The Ultimate Step By Step Guide To Candlesticks

Written by Julie Brownlee on May 20th, 2016

The Ultimate Step By Step Guide To Candlesticks

When it comes to simply looking at the price action of a particular security on charts or using technical analysis, you have a choice to make…

How do you want to see this data represented?

Many traders use candlesticks on their charts.

So what are candlesticks?

Why are they useful?

And how can you put them to use?

Let’s take a closer look…

 

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The 3 Different Types of Charts You Can Use

 

When you use technical analysis software, you have a number of different options on how your platform displays this information.

The three most common types are:

  1. Line charts
  2. Bar charts
  3. Candlestick charts

Line Charts

A line chart is the simplest of the three.

This type only shows you the closing prices of a security over the period of time you select.

Below is an example of a line chart…

Line Chart

Source: Investopedia

Bar Charts

This type of chart gives you a lot more information than a line chart.

Have a look at the example below…

Bar Chart

Source: Investopedia

It shows you the highest price and the lowest price the security reached in each period.

The dashes included in each bar reflect the opening price (the left side dash) and the closing price (right side dash).

In the chart above, red bars mark days when the security has fallen in price in comparison to the day before.

You can see the benefits of using a bar chart over a line chart as it contains much more information.

But there is an even better option to use…

Candlestick Charts

A candlestick chart shows you the same as a bar chart, but it displays the information in a different way…

Candlestick Chart

Source: Investopedia

These charts are much easier to read than bar charts, which makes your analysis easier too.

The candle part, or body, shows you the range between the opening price and the closing price of the security.

The wicks at the top and the bottom of the candlestick display the highest trading price and the lowest trading price within the trading period.

The colour of the candlestick will change depending on whether the security has ended the period at a higher price or a lower price than the previous period.

The diagram below shows you this in more detail…

Types of Candlesticks

Source: Market Traders

Bear in mind that the colours of candlesticks may differ depending on the software you use.

Most platforms allow you to pick the colour, however a lighter ‘hollow’ candle is bullish whilst a filled in candle is bearish.

 

How To Read Candlesticks

 

You can find out a lot from having a good look at what’s happening with candlesticks on your price chart.

Length of The Body

This is one of the first things you should note when looking at your charts.

A long body shows that the buying or selling pressure is more intense than a short body.

Whether it is buying or selling pressure depends on the colour of the candlestick.

Using our green and pink candlesticks above, a long green body shows increased buying pressure, whereas a long pink body shows increased selling pressure.

Length of The Wicks

When a candlestick has a long upper wick and short lower wick, it shows that buyers in the market pushed the price higher, but before closing, sellers pushed prices back down.

On the other hand, when a candlestick has a long lower wick and a short upper wick, it shows that sellers pushed the price down, but before closing, buyers pushed the prices back up.

When you spot long wicks at the top and bottom of a small body, this shows there was a lot of buying and selling activity for the security.

So how can you use candlesticks to work out what may be in store for the price of a security?

 

 

Two Popular Candlestick Patterns You Can Use

 

The Doji

The doji is definitely one candlestick pattern to be looking for.

The Doji

Source: Stockcharts.com

As you can see, a doji looks like a cross.

There is very little body and this shows that the opening and closing price were at the same level.

So what does this tell you?

It shows you that supply and demand match and the price isn’t moving higher or lower.

If you spot a doji on your chart after a security has been on an uptrend for a period of time, pay attention.

It may suggest the trend is coming to an end.

If you spot a doji after a long downtrend, it’s can also indicate the trend is coming to an end.

You can see the impact on the price after the appearance of a doji in the chart below…

The Doji In Action

[CHART] The Doji In Action

Source: FuturesMag.com

By keeping an eye out for a doji you could tighten up your take profit level or you could get ready to put a new trade on if a new trend emerges.

The Engulfing Pattern

There are bullish and bearish engulfing patterns. These are reversal patterns.

Spot this pattern and it could indicate that change is ahead, which could mean profits for you.

Let’s look at how a bullish engulfing pattern works in more detail…

If you’ve been watching the price of a security ebbing lower for a period of time, if you notice that the price really starts to fall, it may be time to sit up and take notice.

If one day you notice that the price starts to fall, but then buyers come in and start to push the price higher, this can show you that the security is oversold.

This may indicate that the price is going to pick up and push higher.

This pattern gets its name due to the appearance of the candlestick.

What you’ll notice is the range of the opening and closing price engulfs the range of the candlestick before it.

It indicates that the buyers are now much more eager than the sellers and this changes things around.

One thing to watch for is the size of the candlesticks.

With engulfing patterns, the larger, the better.

You can see a bullish engulfing pattern at work below…

The Engulfing Pattern In Action

The Engulfing Pattern In Action

Source: Futuresmag.com

A bearish engulfing pattern works in the opposite way to a bullish engulfing pattern.

 

Using Candlesticks With Your Trading

 

Candlesticks are well worth using as they present so much information in an easy to interpret way.

Spend time looking at charts and see what happens to the candlesticks during changes in trend.

You may be able to spot a doji or an engulfing pattern at work.

Depending on your tolerance to risk, you may want to use candlestick patterns along with other technical indicators before you make a move in the market.

Until then, here’s to profitable trading.

Julie Brownlee | The Money Lab

Julie Brownlee
Editorial Contributor
The Money Lab