Candlestick charts are always at the heart of price action analysis and are becoming even more popular lately, given their dynamic features and versatility. They originated in the 1700s when a Japanese ride trader named Honma concluded that human emotions influence price patterns in financial markets.
Unlike line charts, bar charts, or figure charts, candlestick charts are easy to read, understand, and interpret.
Candlestick Chart Components
Befitting its name, a candlestick chart refers to a pattern in which a stock forges the shape of a candlestick. When discussing candlestick charts we refer to shadows or wicks, which are lines appearing above or below the body of the candle. Candlesticks also have opening and closing prices as well as high and low prices.
Open – Used to illustrate the price at which an asset first traded at a given time. It can be either at the top or bottom.
High – This is the highest price traded at a given time, often indicated above the body of a candlestick.
Low – This is the lowest price traded during a given time, often indicated at the bottom of a candlestick.
Close – This is the last price traded at a given time, which can be indicated at the top or bottom of the candlestick body.
Range – Range is used to depict the price difference between the upper and lower shadow during a given period. It is often used to illustrate volatility associated with a given candlestick, as higher range signals higher volatility.
Types of Candlesticks
A Doji candlestick appears whenever there is indecision in the market. In this case, the opening and closing price will be the same. When that happens, the length of the upper and lower ends of the candlestick vary, resulting in a cross, or an inverted cross.
Tops candlesticks appear with a short body with long upper and lower shadows that often exceed the size of the body. Whenever such candlesticks appear in the market, they indicate traders’ indecision.
Long candlesticks with long bodies and short shadows are used to indicate strength in a given direction. They often depict that a trend is developing in a given direction.
Hammer and Inverted Hammer Candlesticks
The inverted hammer candlestick occurs whenever a downtrend or bearish pattern is losing its steam. In this case, it acts as a warning sign of a potential trend reversal.
The hammer candlestick, on the other hand, is a bullish reversal pattern candlestick that forms in a downtrend, signalling that the bottom is near, and that the price might start to rise again.
Technical analysts rely on candlestick patterns to try and predict the direction a market is likely to move. Candlesticks also provide hints of possible trend reversals in addition to providing traders an edge for entering and exiting trades.
For this reason, they act as useful tools for identifying short-term and long-term trading opportunities. For an accurate analysis of the market, candlestick patterns should always be used in conjunction with the prevailing trend, as well as other indicators.