If you’ve ever stumbled across a site for investment enthusiasts or perhaps you were researching investments yourself and saw a chart that had black and white rectangles with a line off the top and bottom, then it was probably a candlestick chart.
These charts, which originated with eighteenth-century Japanese rice traders, are used to analyze investment markets. They’re similar to Western-style bar charts, but not quite the same thing. With candlestick charts, investors can glean a bit more information.
Candlestick charts are commonly used in day trading and forex circles to time the market. While it’s never recommended to try and time the market for retirement or long-term investments, it can be exciting to analyze the stock market and trade shorter investments using these charts.
Why Use Candlestick Charts Over Other Types?
Candlestick charts better reflect the emotions of the traders in the market, which allows you to make a better decision about entering or leaving the market. It doesn’t take very long to be able to read and analyze candlestick charts and once you do, they can provide you with a lot of information at a glance.
Patterns in candlestick charts are regarded as very consistent. This means that once you are practiced at analyzing these charts, you will be able to predict whether the market will stay on its current course or reverse the trend. Even the weakest candlestick chart patterns increase the likelihood of your prediction being accurate.
Candlestick charts don’t need to be used alone or chosen over other strategies. They can be folded into any current trading strategy and still be effective.
Anatomy of a Candlestick Chart
Candlestick charts are called “candlestick” because they resemble candles. There is an empty or filled-in rectangle with a line on the top and the bottom. The rectangle is called the “real body,” and the lines are called “shadows” or “wicks.”
The end of the top wick is the high price for the session and the end of the bottom wick is the low price for the session.
If the real body is filled in, then the opening price is higher than the closing price. If the real body is empty, then the closing price is higher than the opening price. Often chart makers will use red if the closing price is lower than the opening price and green if the closing price is higher than the opening price, instead of filled-in and empty, respectively.
Analyzing a Candlestick Chart
Candlestick charts are usually analyzed using patterns. Patterns can be categorized as either bullish or bearish. A bear market is when “a market experiences prolonged price declines. It typically describes a condition in which securities prices fall 20% or more from recent highs amid widespread pessimism and negative investor sentiment.” The opposite of a bear market is a bull market, or “the condition of a financial market in which prices are rising or are expected to rise.”
Bullish vs. Bearish Conditions
A long green or empty real body usually signifies bullish conditions and pressure to buy. A long red or filled-in real body means bearish conditions and pressure to sell. This could also indicate panic in the market or the dumping of shares. The longer the real body, the more pressure there is to buy or sell.
If the body is very short, that means prices are more stable and there are less intense emotions in the market. If a short body comes at the end of a longer upward or downward trend, that could indicate a possible turn for the price. A candlestick with no real body is called a “doji.” A doji shows that the opening price and closing price for the session were about the same.
Watching for Context and Patterns
Dojis come right at the peak or trough right before a reversal, but candlestick charts shouldn’t be looked at individually. They should always be looked at in groups to see the context and patterns.
Candlestick charts wouldn’t hold true to their namesake without the wick. The wicks hold valuable information. When the wicks are short, that shows very little price fluctuation through the session. If the top wick is long, that means buyers tried to increase the price but the market rejected it. If the bottom wick is long, that means there was a lot of selling that caused the price to fall, but some were repurchased, causing the price to rise back up.
Common Candlestick Chart Patterns
Candlestick charts can come in an infinite number of patterns. Some are more reliable than others. These are a few of the more trusty ones that you can keep an eye out for. They all indicate the price is either about to turn or maintain its current momentum.
1. Evening Star or Abandoned Baby
These are opposite visualizations of the same event. When three or more real bodies moving in their associated direction — upward real bodies indicating bullish conditions or downward for real bodies indicating bearish conditions — are followed by a very small real body in the opposite color. This pattern indicates that the preference for that investment is about to change from buyers to sellers or vice versa.
2. Three-Line Strike
This is another reversal pattern. Three candlesticks that match their trend in a row are followed by a fourth with a long real body going in the opposite direction. The fourth candlestick closes even higher or lower than the first candlestick in the pattern, depending on the trend that’s reversing.
For example, a bullish three-line strike will have three bearish candlesticks in a row, each closing lower than the last, followed by a long bullish candlestick with a higher closing price than the first bearish candlestick.
3. Two Black Gapping
This pattern is a bearish continuation pattern. It shows that the market is falling and will keep falling. There’s a fairly obvious top in a pricing trend followed by two filled-in candlesticks, with the opening price of the second filled-in candlestick even lower than the closing price of the first. Usually, when this happens, it indicates that the price isn’t done falling.
Do You Need To Use Candlestick Charts?
You don’t need to be well versed in candlestick charts to be able to invest in the market, especially for retirement investing, which usually does better when you invest small amounts over a long period of time. Being able to read candlestick charts over the long term, though, can give you valuable information about possible investments.
Even if you’re not a day trader, candlestick charts can give you a lot of useful information about potential investments. Now that you’ve already learned about them, all you need to do is find some and practice reading them. If you want to know more about day trading, check out some strategies.
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