Theory: Candlesticks

Hi all, today I'll have a quick chat on the theory of Japanese Candlesticks. In case you did not realise, there are three main ways to view a trading chart, you can view it as a line chart, a bar chart, or a candlestick chart. Below are what each of these look like:



Candlestick's were first introduced in the 1600's, strangely enough to analyze the price of rice contracts. There is no special calculation, they are simply an alternative way of representing current prices. Below is the basic rundown of what a single candlestick looks like, and how it is interpreted.

This is a candlestick you would see most often in a downtrend, with the black body being a sign that the closing price finished lower than the opening price.

Here you can see labelled the opening, closing, high and low of the particular period that this candle is representing, which could be 5 minutes, 1 hour or 1 day depending on what chart you are looking at.

Some charts have candles that represent this scenario coloured in red, either way, the main thing is to remember that usually this type of candle will usually be filled.

So that is what a "down" candle looks like, a candle representing the opposite scenario, i.e. when the closing price finishes above the opening price usually is white, or uncoloured and looks like below:

You can see that the main difference between this candle and the above candle is that the closing price is above the opening price, indicating that during this period, the price went up during this period.

Some charting packages will show this candle as a green candle, some as white, or some with no colour at all, just an outline. If you set the colour scheme yourself, just recognise that you need to make this candle different to the above candle so you can distinguish the difference.

Now if I was to run through every type of candle that existed in the theory of candlestick charts, I would more than likely get cramp and brain freeze, and not finish this article. So instead, I will run through some basic deduction you can take from interpreting a few different types of candles.

Have a look at this candle (called an inverse hammer), you can see the main difference between this candle and the basic candle I showed you above is the lack of a thin line below body (the thicker white area) of the candle. So what does this mean? The thin lines are refered to as "wicks" or "shadows", and represent when prices move up or down, but are then dragged back.

How to read this candle? Well here the price closed well above it's opening price, there was a push for higher prices as represented by the upper wick, which was pulled back slightly. Depending on the market, you may read this as a sign that price will continue with the upward push, as the price didn't retract too far, and there was no real push for lower prices.

Ok here is another (called a hammer), the inverse of the previous candle, here you can see the closing price was lower than the opening price, hence the black body of the candle. It has a medium length wick also, which again is a sign that there was a move to push the prices lower. You make this candle to be a sign of strength in a down move, or a sign of a reversal, or pause in an uptrend.

To me the wicks are just as important as the bodies of candles, and should be taken into as much consideration as the colour and length of the body. Now there are a bucket load of different candle types as I mention earlier, but to give you an idea, here are a few that I find to be the most telling when reading candlestick charts.

This candle is referred to as a "doji", and you can see has very little, or in this case no body to it. This candle is a sign of indicision in the market, as the wicks above and below the non existant body reflect that there was a push up, and a push down, resulting in a stalemate with the opening price and the closing price being the same in the end.



This candle, a hammer, is a strong sign if seen at the bottom of a downtrend, when you suspect that a currency may be oversold. Here you can see a very long bottom wick in comparison to it's body, and tells the story that prices made a strong move down, but was dragged back above it's opening price, hence the white body. A candle with such a long wick as this, is usually a good sign that the momentum of a downward move is stalling or reversing.


Here you can see a variation on the inverse hammer candle I showed you previously, with the main difference being that this one having a much longer upper wick, and the closing price finished below the opening price. This candle can quite often be a sign of a change in momentum, as the strong push to higher prices, as shown by the long upper wick, was pulled back so far that the prices closed lower, a sign that future pushes to higher prices may be rejected. This candle is especially valid in an uptrend where you may suspect that a currency is overbought.

There are so many more, and I haven't even touched on combining these candles into different formations. I have however, provided a link to an e-book on this subject that covers all the basics in a text book fashion that can be a good reference for you all.

Please do not take this candles as given, like any other indicator, they are just guides that can help you, but it is always safe to look for confirmation either in the next candle or with other indicators. Oh and one last tip, never trade on an incomplete candle, always wait for that period to end before assuming the candle is a certain type. Quite often the biggest moves are at the end of the period you are looking at, and what you thought was one type of candle become something completely different in the matter of seconds.

Best of luck with them, I personally feel candles tell you much more than a line graph ever could, and while bar charts can tell you the same information, I find candlesticks much easier, and more importantly, much faster to read. Please leave a comment if there is something vital I have missed.

Happy trading!