This Tool from the 1800s Can Make You Modern Money
I touched briefly on candlesticks and how you need to be able to read them to trade bull flags, or any pattern correctly.
Over the weekend, I decided that I wanted to go more in depth with you about how you can utilize candlesticks. Over the next few days, I’ll delve into how to read candlestick charts, and patterns that you can use.
Candlestick charts contain a high amount of information in an easy-to-read graphic. It’s a representation of a trading period I can teach you to use for detailed technical analysis.
What Are Candlestick Patterns?
So what is a candlestick pattern? A candlestick pattern is a price movement that can be graphically shown to predict a specific market movement.
Candlestick charts give you a ton of information. A candlestick shows you the opening, closing, high, and low prices for the specific time frame.
But wait, there’s more! You can also see what the general sentiment was and whether buyers or sellers had the upper hand.
One of the reasons I use candlestick charts is because it’s easy to see patterns.
Candlestick chart patterns are almost like a template. The patterns don’t always look exactly the same, but they look similar enough that when you see them over and over, you realize they’re predictable.
That’s when things can get really interesting.
Candlestick patterns are named based on what the pattern or individual candlestick looks like. A couple of examples (which I’ll get to later) are the hammer and the shooting star.
First, let’s start with the basics: how to read the charts.
How to Read Candlestick Charts?
Reading candlesticks isn’t difficult once you know what you’re looking at. Candlesticks have two main parts: the candlestick body, and the shadow.
The body is the part that looks like the body of a candle. The shadow is the part that looks like a wick. Take a look at the picture below. Candlestick shadows can (and often do) extend from both the top and bottom of the body.
The body tells you three things:
- The opening price
- The closing price
- Whether the share price went up or down
In most modern charting software, a green or white candlestick tells you the price closed higher than it opened. Red or black candles signify a closing price lower than it opened.
Traditional candles are black (filled in) for bearish or downtrending candles and open/white (not filled in) for bullish candles.
The bottom of the candlestick body gives you either the opening or closing price. Let’s stick with red and green to make this simple.
A red candlestick shows the open price at the top of the body and the closing price at the bottom of the body.
A green candlestick shows the open price at the base of the body and the closing price at the top of the body.
So what’s with the lines (shadows) sticking out the top and bottom? The shadows tell you the high and low for the time frame. The top shadow gives the high for the period, regardless of whether the candle is bearish or bullish. The bottom shadow gives the low for the period.
Trending Candle vs. Non-Trending Candle
Trending vs. non-trending can mean a couple of different things …
When you look at a candlestick chart, some candles continue or confirm a trend. These are considered trending candles. If a candle goes against the trend it might be considered a non-trending candle.
Something else you often see is candles without an upper or lower wick or shadow. When you see a candle with no shadows it signifies a strong trend during that time frame.
For example, if you see a green candle with no shadows, the open was the same as the low and the close was the same as the high for the time frame. Likewise, for a red candle with no shadows: the open equals the high and the close equals the low. In both cases, there was no resistance to new price movement.
If the price of a stock rises for the first three minutes of a five-minute candle, but then settles back just above where it opened, a shadow remains above the body. The shadow is an example of higher prices being resisted. Yes, the price went there, but it couldn’t hold. Instead, there’s a shadow.
You can consider the shadows as tests of a price range while the bodyconfirms the range for the period.
Clean candles with no shadow signify a strong trend in one direction because the new prices are confirmed instead of resisted. Candles with a long body moving away from a short shadow (e.g. a green, long body, short lower shadow) also signify trend. As do candles with a short body and long shadow …
Don’t give up. I think I can make this easier for you. Check this out …
I’m going to explain different types of candles with examples. This will likely make a lot more sense once you see the examples!
The important thing to remember is that candlesticks provide information about the trend. While they aren’t 100% accurate (trends change, right?) they give you an idea what to look for — and that’s an edge you want with your trading.
So stay with me here. Once this sinks in, you’re gonna be glad you hung in there and learned it.
Benefits of Using Candlestick Patterns
How do you use candlestick patterns for day trading?
Well first you need to know the types of candlesticks.
Types of Candlestick Patterns
How many types of candlestick patterns are there? There are 5 bullish candlestick patterns that most people focus on, a bearish pattern, and a Japanese pattern.
Bullish Candlestick Patterns
The defining attribute of a bullish candlestick is a higher closing price thanopening price.
Bullish candlestick patterns have an upward trend. If the upward trend is contained within the period represented by a single candlestick, it will be either green or white.
Be aware a pattern may develop over several candlesticks and the pattern might include one or more bearish candlesticks. I’ll show you examples, don’t worry.
Bearish Candlestick Patterns
A bearish candlestick signifies the closing price is lower than the opening price.
A bearish pattern has a downward trend. Like the example above, a bearish pattern doesn’t mean every single candlestick is bearish. A lot depends on the time frame for the candlestick.
Japanese Candlestick Patterns
Don’t let this confuse you. When I (or any other trader) talk about candlestick patterns, we’re talking about Japanese candlestick patterns.
The whole concept of candlesticks — open-high-close-low in a simple graphic representation — comes from Japanese rice dealers. They used a few different styles of charts, but what we now call the candlestick was likely introduced sometime in the 1860s.
Back in the late 1980s, candlesticks were introduced to the West by Steve Nison. He was the author of several books on the topic including the classic “Japanese Candlestick Charting Techniques.”
The Bottom Line
Jump forward to today and candlestick charts are the go-to style for many traders. Big props to the Japanese rice trader who figured this out. His name was Homma Munehisa and he made my trading career much simpler.
You’ll likely say the same if you learn how to read candlesticks and take advantage in your trading!
Think of him as an example of someone doing their research and studying, and the great things it can do for your trading career.
Tomorrow, I’ll go over all the examples of the candlesticks that I talked about today, so you can see exactly how you can use them in your own trading.
Editor, Penny Stock Millionaires