- What is a candlestick?
- Why are candlestick charts popular?
- Candlestick basics: time and direction
- Reading price on a candlestick
- Candlestick patterns
- How to trade on candlestick charts
What is a candlestick?
A candlestick is a popular method of displaying price movements on an asset’s price chart. Often used in technical analysis, candlestick charts can tell you a lot about a market’s price action at a glance – much more than a line chart.
Candlesticks were invented in Japan several centuries ago. Today, their full name, Japanese candlesticks, reflects that. But most traders call them candlesticks, or just candles, for short.
Candlesticks are popular chiefly because they give you more information than you’d get on a standard line graph: whether the market went up or down in a session, plus its highest, lowest, opening and closing prices.
Most line charts, meanwhile, will only tell you a market’s closing price for each period.
Technical traders also use candlesticks to get quick insight into the general sentiment surrounding a market. They do this by watching for candlestick patterns – but we’ll cover those in more depth later.
Candlestick basics: time and direction
Before we get on to reading price action on a candlestick chart, there are two fundamentals to learn: how much time each stick covers and how to see your market’s direction in that time.
Each candlestick on a chart tells you what happened within a specific period. You can choose the length of the period by changing your chart’s timeframe. On a 1-hour chart, for instance, each candlestick represents one hour of activity. On a daily chart, it’s a single day.
The most recent candle is an exception to this rule. It shows you what’s happening in the current session.
To see whether a market rose or fell in the time it covers, you just look at the colour of the candle.
- A green candle means that the market rose
- A red candle means it fell
Some charts will use white (up) and black (down) sticks instead.
Reading price on a candlestick
To analyse a market’s price action within each period, you need to examine the two parts of a candlestick: the body and the wick.
The body is the main section on a candlestick – you can identify it because it’s wide and filled in with colour.
The body tells you the opening and closing prices of your market within the period. On a green candle, the open will be below the close, so the bottom of the body tells you the opening price, while the top tells you the closing price.
On a red candle, the opposite is true. The market fell over the period, meaning the top of the body is the open, and the bottom is the close.
A candlestick with a long body indicates a strong trend with a large gain or loss. A small body, meanwhile, tells you that the opening and closing were roughly equal. In this instance, bears and bulls may be cancelling each other out.
The wick is the line that comes out of the top and bottom of a candlestick’s body. Sometimes, you might see it referred to as the candle’s shadow.
- The upper wick comes out of the top of the body and tells you the highest price reached during the period
- The lower wick – also known as the tail – drops from the bottom of the body, indicating the lowest price hit during the period
On both red and green sticks, the upper and lower wick always represent the same thing.
Can’t see a wick on your candle at all? That means the open and close prices were also the highest and lowest points the market hit in the session. A long wick on either side, meanwhile, means that price spiked up or down – but the move reversed before the close.
The difference between bar charts and candlestick charts
The only difference between bar charts and candlestick charts is how they display price information. Both are chart types that tell you a market’s open, close, high and low in a period, but they do so in slightly different ways.
Bar charts don’t have bodies and wicks. Instead, they’re a single straight line with a notch on either side.
- The open is represented by the horizontal notch on the left-hand side of the line
- The close is the horizontal notch to the right of the line
- The top of the line is the high and the bottom is the low
Some traders find it easier to read bar charts; others prefer candles. The best approach is to open an account and try out trading using both – you’ll soon discover which works best for you.
As we mentioned earlier, technical traders believe the patterns made by candlesticks can help you make trading decisions. They tell you where sentiment on a market might be headed, which you can use to predict where price will go next.
Bullish patterns are taken as a sign that an upward move is imminent. Bearish ones mean the opposite. No pattern is infallible, so use them carefully.
The simplest patterns are made up of a single candle. More complex variations may use two, three or even more candles. Let’s take a look at a few examples.
Doji candlesticks have long wicks and very short bodies. What does this tell us? That the market experienced high volatility in the session, but that by the close it had pretty much ended up right back where it started.
There are three types of doji. Dragonfly doji have a long lower wick, signifying a bear run in the session, followed by a rally back to its opening price. Gravestone doji are the opposite, with a tall upper wick indicating a rally that was taken over by bear traders.
A long-legged doji, meanwhile, has both a long upper and lower wick – so the session saw a significant high and low, but ended up where it started.
How you trade a doji depends on what’s happened before it appears. After a long downtrend, for instance, a dragonfly doji may mean that buyers are entering the market, so the downward move might be about to reverse.
Hammers and hanging men
Hammers are similar to dragonfly doji. They have long lower wicks, smaller or missing upper wicks and relatively small bodies. Plus, like dragonflies, they often appear as a bear trend is about to end.
However, hammers tend to have slightly wider bodies than doji. And they can also appear at the end of uptrends.
If you see a hammer on a bull market, it’s called a hanging man – and it may be a sign that the uptrend is about to end. Sellers took control during the session, and buyers weren’t able to take control to continue the rally in any significant way. Positive sentiment could be on the wane.
The engulfing price pattern consists of two candles. The second candle should completely engulf the first, meaning that the top of its body is above the top of the preceding candle’s body, and the bottom of the body is below.
In a bearish engulfing, a green candle is followed by a larger red one. In a bullish engulfing, the larger second candle is green instead.
Like doji and hammers, the engulfing pattern appears at the end of an established trend. A bullish engulfing signifies the end of a bear market; a bearish engulfing means bears have taken over from bulls.
Patterns don’t always indicate reversals, though. Sometimes, they even might predict price action that looks counterintuitive at first glance.
A rising three, for example, consists of a long green candlestick followed by three smaller falling ones. Appearing in uptrends, it may look like bears are taking over – but the rising three is a bullish pattern.
After a long bull market, buyers take a step back in a rising three. That leads to a period of consolidation, before the uptrend continues.
Crucially, the three red bars in the countertrend should all fall within the body of the first tall green candle. And they are followed by another tall green candle that confirms the resumption of the bull market.
A falling three is the opposite. A long red candle, followed by three smaller green candles, then a final red candle indicating that a bear market is back on.