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What are candlestick patterns and how can I use them?

Candlestick charts allow traders to identify buying and selling pressure in the markets.

Candlestick chartThe advent of candlestick charts gave rise to a new way of illustrating price action data. Until the 1850s, very little technical analysis was available in the United States and elsewhere. However, candlestick charting is predicated on several principles including price action, market fluctuations, underlying value and the impact of fear and greed.

Setting up a candlestick chart requires specific pieces of information. These include a data set of values encompassing the following: Open data, High data, Low data and Close data. These points must be available for each and every period of time that is evaluated.

The square block of the candlestick is known as the body and it can be empty or filled in. Above and below the candlestick’s body are vertical lines. These reflect the range of values – the high and low range. The upper line is known as the wick (akin to the wick of a candle) and the lower line is known as the tail.

How do you know what is represented by the candlestick chart?

Candlestick charts are represented in ways that make for easy reading and analysis. Since candlesticks have a square block that is either filled or empty it is easy to differentiate between them.

An empty body will have a lower tail that represents the opening price and an upper tail that represents the closing price. With this type of candlestick chart, a trader can easily see that the opening price of the tradable asset was less than the closing price for that time period. This represents bullish sentiment and a positive outlook for the asset.

By contrast, if the body of the candlestick chart is covered then the line at the top end of the candlestick chart represents the high for the period at the opening price and the bottom end (lower shadow) represents the low for the period – the closing price. In other words, a black candlestick chart will always have a lower closing price than the price it opened at. This represents bearish price movement for the period in question.

Why use candlestick charts as opposed to other charts?

It is relatively easy to glimpse at a candlestick chart and understand what is implied by the visual data, since each candlestick is either filled or hollow. Price action is easy to interpret, while you can also read important data such as the opening and closing, and high and low prices.

When a candlestick chart is hollow, the opening price is lower than the closing price. By contrast, when a candlestick chart is filled, the opening price is higher than the closing price. Through this very basic information we can easily identify buying pressure (hollow candlesticks) and selling pressure (filled candlesticks).

The visual aspect of candlestick charts cannot be understated. A short body on a candlestick is reflective of very little price movement. This is true regardless of whether the candlestick is filled or hollow. Little price movement also represents low volatility of prices. By contrast, a long candlestick represents high volatility of prices and a large amount of buying or selling pressure.

When a new stock has been released, or when significant buying pressure is exerted on a stock, it is likely that a hollow, long candlestick will be reflected. By contrast, when there is a major sell-off and prices drop precipitously on a stock or tradable asset, the candlestick will be long and filled.

This means that selling pressure has been exerted and that the closing price is lower than the opening price. Aggressive selling pressure produces filled, long-body candlesticks.

There are other components of candlestick charts that must be factored into the analysis. These are the upper and lower shadows cast by the wicks and tails respectively.

If the upper tail is longer than the lower tail it means that there was strong buying pressure but that selling pressure dominated at the close of the session. When a short upper shadow is reflected, and a long bottom shadow is evident, it is clear that sellers dominated during the trading session but that buyers had a stronger impact later in the session to force a change in the price movement.

There are many other intricacies when using candlestick charts to trade with. Common patterns to look out for include: Doji, Long White/Black Candles with Doji, Dragonfly Doji, Gravestone Doji, Hammers, Shooting Star patterns, Hanging Man patterns, and more.

Cashing in with candlestick patterns

Many traders will want to wait for final confirmation of the candlestick patterns. However, if you opt to wait until the following day to verify a stock reversal, the opportunity has already been lost. If a candlestick pattern reflects strong buying pressure, then it is clear that the price will rise.

The trick is to enter the market at the right time, not too early and not too late. Ideally, you will want to be part of that group of traders making up that particular trading pattern.

Brett Chatz

Published: 16 June 2015

You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.

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