Candlesticks provide visual depiction of price fluctuations that condense all of the information a trader needs into a single bar. They are commonly used because of the ability to display a lot of information in a straightforward manner, which makes it easy for traders to identify patterns that might assist them in making decisions.
In today’s article, we will talk about candlesticks, what they are & its components, candlestick vs. bar charts and some of the common candlestick patterns.
What is a candlestick?
A candlestick is a single bar on a candlestick chart that shows market movements at a glance. Each candlestick represents the open, low, high, and close price of a market for a specific time period. Traders can use technical analysis to forecast market movements by looking for patterns on candlestick charts.
Price action represented on candlestick can provide traders clues to spot trends and reversals. For instance, clusters of candlesticks may create patterns that happen throughout charts that could possibly signal continuation of trends or reversals. Candlesticks can also form individual formations that indicate buy or sell entries in the market.
The time-frame selected by the trader determines the period that each candle represents. One of the most popular time-frames is the daily time-frame, in which the candle will show the open, close, high, and low for the day. Candlestick charts are available with lots of durations from one minute (a new candle will form for each minute) to one month. When searching for a trade entry, short-term traders often prefer short time frame candlesticks. Based on different components of a candle, traders can be able to predict where the price will go; for example, if a candle closes well below its open, it may suggest further price decreases.
Understanding candlestick components
In order to form a price candle, three particular points (open, close, wicks) are employed. The open and close prices of the candles will form the body of a candle based on where the price of an asset begins and ends for a given period. When you look at the chart, each candle represents the price movement for the time you pick. If your timeframe is daily, each individual candle will show the open, close, upper and lower wick of that day. A typical candlestick is represented in the image below.
- Open price: The first price traded during the creation of a new candle is represented as the open price. If the price begins to rise, the candle will become green. Or, the candle will turn red if the price falls (colors vary depending on settings).
- Close price: The last price traded during the candle creation is the close price. Most charting software will automatically turn red if the close price is lower than the open price. The candle will be green if the close price is higher than the open price (depend on chart settings).
- High price: The highest price transacted throughout the period is shown at the top of the upper wick/shadow. No upper wick/shadow indicates that the open or close price was the highest price traded.
- Low price: The lowest price transacted throughout the period is shown at the bottom of the lower wick/shadow. No lower wick/shadow means that the lowest price traded is either open or close price.
- Wick: Wick is also called ‘shadow’ on a candlestick. Candlestick wicks are crucial because they represent the price extremes for a certain charting period. The wicks can be easily distinguishable since they are visibly thinner than the candlestick’s body.
- Direction: The color of the candlestick (can be changed, depends on settings) represents the direction of the price. If the price of the candle is closing above the opening price, it means the price is going up and the candle would be painted green. If the price of the candle closed below the open, the candle would be red.
- Range: The range of a candle is the difference between its highest and lowest price. Take the price at the top of the upper wick and subtract it from the price at the bottom of the lower wick to get the range. (The range is defined as the highest point minus the lowest point)
Candlestick vs. Bar Charts
The information on bar charts and candlestick charts is the same, but it is shown in different ways. Due to the color of the price bars as well as thicker real bodies, candlestick is considered more visual and can be able to clearly indicate the difference between the open and the close.
Candlesticks are formed based on the movements in the price. Despite the fact that price movements appear randomly sometimes, there are times that they will form patterns, which can be used for analysis or trading purposes.
Patterns are divided into bullish and bearish. Bullish patterns show the rise of the price, while bearish patterns show the opposite direction of the price. Please be informed that candlestick patterns show price movement’s tendencies, so it’s not guaranteed.
There are lots of candlestick patterns, here are some popular patterns for you to find out more:
- Bearish Engulfing Pattern: This pattern occurs in an uptrend, in which sellers outweigh buyers. It is represented by a long red real body engulfing a small green real body. The pattern suggests that sellers have regained control of the market and that the price may continue to fall.
- Bullish Engulfing Pattern: This happens when buyers outnumber sellers. It is indicated by a long green real body engulfing a small red real body. Since the bulls have gained some grip, the price might rise.
Depending on the trading type that you are taking, you can choose the suitable time period of the candlestick chart. It’s always recommended that you should look at a longer time period first to get an overall idea of the trend and key support and resistance levels. Once your initial analysis is finished, you can take advantage of candlestick tools to spot potential changes in the market, along with other technical indicators to make trading decisions.