Candlestick Basics - How they are formed?
Here’s a few helpful graphic to help understand the basics of candlestick charting and how to interpret price action. Candlesticks begin to become very easy to read when you know how they are formed. Every candle will tell the story of where it opened, where it closed, and show the high and the low during that session.
Most traders will see this as “duh, I know this… ” Reality is, they are right – you must understand candlesticks until it becomes second nature, no excuses! Candlesticks are easy to read. Don’t allow yourself to think they are too complicated to learn. Candlestick charts display the high, low, open, and closing prices of a stock / security for a specific period/timeframe. Here’s the most basic example of a green daily candlestick.
Candlestick Basics - What can they tell you?
Now that you’ve locked down what it takes to actually create the visual appearance of the candlestick, we will now work on interpreting what these the candlesticks can mean in various formations.
Understanding candlesticks requires basic understanding of what they actually tell you, it’s important to know this, and to not forget it when looking at candlestick charting.
The candlestick’s shadow or wick shows the high and low and how it compares to the open and close of the candle’s body. The body, or shape of the candle will be red if it closed lower and will be green if it closes higher.
What candlesticks essentially are is a reflection of investor sentiment on security prices and are used to determine when to enter and exit trades. Very important to know because candlesticks are a technique used for trading any liquid financial asset! They’ve been around for a long time too – they were developed in Japan in the 1700s for tracking the price of rice.
Candlestick Basics - Popular Doji Candles
How do you react to Doji Candlesticks when trading? A Doji is created when the open and close for a stock are basically the same. Buyers and sellers are in a standoff!
Doji formations come in 5 main kinds:
2. Long Legged
Doji are seen in times of consolidation and can help traders identify various potential price breakouts. A Doji candlestick often signals market indecision & the potential for change in price direction.
A Doji candlestick often signals market indecision & the potential for change in price direction. Here’s a quick breakdown on these 5 dojis.
1. A Standard Doji doesn’t signify much on its own. Traders must observe the previous price action building up to the Doji.
2. The Long-Legged Doji has a bigger extension of the vertical wick above and below the horizontal line. This shows that during the timeframe of the candle price action moved up & down (with range) but closed at pretty much the same level that it opened. This signifies indecision between buyers & sellers.
3. The Gravestone Doji is the opposite of the Dragonfly Doji. It’s created when price action opens & closes at the lower end of the trading range. After the candle open, buyers push the price up but by the close they lost the bullish momentum. At the tip of a move to the upside, this is a bearish signal.
4. The 4 Price Doji is a horizontal line with no vertical wick above or below the horizontal. It signifies the most indecision since the high, low, open & close (4-prices) are the same. Look for this indecision in a slow trading market.
5. The Dragonfly Doji can appear at either the top of an uptrend or the bottom of a downtrend & signals a potential change in direction. The ‘T’ shape signifies that prices didn’t move above the open price. An extended lower wick at the bottom of a bearish move is considered a bullish signal.
We hope this simple breakdown of these popular doji candles helps you read, understand & execute price action / chart reading in a more calculated way
Candlestick Basics - Popular Hammer Patterns
A hammer candlestick is a price pattern that happens when a stock trades much lower than the it’s open then rallies within the period to close near the open price.
This price action forms a hammer shaped candlestick. It is important to note that the lower shadow/wick must be 2x the size of the body. Hammers occur after a price decline, and illustrates sellers came into the market but the selling was absorbed by buyers moving the price up to around the open.
The candle can either be green or red however it must maintain the hammer shape for it to be considered a hammer candlestick. Look for hammer candlesticks to indicate the chances of a potential price reversal to the upside look for the price confirmation after seeing a hammer form on a price decline before considering going long.
4 Types of Hammer Candles
Hammers occur when the price moves significantly LOWER at the open before rallying HIGHER through the session to close near the open. Bears came into the session, the bulls took over and the trend remained bullish.
The hanging man pattern occurs when the price moves significantly LOWER at the open before rallying HIGHER throughout the session. Unlike the hammer, the hanging man closes the session a bit lower, turning it red.
Inverted hammers occur when the price moves significantly HIGHER at the open before sliding LOWER throughout the session to close near the open. Bulls may have taken control over the price for a little bit of time, but bears fought to control the session and kept prices lowe.
The shooting star pattern occurs when the price moves significantly HIGHER at the open before falling LOWER throughout the session. Unlike the inverted hammer, the shooting star closes a bit lower, turning it red.
Hammers can signal that there is a possibility of a reversal… Confirmation is key before trading any hammer pattern!
There’s a vast amount of ways traders can use candlesticks to their advantage, and we just barely scratched the surface in this short blog. Check out our Trading Room to learn more about our Education Course where we cover candlestick patterns & more! We hope we were able to enhance your trading knowledge when it comes to candlesticks. If you have any further thoughts, or candlesticks you want to see on this page, use the form below to get in contact with us!
These are tips on how to read and understand candlesticks for trading. The more you learn, the more you earn! If you have any questions or comments about candlesticks or any other trading subjects, feel free to use the contact form below to get in touch with us.