Candlestick charts are one of the pillars of technical analysis. They are made of several candles, used to graphically represent the price variations of an asset over a giver period of time time. Candlestick charts give considerably more information than simple price curves and are precious to traders.
A bit about the history of candlestick charts
Candlestick charts have been developed by japanese rice trader Munehisa Homma in the 18th century. He visually represented the price variation of the assets in given timeframes, and added the data together to form charts that allowed him to regognize price variation patterns and build strategies based on market psychology.
What is a candle?
In trading, a candle allows you to observe the evolution of an asset’s price over a given period of time, which can vary from one minute to several weeks. Four different price levels, corresponding to the levels reached by the asset during a certain period, are represented on each candle. These are the lowest point reached by the asset, its highest point and the open and close prices. The color of the candle represents the direction of the price during the timeframe: red for a decrease, up for an increase. The part between the open and the close is called the body of the candle. The thin lines which mark the difference between the open or the close and the high or the low are called the wicks or the shadows.
How to read candlestick charts?
To read a candlestick chart, you need to consider the color, body and wicks of the candles. Candlestick charts are useful to indentify or to predict market movements.
The color of the candle
The color of the candle is the first thing to look at. It allows to determine in which direction the market has moved or is moving. The candle will be green if the closing price is higher than the opening price, and it will be red if the closing price is lower than the opening price. The color of a candle indicates whether a market was bullish or bearish during a given period.
The body of the candle
The body of the candle’s height represents the difference between the opening and closing price (or the current price for the latest candle) of an asset. If the candle is green, the asset gained value, thus the base of the candle’s body represents its opening price and the top represents the closing price. If the candle is red, then it is the opposite: the asset lost value. Thus the top of the body represents the opening price and the bottom represents the closing price.
A large body means that a strong buy or sell tension occured. A small body indicates an equilibrium. Be careful of two things. First, look at the scale of the chart as well as the size of the other candles comparing to the one you’re studying. A seemingly large candle does not necessarily mean that the price has varied a lot. Second, a small body does not necessarily mean that the volume exchanged was small during that time period. Perhaps a lot of buying and selling occured while the price was stabilizing.
Wicks of the candle
The wicks, or shadows, of the candle represent the highest and lowest prices an asset has reached in a given period. The top wick, or upper shadow, is the highest price, while the bottom wick, or lower shadow, is the lowest price.
A candle with a long top wick and a short bottom wick indicates that buyers were very active during that period. However, sellers forced prices down from their highs, causing the markets to close lower than the level reached by the upper wick. Conversely, a candle with a long lower wick and a short upper wick indicates that sellers initially drove prices down, but then buyers mobilized, allowing prices to rise and the market to close higher, as shown by the long lower shadow.
Traders have identified candlestick patterns, that are particular candle shapes or combinations of several candles that are usually followed by predictable price moves. Candlestick patterns are useful technical analysis tools that can be used alongside with indicators to predict price direction more accurately.