The Candlestick Charts, popularly used today, were created in the 17th century in Japan to trade rice. The Japanese man, named Homma, discovered that beside the influence of demand and supply on markets there is another factor – emotions of the traders. The canons set up by Homma are the base for Candlestick Charts.
In order to trade using Candlesticks you have to know what it takes to create a candlestick and understand the candlestick patterns.
The following four pieces create a candle and its wick:
- Open Price – it is the first price traded on the stock. Depending on whether bullish or bearish activity appeared on the stock, the Open Price corresponds to bottom or upper edge of the candle.
- High Price – the highest price reached during the trading day; creates the top wick of the candlestick. If a security opens at a certain price and then it trades only below this price, there will be no upper wick (Open Price = High Price).
- Low Price – the lowest price reported, corresponds to the bottom wick, if the activity on the stock is only bullish and the price doesn’t fall below the Open Price then there will be no bottom wick (Open Price = Low Price).
- Close Price- the price that finishes trading; depending on the performance of the security it corresponds to upper or bottom edge of the candle.
Just by looking at the candlestick you can tell if the trading day was up or down. White candle signifies that the buyers dominated the trading period and if the candle is black it means that there was more selling pressure than desire to buy.
Single Candlestick patterns
Long vs. short bodies
Candlesticks have different body sizes. Long bodies signify strong buying or selling pressure. The longer the body is, the more powerful the buying or selling demand. This indicates that either buyers or sellers were stronger and took control. Short bodies mean small activity.
• Long white candlesticks indicate increasing bullish pressure, prices rose significantly from open to close and buyers were dominant.
• Long black candlesticks illustrate strong bearish pressure, prices decreased dramatically from the open and selling pressure was big.
Long lower and upper wicks provide some information about trading session.
• Long Upper Wick indicates that Bulls controlled the trading session but by the end of the trading session they “lost” with Bears.
• Long Lower Wick signifies that the trading session was dominates for a long time by Bears but in the end Bulls “won”.
Candlesticks that have long upper and lower wicks are called Spinning Tops.
This pattern indicates the indecision during the trading session. Both, Bulls and Bears, had their moments but finally none of them won.
Marubozu is a candlestick that has no shadows. If the Marubozu is white it means that Open Price = Low Price and Close Price = High Price. Conversely, when Marubozu is black then Open Price = High Price and Close Price = Low Price.
Doji with Long Candles
Doji are the candlesticks that have same Open and Close Price or at least their bodies are very small. This pattern suggests indecision or struggle between Bulls and Bears. After Doji appears on the chart we should pay attention to the prior candlestick.
• Doji plus Long White Candle means that the bullish trend is weakening, there are not enough buyers;
• Doji with Black Long Candle means that the bearish trend is becoming exhausted, there’s a lack of sellers.
Hammer and Hanging Man
These two candlesticks look the same but they have different meaning which depends on the previous activity of the price.
• Hammer is a bullish reversal pattern, they might mark the end of downtrend or support level; long lower wick indicates the strong selling pressure;
• Hanging Man is bearish reversal pattern, signifies end of uptrend or resistance level.
Inverted Hammer and Shooting Star
• Inverted Hammer represents a potential trend reverse or support levels, long upper wick indicates that buyers tried to push the price higher but they didn’t manage to do it.
• Shooting Star is a bearish reversal pattern, signifies resistance or trend reverse.
In conclusion, there are many patterns in the Candlestick Charts but we covered only the simple ones in this part of the tutorial. There are many benefits of using this type of chart, like ease in understanding, ability to spot Bulls and Bears and even ability to foresee the next action of the price. However there are some risks connected with using Candlesticks. They are not very good to analyze very short term period, because the patterns that help us taking trading decision are not being created in a short time. Also some patterns are simple; some are complicated so all you need to do to become a serious trader is mastering these patterns.