar types. Some have a bigger body, some have longer wicks, and some with shorter wicks as well. Based on the structure of the body and the wick, candlesticks can be of the following types:

1. Marubozu

A marubozu is a candlestick with no upper or lower wicks. This type of candle indicates a strong trend.

Bullish Marubozu – It is a clean buying candle, which started moving up from the opening level and closed at the highest point. Open = Low and Close = High
Bearish Marubozu – It is a clean-selling candle, which started moving up from the opening level and closed at the highest point. Open = High and Close = Low

The candles marked in the above chart has very short wicks, which can be ignored.

2. Spinning Tops

As the name indicates, this type of candle looks like a spinning top and indicates indecision, consolidation, or even trend reversal. These candles have a small real body and almost equal upper and lower wicks. The colour of the body does not matter as it is small.

A spinning top in a downtrend signals that sellers are getting tired and there is a chance for reversal or consolidation and there could be buying front the bottom.
A spinning top in an uptrend signals that the buyers are getting tired and there is a chance for reversal or consolidation and there could be selling from the top.

3. Doji Candles

It is very similar to a spinning top, except that it has no real body. Open = Close. The upper and lower wicks might be of different lengths. It indicates extreme indecision and possible trend reversal. The types of doji candles are:

Doji Star – It has small wicks.
Long-legged Doji – It has longer wicks.
Dragonfly Doji – It only has a lower wick and no real body.
Gravestone Doji – It only has an upper wick and no real body.

4. Hammer

A hammer pattern forms at the bottom of a downward rally.

They are indicated by a small upper real body and long lower wick.
The length of the lower wick should be around twice as much as the length of the real body.
The colour of the body does not matter.

5. Shooting Star

It indicates the end of bullishness at the top of a rally.

It has a small lower body and a long upper wick
The longer the wick, the higher the bearishness
The color of the candle does not matter, but it is more reliable if it is a red candle

In this article, we learnt what line charts and candlestick charts are. They provide valuable insights into market trends and sentiment. This article serves as a beginner’s guide to analysing candlestick charts and exploring various patterns that help decipher market movements. It’s a great starting point to enhance your understanding and explore the fascinating world of chart analysis.

A candlestick chart graphically represents a share/stock’s price and volume data. They help us visualise the price movement, making it easier to understand and analyse. In the past, traders had to constantly monitor the screen for hours and try to memorise significant price levels, which was practically impossible. Thankfully, the introduction of candlestick charts revolutionised how we interpret market data.

In this article, we will learn how to read candlestick charts, the types of candlesticks, and a few candlestick patterns.

What is a Candlestick Chart?

A candlestick chart is a type of price chart that displays four prices per data point. It shows the opening and closing prices and the high and low prices during a period. These price points are known as the OHLC data in short, which stands for Open, High, Low, and Close, respectively. Furthermore, a candlestick chart also portrays the emotions of the investors and traders.

Candlestick charts originated in Japan, where technical analysis has been in use for centuries. A Japanese rice trader, Homma Munehisa, developed a system of charting price movements using candlestick patterns and observations of market psychology. His work laid the foundation for candlestick charting methods.

Structure of Candlesticks

A candlestick chart is a collection of candlesticks. There are two types of candlesticks based on whether the price increases or decreases. They are bullish (green) and bearish (red) candles. A candlestick has three parts that depict four prices:

The central real body – It is a rectangular shape that connects the opening and closing prices.
Upper shadow – Indicates the high
Lower shadow – Indicates the low

The four price points are:

Open – The price at which the asset started trading in the timeframe.
High – The highest price at which the asset got traded.
Low – The lowest price at which the asset got traded.
Close – The price at which the asset got traded at the end of the time frame. The Last Traded Price (LTP) of the timeframe will be the closing price.

Both bullish and bearish candles have OHLC price points. However, the position of opening and closing prices in both are different.

If the closing price is higher than the opening price, it is known as a Bullish or green candle. On the other hand, If the closing price is lower than the opening price, it is known as a Bearish or red candle. A green or bullish candle symbolises buying, while a red or bearish candle symbolises selling. Next, let’s look at some basic candlestick charts!

Basic Candlestick Patterns

1. Bullish and Bearish Engulfing Patterns

A bearish engulfing candlestick pattern occurs during an uptrend and consists of two candles. The first candle is a bullish (green) candle, followed by a larger bearish (red) candle that completely engulfs or covers the previous candle’s range. This pattern suggests that selling pressure has increased, overpowering the previous buying momentum, and indicates a potential shift toward a downward trend. Traders often interpret a bearish engulfing pattern as a bearish signal.

On the other hand, a bullish engulfing pattern occurs during a downtrend. It also consists of two candles, but in the opposite configuration. The first candle is a bearish (downward) candle, followed by a larger bullish (upward) candle that completely engulfs the previous candle’s range. This pattern suggests that buying pressure has increased, overpowering the previous selling momentum, and indicates a potential shift toward an upward trend. Traders often interpret a bullish engulfing pattern as a bullish signal.

2. Bullish and Bearish Harami Patterns

A bullish harami pattern consists of two candles. The first candle is a large bearish (red) one, indicating a prevailing downtrend. The second candle is a smaller bullish (green) candle that is completely engulfed or covered by the body of the first candle. This pattern suggests that selling pressure may be weakening, and a potential trend reversal towards an upward move could occur. Traders often interpret the bullish harami as a bullish signal.

On the other hand, a bearish harami pattern also consists of two candles. The first candle is a large bullish (green) candle, indicating a prevailing uptrend. The second candle is a smaller bearish (red) candle that is completely engulfed by the body of the first candle. This pattern suggests that buying pressure may be diminishing, and a potential trend reversal toward a downward move could occur. Traders often interpret the bearish harami as a bearish signal.

3. Morning & Evening Star Patterns

A morning star pattern appears during a downtrend and consists of three candles. The first candle is a large bearish (red) candle, indicating the prevailing downtrend. The second candle is a smaller candle with a small body that may be bullish or bearish. This candle represents indecision in the market. The third candle is a large bullish (green) candle that closes near or above the midpoint of the first candle. This pattern suggests that the selling pressure is diminishing, and a potential trend reversal toward an upward move could occur. Traders interpret the morning star pattern as a bullish signal.

On the other hand, an evening star pattern appears during an uptrend and also consists of three candles. The first candle is a large bullish (green) candle, indicating the prevailing uptrend. The second candle is a smaller candle with a small body that may be bullish or bearish. This candle represents indecision in the market. The third candle is a large bearish (red) candle that closes near or below the midpoint of the first candle. This pattern suggests that the buying pressure is diminishing, and a potential trend reversal toward a downward move could occur. Traders interpret the evening star pattern as a bearish signal.

In conclusion, reading candlestick charts is not just about understanding the price and volume data. These candles provide insights into the underlying psychology and market sentiments. Identifying patterns and taking the right action at the right time can only get better with time and practice. Make sure to practice identifying patterns on historic charts to get your game on for actual trading.