Stock candlestick charts are a popular tool used by traders, since they give us a lot of information in one simple indicator.
One candle alone shows the relationship between the high, low, open and close for a given time period (an hour, a day, a week, a month).
Considering the length of a candle and it’s “wicks” and “tails,” along with its position on a chart, can help predict the next price move of a stock.
Candlesticks are valuable indicators for swing traders, because they reveal a visual display of short-term price movements.
Where to Go to Learn About Stock Candlestick Charts
Stockcharts.com has an excellent tutorial on candlesticks and other technical indicators, along with illustrations.
It’s free, and we recommend reading their in-depth explanations.
There are also many excellent books and YouTube videos covering candlesticks and candlestick chart patterns.
Let’s Start With the Basics
Here, we’ll cover a few basics. Figure 1 below shows the anatomy of a candlestick.
The bottom of a green or hollow candle body (a “bullish” candle) shows the opening price, and the top shows the ending price.
Conversely, the top of a red or black candle body (a “bearish candle) shows the opening price, and the bottom shows the ending price.
There are two types of candles: a green or hollow candle, indicating a bullish opinion of the stock that day, and a red or black candle, indicating a bearish move of the day.
The body of a candle can have a “wick” sticking out of the top and/or a “tail” protruding from the bottom. These show the high and low prices of the day.
Long tails and wicks show that prices during the session had a wide trading range.
Short tails and wicks show that prices traded over a narrow range during the day (or whatever time period is being viewed).
Candlesticks with a long wick and a short tail reveal that buyers controlled most of the session.
The price was bid higher, but by the end of the day, the price was pushed down off its high.
Candlesticks that have a short wick and a long tail indicate that the bears dominated the day, but the bulls finished the day strong.
Reading Candlestick Charts
Most free chart websites include a feature to display candlesticks, rather than a line graph. It’s easy to become accustomed to looking at charts with candlesticks.
On a daily chart, one candle is shown for each day. Each candle contains valuable information for that day, including the open, close, high and low prices.
Most important is the ability for candlesticks to reveal investor sentiment.
After all, stocks move up and down due to investor sentiment, caused by “fear” and “greed.”
A “doji” is a candlestick that has no body, and looks like a cross. It indicates indecision.
The bulls and the bears were about
equally matched.
When a doji appears at the bottom of a downward trend, however, look for a bullish candle the next day as confirmation of an uptrend beginning.
A doji in an oversold area, followed by a gap-up, gives a very strong probability that you are about to enter a strong uptrend.
This is one of the great characteristics of candlesticks, namely that they capture investor sentiment.
A doji that has a very small body is called a “spinning top.” By itself, it too, is a neutral indicator, and the stock’s price ends the day at about the same price as it opened.
After a long rise in price, however, the appearance of a bullish spinning top candlestick indicates a weakness in more buying, and it’s likely the uptrend is nearing an end (Figure 2).
Similarly, after a long decline in price, a bearish spinning top candle indicates a weakness in more selling, and a potential change to an uptrend is indicated.
The more doji that appear at the top or the bottom of a trend, the higher the probability that the current trend will reverse.
Read Also: An In-Depth Look at Doji Candlesticks
A Look at Candlestick Chart Patterns
There are certain combinations of candlesticks that form patterns that can help predict price movement.
Figure 3 below is an example of one such pattern that is very accurate at predicting a bullish and bearish trend.
When there are two bullish days in a row, and the body of the second day’s candle is bigger than the day before, extending both above and below the body of the previous day, this is an extremely bullish indicator.
Tomorrow will most likely be a bullish day. This is known as an “engulfing pattern,” where the second day’s candle fully engulfs the previous day’s candle.
The same holds true for a bearish candle engulfed by another bearish candle. Another move downward can be expected.
Stock Candlestick Charts and Moving Averages
Traders know that they cannot rely on one indicator alone to confirm a predicted price move.
Fortunately, candlesticks and moving averages work well together to predict the next move of a stock’s price.
Moving averages are easy to use and simple to understand. All charting websites will plot lines on a stock chart to show the trend of a stock price’s move.
The 8-day EMA (exponential moving average) is very effective at identifying uptrends and downtrends.
One of the candlestick charting techniques used by traders to help identify trends is to use the 8-day exponential moving average in combination with its relationship to a candlestick.
Some traders refer to the 8-day EMA used with a candlestick as being the “trigger line,” or simply the “T line.”
Following are some rules using the relationship between a candlestick and an exponential moving average to predict a short term stock movement.
1. When a bullish candlestick closes ABOVE the 8-day EMA, consider this a BUY signal. As always, it is wise to get additional confirmation from another indicator or by studying the past performance leading up to this point.
2. When a bearish candlestick crosses BELOW the 8-day EMA, this can indicate a SELL signal.
3. When a bullish candlestick closes ABOVE the 8-day EMA, expect an uptrend that will continue until a bearish candlestick appears and a stock price that closes BELOW the 8-day EMA occurs.
4. When a bullish candlestick is ABOVE the 8-day EMA, the stock is in an UPTREND.
5. When a bearish candlestick is BELOW the 8-day EMA, the stock is in a DOWNTREND.
The concept is that once a stock price is ABOVE a short-term moving average, it can signal a upward trend, and vice-versa.
Three consecutive bullish candles with higher highs and higher lows signal a build-up of momentum.
Some traders seeing a stock climb high quickly, however, may believe that the price is overextended and a reversal in the trend is coming, so they will sell short (or buy “put” options).
They are often wrong, and they can be killed!
Other moving averge lines can also be used with candlesticks to give hints as to future price movements.
For example, when a stock closes BELOW the 20-day simple moving average (SMA) after the formation of a bullish candlestick, this indicates a BUY signal.
Candlestick Trading Charts: In Conclusion
Candlesticks can be a trader’s best friend when it comes to a long list of available technical indicators.
Learning some common candlestick chart patterns will be most helpful in determining short-term price movements.
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