What is a Candlestick Chart?
A candlestick chart is a financial chart that typically shows price movements of currency, securities, or derivatives. It looks like a candlestick with a vertical rectangle and a wick at the top and bottom. The top and bottom of the candlestick show open and closed prices. The top of the wick shows the high price, and the bottom of the wick shows the low price.
Candlestick charts have been around since the 1700s, when a Japanese man named Homma invented them. He realized that there was a link between the price of rice, the supply and demand, and the rice traders’ emotions. He developed a chart where each candlestick represented one of the four dimensions in a trading period—the open, the high, the close, and the low. One hundred years later, the West caught up with him, and the rest is history.
These charts show market volatility and trends and can be an important tool for investors and traders wanting a thorough analysis before investment. Technical analysis using candlesticks play a key part in any trader’s plan, determining times to enter and exit trades.
How Does a Candlestick Chart Work?
Candlestick charts show a range of information:
- Open price
- Close price
- Highest price
- Lowest buy price
- Patterns and trends in share prices
- Emotions of trades
The “real body” is the rectangular candlestick, which shows the open and close price of the shares and equities (or rice). The wick or “shadow,” which runs from the top and bottom of the real body, shows the high and low price point for the day. If the real body is black or filled in, it shows that the close price was lower than the open price. If the real body is open, the close price is higher than the opening.
The wicks also show valuable information. A short upper wick on a down candle shows the open price was close to the high price, whereas a short upper wick on an up day shows the closing price was close to the high price.
There is also a trend called a “doji,” where the body of the candlestick has almost completely disappeared and only a cross remains. There are three types of doji:
- Dragonfly: where there is no body, a long bottom wick, and a minimal top wick. This shows lower prices are rejected in favour of higher prices.
- Gravestone: where the long top wick and short bottom wick show a rejection of a higher price over a lower price.
- Long-legged: has two long wicks; it shows uncertainty, with no clear trend.
There is also a hammer and an inverted hammer related to the dragonfly and gravestone doji. However, they have small real bodies, unlike dojis, which have no body at all.
If there are many candlesticks on one chart, these show a variety of trends. These trends and patterns are either called bullish or bearish. Bullish patterns show trends that indicate a likelihood the price will rise, and bearish patterns show that a price is likely to fall. While these patterns are not infallible predictors, they show tendencies in movement.
Trading, while having certain measurable elements, is largely dictated by emotion. Viewed holistically, candlestick charts show this emotion. The relationship between the open, close, high, and low all impacts the look of the candlestick.
Candlestick Chart Patterns
In general, the smaller the wick and the longer the body, the stronger the change of bullish or price rise. The smaller the body and the larger the wick, the more the bearish, or weakening price, is trending.
Bearish Engulfing Pattern
This pattern shows an uptrend where sellers outnumber buyers. There’s typically a long, solid real body engulfing a small, open real body, showing that it’s a seller’s market, and the price could continue a declining trend.
Bullish Engulfing Pattern
This pattern shows when there are more buyers than sellers. A long, open real body engulfs a small, solid body, indicating the price could rise.
Bearish Evening Star
This is a topping pattern, where the last candle opens below the previous day’s small real body. The final candle closes deeply in the real body of the candle from two days previously. This pattern shows that buyers stall, and then sellers take control. It indicates that an increase in selling could develop.
A small solid body is completely inside the day before’s real body. This doesn’t show a pattern that needs to be acted on but is something to watch. It shows indecisiveness, and the days following, whether they reflect an upward or downward trend, will determine action.
This opposite of the Bearish Harami shows a downward trend. A small open body is dwarfed by the previous day’s solid real body. This shows a pause in a trend and needs more days to see any emerging trends.
Bearish Harami Cross
There’s an upward trend of open candlesticks, followed by a doji. This shows the stock is best to watch and wait to see any trends.
Bullish Harami Cross
There’s a downward trend of solid candlesticks, followed by a doji. This shows a stop in a trend and could need further data before actioning, buying, or selling as a result.
Charts Similar to Candlestick Charts
Box and Whisker Chart
A box and whisker chart has boxes with horizontal whiskers; it shows data distribution with outliers and can be used over a wide variety of data. For instance, in psychology, a box and whisker chart can show the top and bottom range (at the end of the whiskers) of what a population’s intelligence quotient (IQ) could be if everything went right or wrong. Then, the box may show the actual IQ range based on testing.
While a candlestick chart has a narrowly defined range of four components (open price, close price, highest price, and lowest price), a box chart, or box and whisker plot, shows outliers, upper and lower bounds, median, and first and third quartile marks. These charts can be used to show a huge range of different data types; although they look similar, their uses are completely different.
One of the most basic charts, a bar chart, can show the same information as a candlestick chart but in a different way. Bar charts are less visual and harder to understand. The thickness of the real bodies on a candlestick chart highlights the difference between the closing and opening prices.
Whether a candlestick or bar chart is used depends on what information is needed. If the open and close prices are most important, the candlestick chart is best. If all parameters are equally important, a bar chart will best display this data.
A simple line chart shows the information from a day or a trend over time. However, if one line represents only the closing or opening price, it can remove the volatility and take the price out of context. Multiple line graphs become too difficult to interpret.
The Heikin-Ashi is a bar chart technique that is best used in conjunction with candlestick charts. It makes candlestick charts more readable and easier to assess trends.
The Renko chart uses price movement rather than plotting a price at a standardized interval. It looks like a series of bricks stacked into mountain structures. It is useful for identifying support and resistance levels because they are simpler than candlestick charts with all the “noise” removed.
The Future of Candlestick Charts
Even though it’s a niche chart, there are still a range of alternatives, such as the Heikin-Ashi and Renko charts. These should all be examined to identify trends and patterns, and it’s best when there’s a range of graphical data available to interpret.
Investors’ emotions dictate a lot about future stock prices and trade movements. While emotion can’t be measured, candlestick charts help traders see trends, assess trends of emotions, and make predictions about the future prices.
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