DEFINITION of ‘Candlestick’
A candlestick is a chart that displays the high, low, opening and closing prices of a security for a specific period. The wide part of the candlestick is called the “real body” and tells investors whether the closing price was higher or lower than the opening price. Black/red indicates that the stock closed lower and white/green indicates that the stock closed higher.
BREAKING DOWN ‘Candlestick’
The candlestick’s shadows show the day’s high and low and how they compare to the open and close. A candlestick’s shape varies based on the relationship between the day’s high, low, opening and closing prices.
Candlesticks reflect the impact of investor sentiment on security prices and are used by technical analysts to determine when to enter and exit trades. Candlestick charting is based on a technique developed in Japan in the 1700s for tracking the price of rice. Candlesticks are a suitable technique for trading any liquid financial asset such as stocks, foreign exchange and futures.
Long white/green candlesticks indicate there is strong buying pressure; this typically indicates price is bullish, however, they should be looked at in the context of the market structure as opposed to individually. For example, a long white candle is likely to have more significance if it forms at a major price support level. Long black/red candlesticks indicate there is significant selling pressure. This suggests the price is bearish. A common bullish candlestick reversal pattern, referred to as a hammer, forms when price moves substantially lower after the open, then rallies to close near the high. The equivalent bearish candlestick is known as a hanging man. These candlesticks have a similar appearance to a square lollipop, and are often used by traders attempting to pick a top or bottom in a market.
Two-Day Candlestick Trading Patterns
There are many short-term trading strategies based upon candlestick patterns. The engulfing pattern suggests a potential trend reversal; the first candlestick has a small body that is completely engulfed by the second candlestick. It is referred to as a bullish engulfing pattern when it appears at the end of a downtrend, and a bearish engulfing pattern at the conclusion of an uptrend. The harami is a reversal pattern where the second candlestick is entirely contained within the first candlestick and is opposite in color. A related pattern, the harami cross has a second candlestick that is a doji; when the open and close are effectively equal.
Three-Day Candlestick Trading Patters
An evening star is a bearish reversal pattern where the first candlestick continues the uptrend. The second candlestick gaps up and has a narrow body. The third candlestick closes below the midpoint of the first candlestick. A morning star is a bullish reversal pattern where the first candlestick is long and black/red-bodied, followed by short candlestick that has gapped lower; it is completed by a long-bodied white/green candlestick that closes above the midpoint of the first candlestick.