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Candlestick
Introduction
You may be asking yourself, "If I can
already use bar charts to view prices, then why do I need another type of
chart?"
The answer to this question may not
seem obvious, but after going through the following candlestick chart
explanations and examples, you will surely see value in the different
perspective candlesticks bring to the table. In my opinion, they are much more
visually appealing, and convey the price information in a quicker and easier
manner.
The Japanese began using technical
analysis to trade rice in the 17th century. While this early version of
technical analysis may have been different from the US version initiated by
Charles Dow around 1900, many of the guiding principles were very similar. The
"what" (price action) is more important than the "why" (news, earnings, and so
on). All known information is reflected in the price. Buyers and sellers move
markets based on expectations and emotions (fear and greed).
Markets fluctuate.
The actual price may not reflect the
underlying value. According to Steve Nison, candlestick charting came later and
probably began sometime after 1850. Much of the credit for candlestick
development and charting goes to Homma, a legendary rice trader from Sakata.
Even though it is not exactly clear "who" created candlesticks, Nison notes that
they likely resulted from a collective effort developed over many years of
trading.
The body of the candlestick is called
the real body, and represents the range between the open and closing
prices. A black or filled-in body represents that the close during that time
period was lower than the open, (normally considered bearish) and when the body
is open or white, that means the close was higher than the open (normally
bullish).
The thin vertical line above and/or
below the real body is called the upper/lower shadow,
representing the high/low price extremes for the period.
Bar Compared to Candlestick Charts
Below is an example of the same price
data conveyed in a standard bar chart and a candlestick chart. Notice how the
candlestick chart appears 3-dimensional, as price data almost jumps out at you.
The long, dark, filled-in real body
represents a weak (bearish) close ( 3a ), while a long open, light-colored
real body represents a strong (bullish) close ( 3b ). It is important to
note that Japanese candlestick analysts traditionally view the opening and
closing prices as the most moment critical of the day. At a glance, notice how
much easier it is with candlesticks to determine if the closing price was higher
or lower than the opening price.
Falling Three Methods
A bearish continuation pattern. A
long black body is followed by three small body days, each fully contained
within the range of the high and low of the first day. The fifth day closes at a
new low.
Rising Three Methods
A bullish continuation pattern. A
long white body is followed by three small body days, each fully contained
within the range of the high and low of the first day. The fifth day closes at a
new high..
Doji
Doji are important candlesticks that
provide information on their own and also feature in a number of important
patterns. Doji form when a security's open and close are virtually equal.
The length of the upper and lower
shadows can vary and the resulting candlestick looks like a cross, inverted
cross or plus sign. Alone, doji are neutral patterns. Any bullish or bearish
bias is based on receding price action and future confirmation. The word Doji"
refers to both the singular and plural form.
Dragon fly doji (Dragonfly)
Dragon fly doji form when the open,
high and close are equal and the low creates a long lower shadow. The resulting
candlestick looks like a "T" with a long lower shadow and no upper shadow.
Dragonfly doji indicate that sellers
dominated trading and drove prices lower during the session. By the end of the
session, buyers resurfaced and pushed prices back to the opening level and the
session high. The reversal implications of a dragon fly doji depend on previous
price action and future confirmation. The long lower shadow provides evidence of
buying pressure, but the low indicates that plenty of sellers still loom. After
a long downtrend, long black candlestick or at support, a dragon fly doji could
signal a potential bullish reversal or bottom. After a long uptrend, long white
candlestick or at resistance, the long lower shadow could foreshadow a potential
bearish reversal or top. Bearish or bullish confirmation is required for both
situations.
Gravestone doji (Pagoda
Gravestone doji form when the open,
low and close are equal and the high creates a long upper shadow. The resulting
candlestick looks like an upside down "T" with a long upper shadow and no lower
shadow. Gravestone doji
indicate that buyers dominated trading and drove prices higher during the
session. However, by the end of the session, sellers resurfaced and pushed
prices back to the opening level and the session low. As with the dragon fly
doji and other candlesticks, the reversal implications of gravestone doji depend
on previous price action and future confirmation. Even though the long upper
shadow indicates a failed rally, the intraday high provides evidence of some
buying pressure. After a long downtrend, long black candlestick or at support,
focus turns to the evidence of buying pressure and a potential bullish reversal.
After a long uptrend, long white candlestick or at resistance, focus turns to
the failed rally and a potential bearish reversal. Bearish or bullish
confirmation is required for both situations.
Long-legged doji
This line often signifies a turning
point. It occurs when the open and close are the same, and the range between the
high and low is relatively large.
Engulfing Patterns
This structure appears when a black,
real body totally covers, "engulfs" the prior day's real body. The market should
be in a definable trend, not chopping around sideways. The shadows of the prior
candlestick do not need to be engulfed.
Bullish engulfing lines
This structure appears when a white, real body
totally covers, "engulfs" the prior day's
real body. The market
should be in a definable trend, not chopping around sideways. The shadows of the
prior candlestick do not need to be engulfed.
Hammer
A candlestick with a long lower
shadow and small real body. The shadow should be at least
twice the length of the real body, and there should be no or very little
upper shadow. The body may be either black or white,
but the key is that this candlestick must occur within the context of a
downtrend to be considered a hammer. The market may be "hammering" out a
bottom.
The hammer is a bullish reversal
pattern that forms after a decline. In addition to a potential trend reversal,
hammers can mark bottoms or support levels. After a decline, hammers signal a
bullish revival. The low of the long lower shadow implies that sellers drove
prices lower during the session. However, the strong finish indicates that
buyers regained their footing to end the session on a strong note. While this
may seem enough to act on, hammers require further bullish confirmation. The low
of the hammer shows that plenty of sellers remain. Further buying pressure, and
preferably on expanding volume, is needed before acting. Such confirmation could
come from a gap up or long white candlestick. Hammers are similar to selling
climaxes and heavy volume can serve to reinforce the validity of the reversal.
Hanging man
Identical in appearance to the hammer, but appears within the context of an uptrend. The hanging man is a
bearish reversal pattern that can also mark a top or resistance level. Forming
after an advance, a hanging man signals that selling pressure is starting to
increase. The low of the long lower shadow confirms that sellers pushed prices
lower during the session. Even though the bulls regained their footing and drove
prices higher by the finish, the appearance of selling pressure raises the
yellow flag. As with the hammer, a hanging man requires bearish confirmation
before action. Such confirmation can come as a gap down or long black
candlestick on heavy volume.
Inverted hammer and shooting star
The inverted hammer and shooting star
look exactly alike, but have different implications based on previous price
action. Both candlesticks have small real bodies (black or white), long upper
shadows and small or nonexistent lower shadows. These candlesticks mark
potential trend reversals, but require confirmation before action.
The shooting star is a bearish
reversal pattern that forms after an advance and in the star position, hence its
name. A shooting star can mark a potential trend reversal or resistance level.
The candlestick forms when prices gap higher on the open, advance during the
session and close well off their highs. The resulting candlestick has a long
upper shadow and small black or white body. After a large advance (the upper
shadow), the ability of the bears to force prices down raises the yellow flag.
To indicate a substantial reversal, the upper shadow should relatively long and
at least 2 times the length of the body. Bearish confirmation is required after
the shooting star and can take the form of a gap down or long black candlestick
on heavy volume.
The inverted hammer looks exactly like
a shooting star, but forms after a decline or downtrend. Inverted hammers
represent a potential trend reversal or support levels. After a decline, the
long upper shadow indicates buying pressure during the session. However, the
bulls were not able to sustain this buying pressure and prices closed well off
of their highs to create the long upper shadow. Because of this failure, bullish
confirmation is required before action. An inverted hammer followed by a gap up
or long white candlestick with heavy volume could act as bullish confirmation.
Harami
A candlestick that forms within the
real body of the previous candlestick is in Harami position. Harami means
pregnant in Japanese and the second candlestick is nestled inside the first. The
first candlestick usually has a large real body and the second a smaller real
body than the first. The shadows (high/low) of the second candlestick do not
have to be contained within the first, though it's preferable if they are. Doji
and spinning tops have small real bodies and can form in the harami position as
well.
Bearish Harami
A two day pattern that has a small
body day completely contained within the range of the previous body, and is the
opposite color.
A two day pattern that has a small
body day completely contained within the range of the previous body, and is the
opposite color.
Bearish Harami cross or Bearish Harami doji
A two day pattern similar to the
Harami. The difference is that the last day is a Doji.
Bullish Harami cross or Bullish Harami doji
A two day pattern similar to the
Harami. The difference is that the last day is a Doji.
Long white (empty) line
This is a bullish line. It occurs
when prices open near the low and close significantly higher near the period's
high.
Long black (filled-in) line
This is a bearish line. It occurs
when prices open near the high and close significantly lower near the period's
low.
Doji
Doji are important candlesticks that
provide information on their own and also feature in a number of important
patterns. Doji form when a security's open and close are virtually equal. The
length of the upper and lower shadows can vary and the resulting candlestick
looks like a cross, inverted cross or plus sign. Alone, doji are neutral
patterns. Any bullish or bearish bias is based on preceding price action and
future confirmation. The word "Doji" refers to both the singular and plural
form.
Bullish doji star
A "star" indicates a reversal and a
doji indicates indecision. Thus, this pattern usually indicates a reversal
following an indecisive period. You should wait for a confirmation (e.g., as in
the morning star,) before trading a doji star. The first line can be empty or
filled in.
Bearish doji star
A star indicates a reversal and a
doji indicates indecision. Thus, this pattern usually indicates a reversal
following an indecisive period. You should wait for a confirmation (e.g., as in
the evening star illustration) before trading a doji star. The first line can be
empty or filled in.
Evening star
This a bearish top reversal pattern
and counterpart to the Morning Star.
Three candlesticks compose the
evening star, the first being long and white. The second forms a star, followed
by the third, which has a black real body that moves sharply into the first
white candlestick.
Evening Doji star
This is a doji star in an uptrend
followed by a long, black real body that
closed well into the prior white real
body. If the candlestick after the doji star is white and gapped higher, the
bearishness of the doji is invalidated.
Morning Star
This is a bullish bottom reversal
pattern. The formation is comprised of 3 candlesticks. The first candlestick is
a tall black real body followed by the second, a small real body, which gaps
(opens), lower (a star pattern). The third candlestick is a white real body that
moves well into the first period's black real body. This is similar to an island
pattern on standard bar charts.
Morning Doji star
This a doji star in a downtrend
followed by a long, white real body that closes well into the prior black real
body. If the candlestick after the doji star is black and gapped lower, the
bullishness of the doji is invalidated.
Three Black Crows
A bearish reversal pattern consisting
of three consecutive black bodies where each day closes near below the previous
low, and opens within the body of the previous day.
Three White Soldiers
A bullish reversal pattern consisting
of three consecutive white bodies, each with a higher close. Each should open
within the previous body and the close should be near the high of the day.
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