How to Read Candlestick Charts
The very basics of candlestick chart reading is covered in this article on How to Read Candlestick Charts. The objective is to give a brief introduction to candlesticks as well as how powerful it can be to provide an insight into the strength or weakness of movement of prices.
Candlesticks was used hundreds of years ago by rice traders in Japan. It basically represents each trading day’s price of open, high, low and close. The most basic candlestick is illustrated in the below diagram.
The candlestick on the left is a bullish day as the price closed higher that the opening price. It is usually represented with a white or green bar.
The candlestick on the right has the closing price below the open price. This is a bearish day and is usually represented with a black or red bar.
One of the major strength of candlesticks is that it clearly shows the exact sentiment of the day. If the sentiment is bullish, there would be a white bar. If the sentiment is bearish, there would be a black bar.
Reading Single Candlestick Patterns
In the above diagram, the white bar was clearly a bullish day and the black bar is a bearish day. In some instances, there could be indecision in the market. In such a case, the open and close would be about the same level. This is called a doji as shown below.
The first candlestick is a doji and it represents an indecision day where the bulls and the bears are equally strong.
The second candlestick is also a doji but it shows that although there is indecision, the bears are getting weaker as the bulls managed to claw back the loss incurred for the day and closed right at the opening price.
A doji is an early warning signal that prices could be reversing soon.
Reading Multiple Candlesticks Patterns
The real forecasting power of candlesticks comes in when reading multiple candlesticks patterns. As you already know, a doji is a indecision candle. The following candle right after the doji could be the decision candle and that would give a clear signal on the direction of the trend ahead. This is illustrated in the below diagram where a doji is followed by a decisive candlestick. In this case, it points to the bulls being in control and further upside is very likely.
Price Gaps and Candlestick Charts
Gaps in price action happens quite frequently in charts and points to either beginning, continuation or ending of a trend. Price gaps combined with candlesticks can tell a lot about the trend. Normally trends end in a strong buying or selling in a panicky market situation. This panic causes prices to either gap up or gap down towards the end of the trend. Thus, it is called exhaustion gaps.
When a doji appears after the gap, that is a signal that the market is exhausted. It does not provide a trade signal yet though. If the subsequent signal after the doji closes the gap and moves in the opposite direction, then you have a strong reversal signal. This is illustrated in the below diagram.
In this case, we have a down trending market and price gaps down and forms a doji. Then price gaps up and forms a bullish candle. This is a signal of a strong bullish reversal. This is one of the high probability trade setups using price gaps and candlesticks.
This price action also establishes a strong support resistance zone which would come into play should prices reach these levels again in future.
If you are interested to learn more in depth about price gaps, do visit this page on How You Can Increase Your Profits by Reading Price Gaps where the topic is covered in great detail with examples of real charts.
Candlestick Charts and Classical Technical Analysis
Candlesticks works very well with classical technical analysis tools such as trend lines, support resistance zones, MACD, RSI, Stochastic and so on. By reading the candlestick as the price approaches a trend line, you can tell whether the trend line is going to get broken. If the candlestick is showing weakness, then the probability that the trend line is going to hold is much higher.
Similarly, a divergence in MACD, RSI or Stochastic could point to weakening momentum in the trend and a candlestick reversal pattern that appears at that juncture could be a buy or sell signal.
Hopefully, you have gained a good insight into How to Read Candlestick Charts. And how it can be a formidable companion in understanding the strength or weakness of a market and for giving early reversal signals of a trend. In the part II of this post (that is coming soon), we would be providing real chart examples on what was covered in this post.
Do share this post or like it using the social media buttons on the left. And do leave a comment, we would be happy to hear from you.