Candlestick charts are one of the most popular ways to track the price of a security. They can be used to track stocks, forex, commodities and more. In this comprehensive guide, we will discuss how to read a candlestick chart, what candlestick charts are, what they tell you, the pros and cons of using them, and how to read them. By the end of this guide, you will be able to use candlestick charts to make informed investment decisions!

What is a candlestick chart?

A candlestick chart is a type of financial chart that shows the price movement of a security over time. The candlesticks are used to show the open, high, low, and close price for the security. The candlesticks are typically color-coded to show whether the price moved up or down during the time period.

History of Candlestick charts

Candlestick charts were first used by Japanese rice traders in the 18th century. The candlestick chart patterns were used to predict the future price movements of the rice.

The candlestick chart patterns were later introduced to the West by Steve Nison in his 1991 book, “Japanese Candlestick Charting Techniques”.

Since then, candlestick charts have become a popular tool among technical traders. Candlestick charts are now used by traders all over the world to predict future price movements of securities.

What do candlestick charts tell you?

Candlesticks show the open, high, low, and close price for the security. 

This information can be used to identify trends, support and resistance levels, and potential buy and sell signals.

Pros and cons of candlestick charts

Candlestick charts have a lot of advantages. They are easy to read and understand, they provide a lot of information about the price movement of a security, and they can be used to identify trends, support and resistance levels, and potential buy and sell signals. 

However, candlestick charts also have some disadvantages. They can be difficult to interpret, they can be misleading, and they can give false signals.

Candlestick components

Each candlestick has two components: Body and Shadow, composed of three parts, Body and Upper and Low Shadow. The body of the candlestick is the part between the open and close price. The body can be either red or green. 

A red candlestick means that the security closed lower than it opened, while a green candlestick means that the security closed higher than it opened. 

How to read a candlestick chart

A daily candlestick chart shows the security’s open, high, low, and close price for the day. The candlestick’s wide or rectangle part is called the “real body” which shows the link between opening and closing prices.

This real body shows the price range between the open and close of that day’s trading.

When the real body is filled, black or red then it means that the close is lower than the open and is known as the bearish candle. It shows that the prices opened, the bears pushed the prices down and closed lower than the opening price.

If the real body is empty, white or green then it means that the close was higher than the open known as the bullish candle. It shows that the prices opened, the bulls pushed the prices up and closed higher than the opening price.

The thin vertical lines above and below the real body are known as the wicks or shadows, which represent the high and low prices of the trading session.

The upper shadow shows the high price, and lower shadow shows the low price reached during the trading session.

Before we jump into learning about different candlestick charts, there are a few assumptions that need to be kept in mind that are specific to the candlestick charts.

Strength is represented by a bullish (green) candle and weakness by a bearish (red) candle. One should ensure that whenever they are buying, it is a green candle day, and whenever they are selling, it’s a red candle day.

The textbook definition of a pattern states certain criteria, but one should state that there could be minor variations to the pattern depending on certain market conditions.

One should look for a prior trend. If you are looking at a bullish reversal pattern, then the prior trend should be bearish, and if you are looking at a bearish reversal pattern, then the prior trend should be bullish.

Candlestick patterns explained

Bearish engulfing pattern

The bearish engulfing pattern is a candlestick pattern that can be used to predict a future price decline. It is formed after an uptrend indicating a bearish reversal. The bearish engulfing pattern is made up of two candlesticks. 

The first candlestick is green and the second candlestick is red. 

The red candlestick should be larger than the green candlestick and it should engulf the green candlestick. 

This pattern is typically seen as a signal that the security’s price is going to continue to decline.

Bullish engulfing pattern

The bullish engulfing pattern is the opposite of the bearish engulfing pattern. It is formed after a downtrend indicating a bullish reversal. The bullish engulfing pattern is a candlestick pattern that can be used to predict a future price increase. 

The bullish engulfing pattern is made up of two candlesticks. The first candlestick is red and the second candlestick is green. 

The green candlestick should be larger than the red candlestick and it should engulf the red candlestick. 

This bullish engulfing pattern is typically seen as a signal that the security’s price is going to continue to increase.

Evening star

The Evening Star is a multiple candlestick pattern that is formed after the uptrend, indicating bearish reversal.

It is made of 3 candlesticks, the first being a bullish candle, the second a doji (Green/Red) and the third a bearish candle.

The first candle shows the continuation of the uptrend, the second candle being a doji indicates indecision in the market, and the third bearish candle shows that the bears are back in the market and reversal is going to take place.

The second candle should be completely out of the real bodies of the first and third candles.

Morning star

The Morning Star is a multiple candlestick chart pattern which is formed after a downtrend, indicating a bullish reversal.

It is made of 3 candlesticks, the first being a bearish candle, the second a Doji and the third  a bullish candle.

The first candle shows the continuation of the downtrend, the second candle being a doji indicates indecision in the market, and the third bullish candle shows that the bulls are back in the market and reversal is going to take place.

The second candle should be completely out of the real bodies of the first and third candles.

Bearish harami

The Bearish Harami is a multiple candlestick pattern which is formed after the uptrend indicating bearish reversal.

It consists of two candlesticks, the first being a tall bullish candle and the second being a small bearish candle, which should be in the range of the first candlestick chart.

The first bullish candle shows the continuation of the bullish trend, and the second candle shows that the bears are back in the market.

Bullish harami

The Bullish Harami is multiple candlestick chart pattern which is formed after a downtrend indicating bullish reversal.

It consists of two candlestick charts, the first candlestick being a tall bearish candle and second being a small bullish candle which should be in the range of the first candlestick.

The first bearish candle shows the continuation of the bearish trend and the second candle shows that the bulls are back in the market.

Doji

The doji candlestick is a candlestick pattern that can be used to predict a future price reversal. 

The doji candlestick is created when the security’s open and close are the same or very close to the same. This candlestick is typically seen as a signal that the security’s price is going to reverse.

The candlestick pattern looks like a cross with a very small real body and long shadows.

Bullish harami cross

The bullish harami cross is a candlestick pattern that can be used to predict a future price increase. 

The pattern is made up of two candlesticks. The first candlestick is red and the second candlestick is green. 

The green candlestick should be smaller than the red candlestick and it should be within the range of the red candlestick. 

The green candlestick should also have a small body with a long upper shadow and a short lower shadow. 

A longer upper shadow & short lower shadow is typically seen as a signal that the security’s price is going to continue to increase.

Bearish harami cross

The bearish harami cross is the opposite of the bullish harami cross. The bearish harami cross is a candlestick pattern that can be used to predict a future price decline. 

The pattern is made up of two candlesticks. The first candlestick is green and the second candlestick is red. 

The red candlestick should be smaller than the green candlestick and it should be within the range of the green candlestick. The red candlestick should also have a small body with a long upper shadow and a short lower shadow. 

This pattern is typically seen as a signal that the security’s price is going to continue to decline.

Bullish & Bearish abandoned baby 

The bullish abandoned baby is a candlestick pattern that forms in a downtrend and is composed of three price bars. The first is a large down candle, followed by a doji candle that gaps below the first candle. The next candle opens higher than the doji and moves aggressively to the upside. The bearish abandoned baby is the opposite of its bullish counterpart.

Head and shoulders

A head and shoulders pattern is used in technical analysis. It is a specific chart formation that predicts a bullish-to-bearish trend reversal. The pattern appears as a baseline with three peaks, where the outside two are close in height, and the middle is highest.

The head and shoulders pattern forms when a stock’s price rises to a peak and then declines back to the base of the prior up-move. Then, the price rises above the previous peak to form the “head” and then declines back to the original base. Finally, the stock price peaks again at about the level of the first peak of the formation before falling back down.

The head and shoulders pattern is considered one of the most reliable trend reversal patterns. It is one of several top patterns that signal, with varying degrees of accuracy, that an upward trend is nearing its end.

Double tops and bottoms

A double top is an extremely bearish technical reversal pattern that forms after an asset reaches a high price two consecutive times with a moderate decline between the two highs. It is confirmed once the asset’s price falls below a support level equal to the low between the two prior highs.

• A double top is a bearish technical reversal pattern.
• It is not as easy to spot as one would think because there needs to be a confirmation with a break below support.
  

A double bottom pattern is a classic technical analysis charting formation that represents a major change in trend and a momentum reversal from a prior down move in market trading. It describes the drop of a security or index, a rebound, another drop to the same or similar level as the original drop, and finally another rebound (that may become a new uptrend). The double bottom looks like the letter “W.” The twice-touched low is now considered a significant support level. While those two lows hold, the upside has new potential.

Triangles

The triangle candlestick pattern is a continuation pattern that is used to predict that the price of a security will continue to move in the same direction. 

The triangle candlestick pattern is formed by a series of candlesticks. The first candlestick is the apex, and the candlesticks that follow form the sides of the triangle.

To confirm that the triangle candlestick pattern is forming, you need to wait for the price to break out of the triangle. The breakout can occur to the upside or downside.

Candlestick charts are easy to read if you know what to look for. The candlesticks show the open, high, low, and close price for the security. The candlesticks are typically color-coded to show whether the price moved up or down during the time period.

If the candlestick is green, it means that the security’s price went up during the time period. If the candlestick is red, it means that the security’s price went down during the time period.

The candlesticks are also typically organized by time period. For example, you might see candlesticks that represent the price movement of a security over the past week, month, or year.

Dark Cloud Cover

The dark cloud cover candlestick pattern is formed by two candlesticks. The first candlestick in a dark cloud cover is a long white candlestick that forms part of an uptrend. The second candlestick in a dark cloud cover is a short black candlestick that opens above the previous candlestick’s close and then closes below its midpoint. The dark cloud candlestick pattern is considered to be bearish.

Understanding Bullish Reversal

There are several candlestick patterns that are used to predict that the price of a security will go up. These candlestick patterns are typically referred to as bullish reversal patterns.

The most common bullish reversal candlestick patterns are the inverted hammer, and the dragonfly doji.

The inverted hammer bullish reversal pattern is formed by a candlestick with a small body and a long upper shadow. The candlestick should be located near the bottom of a downtrend. This candlestick pattern is typically seen as a signal that the security’s price is going to start to move up.

The dragonfly doji candlestick pattern is carries a small upper shadow and long lower shadow formed both down and uptrend. This candlestick pattern is typically seen as a signal that the security’s price is going to start to move down.

Understanding Bearish Reversal 

There are several candlestick patterns that are used to predict that the price of a security will go down. These candlestick patterns are typically referred to as bearish reversal patterns.

The most common bearish reversal candlestick patterns are the hanging man candlestick, and the gravestone doji.

The hanging man candlestick pattern is formed by a candlestick with a small body and a long lower shadow. The hanging man candlestick should be located near the top of an uptrend. This hanging man candlestick pattern is typically seen as a signal that the security’s price is going to start to move down.

The gravestone doji candlestick pattern is formed by a candlestick with a small body and a long upper shadow and small lower. The candlestick should be located near the top of an uptrend. This candlestick pattern is typically seen as a signal that the security’s price is going to start to move down.

Long vs short bodies

The candlesticks can have either long or short bodies. A candlestick with a long body means that the open and close price are far apart. This typically happens when the security’s price has moved up or down significantly during the time period.

A candlestick with a short body means that the open and close price are close together. This typically happens when the security’s price has not moved up or down significantly during the time period.

Long vs short shadows

The candlesticks can also have either long or short shadows. A candlestick with a long shadow means that the security’s price has moved up or down significantly during the time period.

A candlestick with a short shadow means that the security’s price has not moved up or down significantly during the time period.

FREQUENTLY ASKED QUESTIONS

Conclusion

Candlestick charts are a popular tool among technical traders. Candlestick charts can be used to predict future price movements of securities. However, candlestick charts are not 100% accurate and should not be used as the sole basis for trading decisions.