Candlesticks Charts Explained

Introduction

Candlestick charts were derived over 200 years ago by the Japanese, who used them for the purpose of doing analysis of the rice markets. The technique evolved over time into what is now the candlestick technique used in Japan and indeed by millions of technical traders around the world. They are visually more attractive than standard bar and line charts and they make for a clearer market reading, once understood.

The major component of a candlestick is the body, i.e. the part that forms the rectangular shape between the open and close points. While traditional Japanese candlesticks use black and white bodies, we use green and red in our representations as we believe the colours better define the market direction and we find them to be visually more striking. A green body means that the close is higher than the open and thus the price has increased over the period, whereas in a red body the closing price is lower than the opening price and the value has decreased over the period.

The extension lines at the top and lower end of the candlestick bodies are called the shadows. The pinnacle point on the upper shadow is the high price of the period, while the lowest point on the lower shadow represents the low price of the period. If there is no shadow on the upper end of the candlestick body, it means that the close price (in the case of a green period) or the open price (in the case of a red period) = the high price. Conversely, if there is no shadow at the lower end of the candlestick body, it means that the open price (in the case of a green period) or the close price (in the case of a red period) = the low price of the trading period.

Note: A trading period can be a week, a day, an hour or even less. What period is most appropriate depends on the market and the nature of the trade. In our experience, trading periods under an hour are not good measures for currency markets.

There are 21 principal Candlestick types, each of which we explain in the next section. We do ask that when using candlestick indicators, you should always use them in combination with some other trend indicators, such as the slow stochastic indicator, RSI and Bollinger bands. Also, be aware that technical analysis on its own is not enough as economic indicators are often the triggers for price action, so fundamentals are also critical to active trading.

For all of the candlesticks we discuss, we are talking about a default trading period. It is entirely up to the trader to determine the length of the period they which to analyse. For stock markets this might be using a daily chart, whereas for currency markets, it could be an 8 hour, 4 hour or 1 hour chart. Using anything less than an hour is not recommended.

Candle Stick Types

1) Long Periods

Long periods show a significant gap (represented by the body) between the open and close prices during the trading period. Usually the shadows at either end of the candlestick body are quite short, indicating that the market movement was primarily one-directional during the same period.

2) Short Periods

Short periods with compressed candlestick bodies indicate that there was very little price movement during the trading period, and what little movement there was had been upwards in the case of a green candlestick body, or downwards in the case of a red candlestick body.

As with a long period candlestick, a short period candlestick has short shadows at either end, indicating very little price fluctuation for example between open price and low price and between close price and high price for a bullish green candlestick.

3) Marubozu

A green Marubozu is a long green body with no shadows at either end and it represents a bullish trend, meaning the open price was the low price and the close price was the high price. It generally comes at the start of a continuation bullish trend, or a bullish reversal pattern. A red Marubozu has a long red body and comes at the start of a continuation bearish trend or indicates a trend reversal.

4) Spinning Tops

Spinning Tops have longer shadows than bodies and whether they are green or red is usually not significant as they imply market indecision and the trend is neither bullish nor bearish. The open and close prices for the period are very close, so in real terms the market has not really shifted, although there may have been a high or low spike (or both) during that period.

5) Doji

Doji sticks have the same open and close price. Obviously in fluctuating currency markets, identical open and close prices may be rare, but if they are close enough then the candlestick can be said to be a Doji.

A Long-Legged Doji has long shadows protruding from it, indicating that there is considerable fluctuation on both sides of the open price, during the course of the trading period. Ultimately the period ends with the close price retracting back to the open price. It is a good signal of market indecision.

A Dragonfly Doji has only one long shadow, on the lower end of the open and close price. This indicates that all price activity during the trading period is on the lower side of the open price, but by the end of the trading period the price has moved back up to the open price. It is a good signal of a bearish trend reversal, i.e. price should now move upwards.

A Gravestone Doji is the opposite of a Dragonfly and again has one long shadow, to the high side of the open and close price. It indicates that during the price period all price activity is at the upper end, but that the price retracts back to open price by the end of the trading period. It is a good signal of a bullish trend reversal, i.e. price should now move downwards.

A 4-Price Doji is a rare event, in that for the prescribed trading period, the open, close, high and low price points are the same. Such an event is rare in currency trading and normally only happens when trading is suspended.

6) Stars and Raindrops

A star occurs when a short body candlestick gaps above a long body candlestick. When the short body appears after and above the long body period, the long body must be an upside green candle. If the short body appears after and below the long body, then the long body must be a downside red candle. Stars and raindrops form part of a more complicated pattern, usually a reversal pattern, but need to be examined in a wider context.

7) Paper Umbrella

A paper umbrella forms when a small body has a long shadow to its underside. This can be a strong reversal indicator. Whether the body is green or red, both umbrellas indicate a bearish trend reversal, as the downward price probe ultimately fails.

8) Hammer

A hammer is a very important indicator of reversal trend and it is named such because the market is attempting to hammer out a market bottom. It is a very good indicator of a bullish trend on the way, whether the body is green or red.

How to recognise a Hammer: The hammer appears during a downtrend only. The body of the hammer has a long shadow on the underside - at least 2-3 times the length of the body and little if any shadow on the upside. The colour of the body does not matter.

9) Hanging Man

A hanging man is so-called because it has the shape of a man in hanging position with his legs dangling underneath. It occurs during an uptrend only and it is a very good indicator of a trend reversal to a bearish market.

How to recognise a Hanging Man: The body is at the upper end of the trend and has little or no shadow to the upside. The body has a shadow at least 2-3 times its length to the underside. The hanging man market period is preceded by uptrend periods. The colour of the body is not important to the trend reversal, other than a red hanging man is more bearish than a green hanging man.

10) Engulfing

Engulfing is when a trading period's body completely engulfs that of the preceding period's body. It is an indicator of a trend reversal. When a green body engulfs that of a red body from the preceding period, this is an indicator of a bullish trend. Likewise, when a red body engulfs the green body of the preceding trading period, then this is an indicator of a bearish trend.

11) Harami

A Harami is the reverse of engulfing. The word means impregnated in Japanese. The new body is dwarfed by the trading body from the previous period. It indicates a turnabout and a trend reversal.

How to recognise a Harami: The body of the current trading period is shorter and fits into the body of the preceding period. The colour of the larger body is the opposite colour to that of the smaller body.

12) Harami Cross

The Harami Cross is a significant indicator of trend reversal, particularly when it occurs after a long body in a downtrend. It is the same as the Harami, except that the second candle is a Doji.

How to Recognise a Harami Cross: The second candle has the same open and close prices, i.e. it is a Doji. The Doji candlestick fits within the longer body of the preceding trading period. The longer body is part of a sustained directional trend.

13) Inverted Hammer

The inverted hammer usually occurs at the bottom of a downtrend and can indicate a trend reversal.

How to recognise an Inverted Hammer: The hammer has a smallish body at the bottom of the price range. It has a very long shadow protruding upwards from the body. It is only evident on a downtrend. The body of the hammer is green and the opposite colour of the larger body preceding it, which is red.

14) Shooting Star

A Shooting Star is a bearish pattern and occurs when a small green body with a long upside shadow follows a long green body, during an uptrend. The star body indicates that the market price opened and rallied upwards, before falling back significantly by the close.

How to recognise a Shooting Star: It happens during an uptrend. The smaller body has a long shadow pointing upwards. The smaller body is preceded by a much longer upward trending body.

15) Piercing Line

The Piercing line is a bullish indicator that indicates a trend reversal. A long green body follows a long red body, but the close price of the green body is above the midpoint of the preceding red body.

How to recognise a Piercing Line: It happens during a sustained downtrend. The opening price of the green body is below the close point of the red body and the green body pierces the mid-point of the preceding trading (red) period.

16) Dark Cloud Cover

The Dark Cloud Cover representation is a bearish pattern and an indicator of trend reversal. It is made up of a long green body followed by a long red body, where the price peaks on the red body, before falling extensively.

How to recognise a Dark Cloud Cover: It occurs in an uptrend only. A long green body is followed by a long red body, where the high price on the red body is above that of the green body, and where the red body pierces the mid-point of the preceding green body.

17) Doji Shooting Star

A Doji Shooting Star is a trend reversal indicator. In a downtrend, a long red body is followed by a doji (a period with the same opening and closing price) - this is a bullish Doji Star. During an uptrend, when a long green body is followed by a Doji, then this is a bearish Doji Star.

How to recognise a Doji Shooting Star: It may occur during an uptrend or a downtrend, but the key criteria are that a long green or long red body is followed by a Doji. The Doji is gapped below or above the long body. In the case of a bullish Doji Star, the Doji open/close price level is below the long red body and in the case of a bearish Doji Star, the open/close price is above the long green body.

18) Morning Star

A Morning Star is a bullish indicator and points to a trend reversal. It consists of 1) a long red body during a downtrend, 2) a star with a short green body that is gapped away from the red body and finally 3) a long green body, which is the confirmation of the trend reversal.

How to recognise a Morning Star: It happens during a downtrend. The shooting star has a short green body which is separated below the red body period. There is a 3rd candle which has a long green body that confirms the trend upwards and has a close above the mid-point of the long red body.

19) Evening Star

An Evening Star consists of 3 candles - 1) a long green candle, 2) a shorter star candle where the price goes higher and finally 3) a long red candle in the final trading period. This pattern is a good indicator of a trend reversal and is a bearish sign. How to recognise an Evening Star: There are 3 candles and the pattern comes during a sustained uptrend. The first candle has a long green body. The second candle is much shorter and gaps above the long green body. The third body is red and its close pierces below the mid-point of the long green body.

20) Morning Doji Star

A morning Doji Star is similar to a Morning Shooting Star and is a reversal indicator, following a downtrend. It consists of a long red body, a Doji (open and close price is the same) which is gapped below the red body and finally a long green body, which follows the Doji and which pierces above the mid-point of the long red body and confirms the trend reversal.

How to Recognise a Morning Doji Star: There are 3 candles - 1) a long red candle, followed by 2) a Doji which is gapped below the red candle period and 3) a long green candle which follows the Doji. The close price of the green candle pierces above the mid-point of the red candle body.

21) Evening Doji Star

An evening Doji Star occurs during an uptrend and is a trend reversal indicator. The pattern consists of 3 candles - 1) a long green candle, 2) a Doji which gaps above the long green candle body and 3) a long red body which follows the Doji and whose close price pierces the mid-point of the long green body. How to recognise an Evening Doji Star: The sequence of the 3 candle periods are a long green body, a Doji and a long red body following the Doji. The pattern occurs during an uptrend only. The open and close price of the middle candle period - the Doji is the same. The Doji is gapped above the green body of the first candle.