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Understanding Candlestick Charts

Some time ago, we studied the differences between Fundamental and Technical analysis in this article. Candlestick charts are used in a technical analysis. By visually reflecting the scale of price movements with various colors, and candlesticks illustrate emotion. Traders use candlesticks to draw trading decisions based on trends that routinely occur to predict the price’s short-term course.

Background

About 100 years before the West established the bar and point-and-figure charts, candlestick charts emerged in Japan. In the 1700s, a Japanese man named Homma discovered that the markets were strongly affected by traders’ emotions, even though there was a correlation between price and rice supply and demand.

Components of a Candlestick Chart

Like a bar chart, a regular candlestick displays the open, high, low, and close price of the day for the market. There is a wide part of the candlestick, which is called the ‘real body.’

This real body defines the price range between the open and close of that day’s trading. It means that when the actual body is filled in or black, the closing is lower than the opening. If the real body is empty, it implies that closing is higher than the opening.

On its trading platform, traders can alter these colors. A down candle down is often shaded red instead of black, for example, and up candles are often shaded green instead of white.

Comparing Candlestick Charts to Bar Charts

“The “shadows” or “wicks” are just above and below the real body. The shadows display the high and low trading rates of the day. If the upper shadow on a down candle is short, it means that the day’s opening was near the day’s peak.

The relationship between days open, high, low, and close defines the daily candlestick’s appearance. Shadows may be long or short – A short upper shadow on a high day determines that the close is near the high and actual bodies can be long or short and black or white. 

Candlestick charts are more visual due to the color-coding of price bars and thicker actual bodies, which are best suited to highlighting the disparity between the open and the close. 

Essentially, bar charts and candlestick charts show the same data, just in a different manner. Candlestick charts present a real body’s thickness, while a bar chart illustrates a cleaner display of data.

Example of a Bar Chart:

Source: TradingCharts

Candlestick Patterns

Candlesticks are generated by up and down price changes. While these price fluctuations often seem spontaneous, they also form trends that traders use for research or trading purposes. 

The trends are classified into bullish and bearish. Bullish trends mean that the price is likely to increase, while bearish patterns imply that the price is expected to fall. No pattern works every time, as candlestick patterns reflect trends in price movements, not promises.

There are several patterns of candlesticks, as illustrated below:

Bearish Engulfing Pattern

In an upward trend where sellers outnumber buyers, a bearish engulfing pattern develops. This behavior is reflected by a long real red body that engulfs a tiny real green body. The trend shows that sellers are back in charge and that the price will continue to decrease.

Bullish Engulfing Pattern

When buyers outpace sellers, an engulfing trend on the market’s bullish side takes place, represented in the graph by a long real green body that engulfs a small real red body. The price could head higher with bulls having gained some leverage.

Bearish Evening Star

An evening star is identified by a topping pattern and the last candle in the pattern opening below the small real body of the day before (can be red or green). Two days back, the last candle closes deep into the real body. The pattern indicates that buyers have stalled and sellers are taking control – Suggesting that more selling may occur.

Bearish Harami

A bearish harami is a tiny real body (red) fully inside the previous day’s real body. This is not so much a trend in which to act, but it may be one on which to watch. On the part of the buyers, the trend indicates indecisiveness. If the price goes higher afterward, all could still be well with the uptrend, but a down candle suggests a further slide following this pattern.

Bullish Harami

The bullish harami is the opposite of the bearish harami, which is upside down. A downtrend is in motion, and inside the large real body (red) of the prior day, a small real body (green) occurs – This informs the technician that it is pausing the trend. More upside may be forthcoming if it is followed by another up day.

Bearish Harami Cross

In an uptrend, a bearish harami cross occurs where an up candle is accompanied by a doji – the session in which the candlestick has an identical open and close, and the doji is inside the previous session’s real body. 

Bullish Harami Cross

In an downtrend, a bearish harami cross occurs where a doji accompanies a down candle – Like a bearish harami cross, the doji is inside the previous session’s real body. 

Bullish Rising Three

This pattern begins with what is called a “long white day.” On the second, third, and fourth days of trading, the price is lowered by small real bodies, but they remain within the long white day price range (day one in the pattern), while the fifth day of the pattern displays another long white day.

Bearish Falling Three

The pattern begins with a day of heavy downs, followed by three small real bodies that make upward progress but remain within the range of the first big day down. When the fifth day makes another big downward move, the pattern finishes, suggesting that buyers are back in charge and that prices could get lower. 


Closing Thoughts

When equipped with the right knowledge of fundamental and technical analyses, and understanding of chart patterns, you will be able to trade all asset classes, even crypto, on a reputable exchange with confidence.

For related articles, read DigiFinex Academy.

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