Candlestick charts are similar to bar charts with regard to having a High, Low, Open and Close, but are much more visually appealing than the classic bar charts. They contain a lot of information about the market in a seemingly simple bar.

Candlesticks originated in Japan by Munehisa Homma in the mid 1700’s but were not widely used in the western world until after 1990.  
The candlestick format is unique in that the emphasis is on the ‘body’, which is the area between the open and close marks. As you will soon see this visual representation adds depth to understanding the market behavior (the psychology of the market participants as a whole).

Candlestick patterns show the markets psychology by reflecting regular reversal and continuation patterns. These patterns highlight imbalances in buyer and seller pressure, giving a high probability indication of the most likely future movement of that market. Most of these patterns are unique to candlestick charting and not available through any other method.

The ‘body’ of the candle is created by ‘closing in’ the area between the open and the close prices, like a box. The candlestick body shows where the majority of the trading has happened for that particular time period, unlike the bar range that takes in the whole movement for the time frame. So the bigger the body – the more confident were the traders buying or selling into that direction.

In the image above, the first candle has a fairly large ‘body’ in comparison to the ends poking out, which are known as the ‘wick’ or the ‘shadow’. This first candle is also a white candle whilst the next candle alongside it is a black candle. What is the distinction between the white and black candles?

The different colors indicated a higher or lower close from the open. The WHITE candle has its ‘close’ ABOVE its ‘open’; so is a ‘bullish’ bar where there are more buyers than sellers in the market for that time period and through ‘supply and demand’ are pushing the prices up.

The BLACK candle, on the other hand, has its ‘close’ BELOW its ‘open’ and can be classified as a ‘bearish’ candle; there are more sellers than buyers for this time period and the prices are forced down. Therefore, depending on how long the body is, the candle shows a trader just how determined the buyers (white candles) or the sellers (black candles) are.

The ‘wick’ also holds important details as it can show traders a potential change in direction. For example; if a candle with a long wick is found following a strong trend of either mostly white candles or a strong trend of mostly black candles – this can signify the previous dominant market participants are exhausted.

A candle with a long wick above the body shows that the buyers are running out and the sellers are moving in. And is the opposite for a candle with a long wick below, the sellers are running out and the buyers are moving in. Check out how many can be found just in the image below:

Candlestick Charts – Advanced

In the 1980s the Japanese became more aggressive in western markets – and were very successful, mainly because of their unique advantage to view price over time in a three-dimensional view. This perspective gave them a mathematical illustration of market sentiment, which they closely observed throughout history, seeking recognizable patterns for reversals and continuation of the market.

Historically, there were significant differences between eastern & western technical trading methods, specifically around where the emphasis of the analysis should be placed. Western analysis traditionally compared the current CLOSE to the prior sessions CLOSE, whilst the Japanese emphasis is on the OPEN to the CLOSE of current session. This highlights the current session’s battle between bull and bears, and is graphically illustrated in the candlestick.
The candlestick also has a universal quality – it can be applied and successfully used within all markets and across all time frames. It is a reflection of the psychology of the masses of market participants, both that are in and outside of the market. The participants who are currently trading within that market clearly indicate the price levels they are willing to play a part at, which is also an indication of what the participants outside of the market are willing to accept or not accept.

Candles are not a stand-alone system and are best used with other indicators to enhance systems. The Japanese now regularly combine candlesticks with the Western’s moving averages and are very successful in doing so.
The basic colors of candles are the white and the black. The white candle (empty candle) = dominance of bulls, whilst the black candle (full candle) = dominance of bears.  These colors can be changed from white to green – showing movement upwards like the growth of new plants reaching for the sky; and change the black to a red candle, which can be compared with the money being ‘bled’ from your account as the prices plummet downward should you be trading the market ‘long’.

Candles are used to determine short-term trend changes – called ‘reversal patterns’, and also to determine the likelihood that a share will continue into the direction it has been traveling in – these are called ‘continuation patterns’.
The trader is using information such as the Candle Range, the Candle Color, the Candle Body Size, the Wick Size, the Wick Location, and the Candle Location to gather insight into these patterns.

When back testing to identify the most common candle patterns for a particular market, it is important to look for the frequency of the pattern appearing - the immediate reaction when the candle appears and the longer-term success of the formation.

• Candle UPTREND definition = successive sessions with higher closes (all white candles).
• Candle DOWNTREND definition = successive sessions with lower closes (all black candles).
• SIDEWAYS = mixture of both types candles.

The most common candle formations are displayed below. The main candle described is the center candle (trigger candle), the other two on either side are simply an example of the scenario leading up to the trigger candle, and the reversed trending candle as it moves into the opposite direction. It is important to note that these reversal candles are more significant when the trend of candles leading up is strong.

In the following image, you can follow the commentary as it outlines some of the reversal patterns found in the candlestick chart.

• Candle 1 – Hammer Reversal.  

The market leading up to the signal hammer candle is represented with black candles showing that the bears are in control and more dominant for those sessions in the market. The market then opens high on the ‘signal’ candle trades down for most of the session but by the end has traded back upward closing above the open, creating a smaller body high up on the bar, with a long wick that is at least two times the length of the body. It is also a white candle which gives more significance to the potential reversal. 

The following day the market gaps up and opens above the close and the body of the signal candle confirming the reversal pattern – the market continues to trade higher reversing the down trend.  The market then trades on in an upward trend, only to make short pauses along the way.

• Candle 2 – Hammer Reversal. 

After a fairly bullish trend the market gives a short term pull back which at the bottom another hammer reversal pattern forms before recommencing the bull trend.

• Candle 3 – Common Doji.

Again after a series of strong white candles the market drifts sideways for 4 days, whilst making a couple of Doji candles followed by a Bearish Engulfing Pattern giving traders ample warning a top may be following.

• Candle 4 – Common Doji.

Here is another Doji turning the market from down to up. The market leading down to the Doji are strong black candles showing the bears are in power. Then as quickly as the market dropped it rebounded – and right in the middle of the direction change is a Doji, giving savvy traders an early indication that the trend is likely to change.

• Candle 5 – Common Doji.

Another Doji appears and successfully turns the market. The next session following the Doji confirms the change of direction with a Bearish Engulfing pattern.

Break Out Patterns

In the image below, you can see that the market is trending through a wedge formation. At Position-1 the market made a Doji reversal pattern before trending down, but each time it came back up to a price level close to the same price of the high of Position-1, (marked with a horizontal line), it would then retreat back down, sometimes making another reversal candle. On the lower side of the wedge the price action would find support on a trend line (diagonal line of support). When the market finally broke up out of the wedge, marked with Position-4, it did so with a strong white candle which was the only time and had not happened anytime previously within the wedge.

Break outs of sideways patterns; wedges, flags, pennants, triangles etc, with a strong white or black candle (that have the open and close on opposite ends of the bar range) indicate that the direction of the break out is most likely to continue – especially if the break out candle coincides with medium to high volume.  
Interesting to see at Position-5 of the above image, a Doji was created and the market again fell away. Did you notice how once you know what you are looking for, the patterns seem to jump off the page right at you?

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