Introduction
Candlestick charts developed in Japan in the 18th century. They began in rice trading but quickly moved to the Japanese stock market.
Candlestick charting growth in popularity into the USA and Europe did not begin until the 1980s. The candlestick charts grew in popularity in the west because they were able to convey more information available at a glance. As a result they provided traders with the ability to understand price action more quickly. Another benefit that candlesticks (candles) can also provide is the ability to predict short-term trading signals due to their huge number of formations.
Candlestick formations are equally reliable as tools for visualizing chart reversal formations like double tops or bottoms, head-and-shoulders, etc. Due to the predictive nature of these formations this method of presenting price action has overtaken older methods such as line and bar charts. As a result it is recommended that in order to become fully proficient in technical analysis, understanding the “candlestick” charting technique is a critical tool for success.
Learning the basics of candlesticks does not take long and can be a huge benefit for any investor, therefore it is well worth the short effort to understand it.
How are the Candles Constructed?
Candlesticks can be visualized over any time scale, for example, depending on the time scale one candle can represent 1 minute, 5 minute, 15 minute, 4 hours, 1 day, 1 week, etc.
The same as with line or bar charts the candles' statements and predicting power are the same for each time grid. Structurally, the candle is made up of a body, an upper wick, and a lower wick. Wicks are also known as shadows.
A candle can be either green or red in color (in some representations black instead of red, or white instead of green or custom colors). A green candle represents a closing price above the opening price, while a red candle shows a closing price below the opening price. The color of the candle indicates whether the time period concluded positively or negatively. But watch out: the color relates to the candle's time period, not the previous day's closing price. That is, the color of the candle is unaffected by whether today's closing price is higher or lower than yesterday’s! The wicks of the candle represent the period's peak and low.
Meaning of Individual Candles
Individual candles have special significance depending on the relationship between their wick and their body, which on the one hand describes the trading day (or the respective time period selected for the candle) and sometimes also provides an indication of how the immediately following time periods may proceed.
Let's take a look at the most important ones. Here are the bullish, green candles with a largely optimistic meaning, followed by their bearish, red counterparts, each with its own name:
These were the relatively simple candles that, on their own, showed a bullish (green) or bearish (red) trend. Additionally, there are candles that signal a likely change of direction, or at the very least, an increase in the traders' uncertainty. They're known as "Dojis."
They can take four different forms, which we'd want to go over in greater depth to assist you grasp or internalize the "inner message" of the candlesticks:
Candles with no or only a barely visible body are known as Dojis. This indicates that the opening and closing prices are almost identical. It may be determined from this that the power of the buyers and sellers balance each other out, indicating that the strength of the previously dominating side is gradually fading following a prior trend impulse.
A "Long Legged Doji" with prominent upper and lower wicks implies that, because the high and low are far off from the opening and closing prices, the Doji resulted from a draw following intense buying and selling. This indicates that both sides were quite active, implying that this Doji would drive a trend impulse, implying that one side will win.
The opening and closing of the Dragonfly Doji, as well as the Gravestone Doji, are near to or right at the top or low of the day's trading range. This suggests that the bulls were able to recoup substantial losses (Dragonfly Doji), or the bears were able to reverse a significant price gain. In the coming future, these two Dojis signal that price may continue to move in the last direction before the closing (i.e. upward for the Dragonfly Doji, downward for the Gravestone Doji).
Significant Candlestick Formations
Even single candles, as you can see, have their own importance. The so-called candlestick formations, which indicate a change in the current trend and consist of numerous candles whose message originates from the image that they present together, are far more intriguing and crucial for the next trend.
Following that, we'll show you the most significant formations, each with a brief description.
"Hammer" (potentially bullish)
At the bottom of a downward movement, a green candle with a long lower wick. This bullish trend reversal pattern is only verified when the hammer is followed by another green candle.
"Hanging Man" (potentially bearish)
At the conclusion of an upward movement, a green or red candle with a small body and a long lower wick. This bearish trend reversal formation is only regarded verified when the Hanging Man is followed by a bigger red candle. At first glance, you could believe this configuration is bullish. It isn't, because it implies that the buyers are doing all possible to avoid a negative outcome. This is a sign of anxiety and waning powers.
Morning Star (potentially bullish)
At the end of a downward trend, a red candle is followed by one (or two) small red or green candle(s) or a Doji, which is then followed by a bigger green candle. This bullish trend reversal pattern does not require rapid confirmation through another green candle, but it would improve accuracy. In the world of candlestick analysis, the Morning Star is one of the most important trend reversal forms.
Shooting Star (potentially bearish)
At the conclusion of an upward movement, a green or red candle with a small body and long upper wick. This bearish trend reversal pattern is only regarded verified when the Shooting Star is followed by a bigger red candle.
Evening Star (potentially bearish)
A green candle is followed by a (sometimes two) little red/green candle(s) or a Doji, which is then followed by a bigger red candle. This bearish trend reversal pattern does not require any more confirmation. However, it would be safer if a red candle followed this one right away.
Bullish Engulfing Pattern (potentially bullish)
A green candle that encloses the body of a preceding red or green candle at the end of a downward movement. This bullish trend reversal pattern is more of an "announcement" and requires more confirmation in the form of a second, additional green candle.
Bearish Engulfing Pattern (potentially bearish)
A red candle that completely envelops the body of a preceding red or green candle toward the end of an uptrend. This bearish trend reversal formation should be taken as an "announcement" that requires further confirmation in the form of a following, further red candle.
Bullish Harami (potentially bullish)
Following a downward movement, a smaller green candle appears shortly after a larger red candle. The green candle, including any wicks, must be contained within the red candle's body. A second green candle is required to validate this formation. The bullish side has managed to break the negative trend, which is the basis for the probable positive statement. It might also be a little candle with a red body, but the odds are better if the candle body is green, and the closing price is higher than the opening price.
Bearish Harami (potentially bearish)
Following an upward movement, a smaller red candle appears shortly after a bigger green candle. The red candle, including any wicks, must be contained within the green candle's body. A confirmation in the shape of another red candle is required for this formation.
"Piercing Line" (potentially bullish)
A green candle opens following a downward movement beneath the body of a preceding red candle but closes above the red candle's body's center. A further green candle is required to validate its formation.
Dark Cloud Cover (potentially bearish)
A red candle begins by rising over the body of a preceding green candle, but subsequently falls below the center of the prior green candle's body. To be considered a bearish indicator, this formation must be confirmed by a subsequent red candle.
The "Reach" of Formations
It is important to keep in mind that the projection range for trend reversal patterns is four to five candles. Even unique patterns such as a Morning Star have a "range" of four to five weeks if the candles are seen weekly; four to five days if candles are viewed daily and so on. As a result, they are neither designed or appropriate for obtaining a long-term turnaround. Reversal patterns from traditional charting techniques, like double tops, are useful for that!
Conclusion
Candlestick formations virtually spring into the eye of a relatively experienced trader who has faith in them and sharpens the eye in order to identify probable chart reversal points. They can always be deduced logically, that is, they are predicated on an imminent shift in market mood and investment behavior. As a result, the "candles" are a "tool" that will always be useful to you. Memorize what you have read and start looking for them.
