One of the tools many active traders use to keep track of prices and find patterns is a candlestick chart. Learning how to read candlesticks is an essential skill for aspiring traders. Let’s take a look at what a candlestick chart is, and how you can use one to make decisions in trading.
The Short Version
- Candlestick charts are the price history of an asset. They are called candlesticks because they look like candles.
- They generally have a color or are filled in, which reference the day’s trading. The candlesticks include the opening and closing price, the high price, and the low price.
- Traders use candlestick charts to identify trends and price patterns.
What Is a Candlestick Chart?
A candlestick chart is a visual representation of the price history of a particular asset or trading position and is so named because it looks like a candle. A candlestick chart is a way to quickly and easily get a feel for price trends through a representation of four items for a day of trading:
- Opening price
- High price
- Low price
- Closing price
Candlesticks usually have a color, which allows for a quick reference of a day’s trading. When you know how to read candlesticks, it becomes fairly easy to understand trends and potentially take advantage of what could be next.
How to Read Candlesticks
There are three main elements to a candlestick. Understanding these elements can help you quickly interpret the four data points related to price each day.
The body of the candlestick — the thick part — displays the opening and closing price, which is indicated at the top and bottom of the candlestick. It’s also possible to understand how much activity was involved during the day by looking at the body. A longer body indicates a lot of selling, while a short body indicates a relatively low amount of activity.
The thin wicks at the top and bottom of the body indicate the high and low prices for the day. The high price for the day is indicated by the upper wick, and the low price can be seen in the lower wick.
Finally, the color can give you an idea of what happened during the trading period. If the candle body is green, it means the price closed above the open. A red body means that the price closed below the open. Some platforms use white for an above-open close, and black for a below-open close. Check the platform you use to see the color scheme used.
How to Recognize a Price Pattern in Multiple Candles
Because the point of learning how to read candlesticks is to identify patterns, it’s important to understand that you can break down charts into smaller increments. You can see a new “open” and “close” every five minutes throughout the day. Understanding that you have a new candle every few minutes, and watching them progress through the day is how you start seeing patterns. Watching the candles move in specific patterns can give you an idea of when it’s time to enter or exit a trade.
Traders recognize that different candle patterns have the potential to indicate whether a price could be heading higher, or whether a reversal is in the works. Here are some of the basic patterns.
Bullish Hammer Pattern
When you see a short body with a long lower wick, that’s an indication of nearing a point where a bottom is being reached and the price could start going up.
Bullish Engulfing Candlestick
With this pattern, you are looking at two candlesticks. If there’s a short red (or black) candlestick being overtaken by a long, bigger green (or white) candle, there’s a good chance that a bullish trend is forming, resulting in higher potential prices.
Bearish Engulfing Candlestick
On the other hand, the bearish engulfing candlestick indicates a potential reversal into a bearish trend where the price is likely to fall.
Bullish Morning Star
If you see three candles together — the first long and bearish, the second short and somewhat indecisive, and the third is long and bullish — it could indicate that the selling pressure is easing and things will improve.
Bearish Evening Star
This is the opposite of a morning star. If the last candle in the three-candle pattern is opening below a small body, it could mean that a selling trend is forming and the price is likely to drop.
Harami Bearish vs. Bullish
A harami is when you see a small body candle inside a large body candle. A bearish harami is indicated by a red (or black) small body following a green (or white) larger body. The bullish is the opposite, with a green (or white) small body candle following the bigger red (or black). This indicates that there’s some indecision going on. Rather than acting, it’s a good idea to pause.ad see whether the next candlestick indicates that a trend is forming.
In some cases, you might see a small cross following a candlestick. This small cross is called a doji and it indicates that the open and close for that session is basically the same. When a cross follows a candlestick, it could be time to pause, since the trend might be changing.
In this scenario, you’ll see a long body green (or white) candlestick followed by three short body red (or black) candlesticks. In this case, the short bodies should all be in the range of the original long body. If the candlestick following the three is a green or white long body, it indicates that there was a bit of a hold, but the upward trend is ready to resume.
This is the opposite color scheme of the rising three. You’ll see the long body red (or black), followed by short bodies in the opposite color, showing an attempt to move higher. The final candle will be a long body red (or black), indicating that the asset price is likely trending downward.
Candlestick Charts vs. Bar Charts
At first glance, it appears that these are very similar. However, a bar chart doesn’t have the wicks and bodies that make the candlestick chart so visual. It can be harder to see some of the subtleties with a bar chart. While the bar chart looks cleaner, learning how to read candlesticks can help you quickly grasp nuances due to the thickness of the candle bodies.
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The Bottom Line
If you get involved with active trading, especially day trading, you need to learn how to read charts and understand when trends are forming. Learning how to read candlesticks can be one way to quickly assess trends and ascertain whether it’s time to enter or exit a position. Being able to take advantage of these movements is essential to successful trading.
Remember, though, that trading comes with risk and you have the potential for large losses. Becoming proficient at reading candlestick charts can take time, and you might be better off starting to risk small amounts of money as you get the hang of the charts.