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How To Read Candlestick Charts

Learning how to read candlestick charts helps investors become better at trading using technical analysis. For traders who don’t already understand these patterns and what they can reveal, we’re ready to help. Traders can review this comprehensive guide to candlestick charts to add yet another strategy to their investing toolkit.

How to read candlestick charts:

  • Check the color: A green, blue, or white candle indicates an upward-trending asset, while a red or black candle is used to designate an asset that’s trending downward over the measured period.
  • Find the indicated prices: Each candle on a candlestick chart indicates the high price, low price, close price, and open price for the time period in question.
  • Review price direction: Look at the candle’s placement on the chart to gain information about its price direction compared to previous time periods.
  • Determine the range: To assess the price range over the time period, look at the candle’s wicks (or shadows), or subtract the period’s low price from the period’s high price.
  • Look for patterns: Traders who use technical analysis rely on single-candle and multiple-candle formations to glean additional insights about the stock or asset.

What Is a Candlestick Chart?

Image via Flickr by wuestenigel

A candlestick chart is a technical analysis tool that offers a wealth of valuable information about a stock or asset in an intuitive, easy-to-read design. Traders can use these charts to predict potential price movements based on their assessments of past patterns.

With a candlestick pattern, each time period on the chart is represented by a single rectangular ‘candle.’ Each candle indicates the asset’s high, low, open, and close prices for the specified time period, which can be as small as five minutes or as long as a full day.

Many investors use a daily candlestick chart to see how their target asset changes from day to day at a glance. Candlestick charts illuminate the asset’s price range and trend for the period in question. Traders can use the following steps to learn how to take advantage of a candlestick chart.

Check the Color

Most charts use a green, blue, or white candlestick to indicate an asset that’s on a positive trend and either a black or red candlestick to notate a downtrend. During the time period in question, the candlestick may change color. The chart shows the final color only when the time period for that candle has ended. As soon as one candle is complete, the formation of the next candle begins.

Find the Indicated Prices

When investors look at a candle on a candlestick chart, the open price typically appears on the bottom of the candlestick if the asset is trending up and on the top if it is trending down. The asset’s high price for the designated period lies at the top of the candle’s wick, which looks like a shadow or tail above the rectangle. When the high price matches either the open or close price, the candle is wickless.

Look at the tail at the bottom of the candle to find the stock’s low price for the period. As with the high price, there will be no tail if the low price matches either the open or close price.

On a green, blue, or white candle, the asset’s close price for the designated period appears at the top of the candle. In comparison, black and red candles show the closing price at the bottom of the candle.

Review Price Direction

In addition to the trend information that traders can glean from a candlestick’s color, its placement also provides details about the trend for that time period in relation to previous periods. When a stock opens higher than the closing price for the previous period, it will appear to the right and above the previous candle on the chart. A stock with a lower opening price than the previous closing price has a candle that appears below the last candle and to the right.

Determine the Range

Investors can find the stock’s price range for the given period by subtracting the low price from the high price. They can also measure the distance between the upper wick and the lower tail of the candlestick. Generally, the longer the candle, the higher the buying or selling pressure for that particular asset. A long red or black candlestick signifies strong selling pressure, while strong buying pressure shows up as a long green, white, or blue candle.

Look for Patterns

Now that we’ve discussed the basics of how to read candlestick charts, it’s time to learn how to read candlestick patterns. Looking for specific formations on a candlestick chart can inform smart trades.

Single-Candle Formations

Even a single candle can reveal important information about a target asset. One of the most common single-candle formations is the hammer, which often signifies an upcoming trend reversal. A hammer candle is characterized by its small body, a long lower wick, and an opening price below the closing price. If a trader notices a hammer on their chart, smart actions to take may include:

  • Exiting a short position.
  • Tightening the reins on a stop-loss.
  • Buying shares of that specific stock.
  • Executing a long trade after the hammer closes.

Investors might also notice an inverted hammer candle, which looks exactly like an upside-down hammer. This pattern usually signifies support or trend reversal. Before using the inverted hammer to make trade decisions, make sure to find a bullish confirmation like a gap up or a long uptrend candlestick after the inverted hammer.

A spinning top is a small-bodied candle with a long top wick and a long lower wick (shadow). This type of candle reflects indecision in the marketplace, indicating little change from open to close and significant volatility during the measurement period. When a spinning top shows up after a long positive candle or negative candle, it usually foretells a reversal in trend.

Multiple-Candle Formations

Traders can also look for price patterns created from multiple candlesticks. One such chart is the bullish engulfing pattern, characterized by a red or black candle immediately followed and completely engulfed by a blue, green, or white candle. In other words, the upward-trending candle covers the same area as the downtrend candle and then some. Actions to take after noticing a bullish engulfing pattern may include:

  • Waiting for the second candle to close, then entering a long position.
  • Placing a stop-loss under the low point of the candlesticks.

Another bullish pattern to look for is the three-line strike reversal. This chart has three downtrend candles in a row, each closing near the chart’s intrabar low, and each with a lower low and lower high than the last. The fourth bar in the pattern has an even lower opening but closes for the day above the first candle’s high price. When investors see this pattern, they can reasonably expect a reversal with higher prices on the horizon.

A candlestick chart may also form a piercing line, a two-stick pattern in which an uptrend candle with a long range immediately follows a downtrend candle with a long range. The piercing line also features a gap between the closing of the first candlestick and the opening of the second candlestick, which traditionally highlights strong pressure to buy the asset in question.

In a bleak market, savvy traders keep an eye open for the morning star candlestick pattern. This three-stick pattern consists of one short candle that pops up between a long downtrend candle and a long uptrend candle. The shorter candle, known as the star, should not overlap with the two longer candles since gaps on the market open and close distinguish this pattern and indicate the rise of a bull market.

The evening star is the morning star’s counterpart. It shows up as a short candle between a long positive candle and a long negative candle. This signifies an upcoming downtrend.

After a downtrend, investors may notice the three white soldiers pattern, indicated by three long positive candles with increasingly higher closing prices and opening prices. The ‘soldiers’ usually have short top and bottom wicks. This pattern indicates a strong increase in buying pressure, although it can also be a red flag for short-selling activity that will result in a price decline.

Once a trader becomes familiar with candlestick charts, they will be able to spot even more patterns that clue them into market movements. Knowing how to read candlestick charts is a key skill for any technical investor.