Candlesticks have been used in technical analysis in finance since they were first employed by rice merchants in 18th-century Japan. They remain one of the most popular methods of representing financial market data. This is most likely due to their informative value and ease of interpretation.
Candlesticks have been used in technical analysis in finance since they were first employed by rice merchants in 18th-century Japan. They remain one of the most popular methods of representing financial market data. This is most likely due to their informative value and ease of interpretation.
Candlesticks provide an illustrative, color-coded representation of falling and rising market trends, taking into account different parameters such as the opening price, closing price, highest price, and lowest price. This article presents how candlestick charts are read, equipping you with the knowledge required to start trading crypto based on market trends.
CANDLESTICK ESSENTIALS
Candlesticks are the most popular way to present data from technical analysis.
The body of a candlestick represents the opening and closing prices.
The top wick, or shadow, of a candlestick represents the highest price. The bottom one represents the lowest price.
In line with market trends, candlesticks can be either bullish or bearish.
Bullish candlesticks are commonly green or white. Their opening price is lower than their closing price.
Bearish candlesticks are commonly red or black. Their opening price is higher than their closing price.
Candlesticks can take one of several frequently-encountered shapes, referred to as the doji, hammer, hanging man, inverted hammer and shooting star.
The anatomy of a candlestick
Many traders believe candlesticks are the most visually-appealing and easiest to interpret way of presenting data obtained in technical analysis. However, for traders to read candlestick charts, they must first understand what their different parts represent.
When inspecting a candlestick chart, colour coding is often the first feature that catches your attention. Candlesticks come in either green or red (alternatively in white and black) unless, of course, design limitations dictate otherwise.
Normally, green or white candlesticks, termed bullish candles, represent an upward market trend, predominantly characterized by purchases. By contrast, red or black candles, termed bearish candles, primarily show a declining trend and signal that sales are dominating the market. However, this is not always the case. Candlesticks should never be read individually. Instead, they should be read within the context of the surrounding chart data.
The longer the body of a bullish candlestick, the higher the buying pressure. This means that the further the close is above the open, the more aggressive buyers are. Conversely, the longer the body of a bearish candle, the higher the selling pressure. While highly bullish and bearish candlesticks normally indicate equally bullish and bearish markets, they should be inspected within a broader context.
How does a candlestick form?
A candlestick is merely a visual representation of price movement in a particular time frame. This time frame may range from a minute to month-long intervals.
The opening price marks the “open” of a candlestick, which is located at the bottom of the rectangular body in bullish candles and at the top of the body in bearish candles.
Then, the price starts going either upwards or downwards, most often fluctuating between high points and low points. The price of the asset at the end of the time frame is referred to as the “close” and is marked by the top of the rectangular body in bullish candlesticks and at the bottom in bearish candlesticks.
The highest and lowest prices between the opening and closing prices are referred to as the high and the low. The high is represented by the top of the upward wick, and the low by the bottom of the downward wick, whether the candle is bullish or bearish.
Common types of candlesticks
Most often, the body and wicks of a candlestick will take one of three candlestick types frequently encountered in cryptocurrency charts. These include the doji, hammer and shooting star.
A doji is characterized by a very thin body, which is normally, but not always, located at the center of the candlestick. A doji is created when the price swings in both directions before it closes near its opening price. It represents an indecisive market.
A hammer is distinguished by a thin body on top of a long wick at least twice the length of the candlestick body. It appears at the bottom of a downtrend and is formed when the price falls below the open and then later returns and closes just below or just above the open. A hammer is the precursor to potential upward trends. As such, it can be very profitable for bull investors. It indicates that, at one point during the trading period, sellers gained control, only to lose it back shortly after. Conversely, the same shape of a candlestick at the top of an uptrend is referred to as the hanging man. It most often predicts an end of a bullish trend.
The last type of candlestick we are presenting here is a shooting star. It is distinguished by a wick roughly two times the size of the candlestick body on top of the body itself. It normally occurs at the peak of an uptrend, signaling a potential downward reversal. The trading period is started by bulls (the wick extension points upwards), but bears outweigh them to drag prices to a close near or below the open. An inverted hammer takes the same form as a shooting star, but appears at the bottom of a downtrend. Most often, an inverted hammer signals a potential upward trend reversal.
The longer the duration of the candlestick, the more powerful its effect on the overarching trend. In other words, a hammer formed in a one-hour period is highly unlikely to have any impact on a 6-month-long downtrend. A week-long candlestick, by contrast, would have a greater impact.
But candlesticks should not be read individually. Market trend speculations should be based on a broader time frame, taking into account entire candlestick patterns rather than individual candles. Take a look at the article on candlestick patterns or explore the even more broadly-framed chart patterns to learn more about them:
- Introduction to chart patterns
- Continuation chart patterns
- Reversal chart patterns
- Bilateral chart patterns
The simplicity and informative value of candlesticks has granted them real staying power and made this type of price movement representation one of the most popular ones in trading circles.