Candlesticks 101

If you’re planning to trade in the financial markets, knowing the various technical analysis techniques is crucial to being successful. Candlesticks are one of the many ways to technically analyse an asset. In addition to giving you price information on an asset, candlesticks can also give you insights into the market movement and sentiment for a specific period. 

In this article, we’re going to explore the meaning of candlesticks, how to read them and the different types of candlesticks you’re likely to encounter. 

What are Candlesticks and What Do They Mean For a Trader? 

Candlesticks are a type of charting method used in financial trading to visually represent the price movements of an asset. They provide more information than a simple line chart or a bar chart as they show the opening, high, low and closing prices of an asset for a particular time period. 

Since each candlestick visually represents an asset’s movement and sentiment within a set period, traders often find it easier to spot potential trends and reversals in the market by simply reading through candlestick charts. By closely analysing the various patterns of candlesticks, traders can accurately predict the short-term price direction of an asset and make strategies accordingly.

How to Read Candlesticks? 

Now that you know the meaning of candlesticks, let’s look at how to read them. 

A candlestick can be deconstructed into three parts - the body, the wicks and the colour. Here’s a closer look at each of these three parts and what they signify. 

• Body 

The body of a candlestick, often shaped in the form of a cylinder, represents the opening and closing price ranges of an asset. The length of the body can give further insights into market behaviour. A long body suggests strong buying or selling pressure, while a short body indicates little price movement and potential consolidation.

• Wicks

Every candlestick has a wick on the top and a wick on the bottom of its body. The wicks, also known as shadows, represent the highs and lows that the asset has touched during the specified time period. 

• Colour 

The body of the candlestick is assigned a colour depending on how the asset price has moved. If the asset price falls after the opening and closes lower, the body of the candlestick will be coloured red or black. On the other hand, if the asset price rises after the opening and closes higher, the body of the candlestick is coloured green or white. By simply looking at the colour of a candlestick, traders can instantly determine whether the asset price has decreased or increased. 

To help you understand the concept better, here is an example of a candlestick and what it means. 

Assume there’s a candlestick with a long green-coloured body, a short wick on the bottom and a long wick on the top. The green-coloured body indicates that the price of the asset increased after opening, went up throughout the session, and closed higher. 

The short wick on the bottom indicates that the price of the asset briefly fell lower than the opening price but rose afterwards. The long top wick indicates that the price of the asset rose sharply to touch a high briefly but couldn’t sustain the momentum and fell back down, closing lower than the intraday high but much higher than the opening price. 

Common Candlestick Patterns 

Now that you know how to read candlestick charts and interpret them, let’s look at some of the most common candlestick patterns you’re likely to encounter and what they mean. 

1. Doji

The Doji is a candlestick pattern that involves a single candle. Here’s how it looks and what it means. 

Appearance: A Doji candlestick can be identified by its small or nonexistent body, often appearing as a thin line. This is due to the opening and closing prices being nearly the same. Although the wicks may vary in length, they are generally long. 

Inference: The appearance of a Doji in a candlestick chart signifies indecision in the market. The long wicks on the top and bottom indicate that despite touching an intraday high and low, neither the buyers nor the sellers could gain complete control over each other. Traders often view Doji as a sign of potential trend reversal, especially if it appears during a bullish or bearish market trend. 

2. Bullish Harami 

The Bullish Harami is a multiple candlestick pattern that involves two candles. It is among the most common types of candlesticks. Let’s take a look at its appearance and what it means. 

Appearance: The Bullish Harami pattern consists of a large red candle immediately followed by a smaller green candle. The body of the smaller green candle is fully enclosed within the body of the large red candle. 

Inference: The Bullish Harami candlestick pattern usually appears at the end of a downtrend and indicates a potential reversal. It indicates diminishing selling pressure and may suggest a potential bullish uptrend. Traders often consider entering into long positions after a Bullish Harami. 

3. Bearish Harami 

The Bearish Harami is another multiple candlestick pattern involving two candles. It is basically the inverse of the Bullish Harami. Here’s a quick overview of how it looks and what it indicates.

Appearance: The Bearish Harami pattern consists of a large green candle immediately followed by a smaller red candle. The body of the smaller red candle is fully enclosed within the body of the large green candle. 

Inference: The pattern usually appears at the end of a bullish uptrend, signalling a possible reversal. It basically indicates that the buying pressure on the asset is decreasing and may suggest a bearish downtrend. Traders generally tend to take up short positions if the Bearish Harami is spotted on the charts.

4. Hammer 

The Hammer is a single candlestick pattern like the Doji. It is also one of the most commonly spotted types of candlesticks. Let’s look at its appearance and what it means. 

Appearance: The Hammer pattern has a small body at the top with a long lower wick, which is at least twice the length of the body. It usually doesn’t have an upper wick, but in some cases, it could have a small upper wick. The candle appears a lot like a hammer. 

Inference: The Hammer is a bullish reversal pattern that usually occurs during a downtrend. It suggests that although selling pressure was present, buyers managed to overcome it and push the price back up. This hints at the price of the asset bottoming out and making an upward turn.

5. Hanging Man 

The Hanging Man is very similar to the Hammer, except for one major difference. Here’s what it looks like. 

Appearance: The Hanging Man pattern also has a small body at the top with a long lower wick, which is at least twice the length of the body. It has little to no upper wick. 

Inference: The Hanging Man is a bearish reversal pattern that occurs during an uptrend. indicates that selling pressure is starting to outweigh buying pressure during a bullish trend, potentially leading to a price reversal or decline. Traders generally see this as a sign to exit long positions or to prepare for a possible downtrend by short-selling the asset. 

Conclusion

Understanding candlesticks is essential for traders to make sense of market trends and sentiments. These patterns can provide valuable clues about the potential future movements of the market. By recognising and interpreting these patterns, traders can improve their strategies, making more informed decisions on when to enter or exit trades. 

With Research 360, powered by Motilal Oswal, you can view candlestick charts for all kinds of market indices and assets. You can customise the chart by selecting the time frame of the candle and the colour. Furthermore, you can also superimpose a wide range of technical indicators, such as RSI, Bollinger Bands and EMA crossovers, on top of the candlesticks to gain more accurate market insights. 

So, what’re you waiting for? Sign up for the Research 360 platform today and enjoy the advanced candlestick charting features.