How to Understand Candlestick Charting
Candlestick charting is one way to chart the financial markets. It contrasts with bar charts and line charts as a common way to observe price action. Traders apply candlestick charting to the stock market, foreign currency exchange market and other markets. The analytical methods used in candlestick charting have their foundation in ancient Japanese investment techniques. Candlesticks charting patterns offer opportunities to profit from the prediction of future price movement. They are a fairly simple form of technical analysis, but no strategy is foolproof. While candlestick patterns do often result in profitable trades, they also fail sometimes as well.
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Instructions
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Setup the Candlestick Chart
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Open your stock charting software or other charting program for the financial market you trade. Most brokers provide clients with trading software. If you do not have a standalone program, many free online charting service provide candlestick charting features (See Resources).
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Select the "candlestick" chart style in your software. Most programs provide at least three charting styles, including candlestick, line and bar charts. You must usually specify which style you prefer for the chart. Some online services automatically default to the candlestick style for all the charts they display.
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Chart any stock or financial instrument. Usually, this simply requires that you type the ticker symbol into a search box and press "Enter." A chart is drawn for that particular symbol.
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Identify the many parallel vertical bars that populate the chart. These are the "candles." They are either red or green in most charting programs. A red candle means its opening price was higher than its closing price. A green candle represents the opposite: prices rose by their close for the time period of that candle.
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Identify the "body" of each candle. This is the main rectangular portion of the candle that is filled in with other red or green. The body is defined by the trading range established between the candle's opening and closing prices.
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Notice the "wicks" of each candle. These are the thin lines that extend above and below the body. The wicks extend to the highest and lowest prices of the candle.
Candlestick Patterns
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Identify a candle with a body that extends above and below the entire range of the previous candle, and has the opposite color of the previous candle. This is one of the most common candlestick patterns and often begins a major reversal in prices. The pattern is called an "engulfing" candle. It visually demonstrates how market behavior significantly changed direction, by not just reversing the prior day's activity but doing so dramatically, overwhelming the prior day's trading range.
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Identify a candle with one wick that is much longer than the body and the other wick combined. This is called a "hammer," "shooting star" or "pin bar" and visualizes a "failed auction." Prices rose or fell to the extreme of the wick, but then retreated back toward the day's opening price. The market was unable to sustain the activity at the outer extreme. This often predicts a reversal in prices in the opposite direction of the wick.
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Study a catalog of candlestick patterns to learn many of the common recurring visualizations that this style of charting provides. While pin bars and engulfing candles are the easiest to identify, there are dozens of other patterns that traders often use to inform trading decisions.
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References
Resources
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