Ookiversity: Candlesticks
Candlestick charts were developed in Japan in the 18th century. Although they were initially used in rice trading, they were soon applied to the Japanese stock market.
Candlestick charting did not gain popularity in the USA and Europe until the 1980s. These charts became favored in the West as they provided a wealth of information at a glance, enabling traders to quickly grasp price action. Additionally, candlesticks offer the advantage of predicting short-term trading signals through their extensive array of formations.
Candlestick formations are as reliable as they are versatile, effectively illustrating chart reversal patterns such as double tops or bottoms, and head-and-shoulders. Owing to their predictive capabilities, candlestick charting has surpassed traditional methods like line and bar charts. Thus, mastering candlestick charting is essential for anyone seeking to excel in technical analysis.
Learning the fundamentals of candlestick charting is a straightforward process that offers significant benefits to investors. The effort to understand this technique is minimal compared to the profound insights it provides.
How are the Candles Constructed?
Candlesticks can be visualized over any time frame, ranging from as short as 1 minute to as long as one week or more. Similar to line or bar charts, the interpretive and predictive value of candlestick patterns holds consistent across different time scales. Structurally, a candlestick consists of a body, an upper wick, and a lower wick—these wicks are also referred to as shadows.
Candlesticks may appear in different colors: typically green or red, though some charts use black instead of red, or white instead of green, and may even feature custom colors. A green candle indicates that the closing price was above the opening price for that period, suggesting a net gain. Conversely, a red candle indicates a closing price below the opening price, reflecting a net loss. Importantly, the color of a candle relates solely to its own opening and closing prices within its specific time frame, and is not influenced by the closing price of the previous day. The wicks of the candle denote the highest and lowest prices during the period.
Meaning of Individual Candles
Individual candles are significant as they reflect the relationship between the wick and the body, which not only characterizes the trading activity during the selected time period but also can provide insights into potential future market movements. This relationship can indicate whether the upcoming trading periods might continue in the same direction or reverse, offering traders valuable clues for strategizing their next moves.
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 that display no or a minimal body are termed "Dojis," signifying that the opening and closing prices were nearly identical. Such formations suggest a balance of power between buyers and sellers, indicating a weakening momentum of the prevailing trend.
A "Long Legged Doji," characterized by significant upper and lower wicks, indicates a session marked by intense buying and selling, where neither side secured a definitive advantage. This pattern suggests a potential shift in market dynamics, indicating a possible upcoming trend impulse as one side may eventually prevail.
The "Dragonfly Doji" and "Gravestone Doji" have opening and closing prices close to the extreme ends of the trading range. A Dragonfly Doji, where the open and close are near the low, suggests that buyers managed to recover losses, potentially signaling an upward price continuation. Conversely, a Gravestone Doji, with the open and close near the high, indicates that sellers overcame earlier gains, possibly leading to a downward continuation. These patterns provide clues about future price movements, hinting at the direction the market could take following their formation.
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.
About Ooki
Ooki is a protocol for margin trading, borrowing, lending and staking enabling the building of Decentralized Applications for lenders, borrowers, and traders to interact with the most flexible decentralized finance protocol on multiple blockchains. Ooki is a fully decentralized, community-run DAO, governed by the community vote for all major changes to the protocol. Ooki users can engage in margin trading with up to 15x leverage using a fully decentralized trading platform.