Candlesticks are the most important aspect of Technical Analysis. In today’s article, I am going to tell you the Top 4 Things To Know About Candlesticks. Without Candlesticks, it is very difficult to analyse and understand the psychology of the market but before going deep into this topic, let us understand-
Candlestick charting was invented in the 18th century. To analyse the price of rice contracts a wealthy Japanese businessman, Munehisa Homma, developed a technical analysis method, and that method is called candlestick charting. Now, it is widely used in analysing charts. Munehisa Homma started trading at the local rice exchange around 1750.
He carefully observed the specific pattern in the prices of rice and boosted his profits by identifying certain patterns. Homma is known as the Grandfather of candlesticks because of his research on price pattern recognition.
Candlestick is a method of representing the information on the charts. Candlestick represents four important parts of the price, and that is ‘OHLC‘
Full-form of OHLC is-
O – Open
Let us consider, we are analysing the daily chart of a specific stock, the price at which that particular stock opens is referred to as ‘open’ of the candlestick pattern. The highest price of that particular stock is noted and that point is referred to as ‘High’ of that candlestick.
Similarly, the lowest price of the stock is noted and referred to as ‘low’ of that candlestick. Lastly, the price at which stock closes is referred to as ‘close’ of that candlestick.
Basically, there are 2 types of candlesticks-
In green candlestick, the closing price of the stock is greater than its opening price.
In the above figure, the green colour indicates the body of the candlestick, and the distance between the close to high is referred to as upper shadow, and the distance between open to low is referred to as the lower shadow of that candlestick.
In red candlestick, opening price of the candle is more than the closing price
In the above figure, the red colour indicates the body of the candle, and the distance between the open to high is referred to as upper shadow and the distance between close to low is referred to as the lower shadow of that candlestick.
A green candle indicates the power of buyers whereas, a red candle indicates the power of bears in the market. In both of these candles, the opening and closing points differ whereas, positions of low and high points remain the same.
Up to this, we have understood the concept of candlesticks and how they are represented. Now, I will tell you some of the important candlestick patterns that indicate certain signals or indications regarding price change, trends, etc. Here are some important candlestick patterns-
Doji – It is a single candlestick pattern in which the open price is almost equal to the closing price with no body or thin body (due to the slight difference between opening price and closing price). However, the low and high of that candle may be of any length. A Doji candle appears like a plus sign.
The Doji pattern is like a drawn battle between buyers and sellers in which price makes highs and lows, but in the end, the price closes near its opening price indicating indecision in the market.
The Hammer Pattern – Hammer pattern is a single candlestick pattern that occurs at the bottom of the trend. The Hammer pattern is a reversal pattern. A hammer contains a small body and a long lower shadow. There is almost no upper shadow in the hammer pattern. However, there may be some slight presence of the upper body but that can also be considered as a hammer pattern.
As shown in the figure, it is a trend reversal pattern, and the longer the lower shadow the stronger the pattern will be. The color of the hammer pattern doesn’t matter much. It can be red or it can be green, but this pattern works best at the bottom.
Hanging Man – Hanging man is a single candlestick pattern that occurs at the top of the uptrend. A candlestick pattern is considered as a hanging man only if it precedes an uptrend. The bearish hanging man indicates selling pressure on high levels.
As shown in the figure, the hanging man pattern is the same as the hammer pattern. The only difference is, hammer occurs at the bottom of the trend and the hanging man occurs at the top of the trend.
Bullish Engulfing Pattern – This is a double candlestick pattern that occurs at the bottom of the trend. As the name suggests this pattern indicates the power of buyers in the market, and this pattern generally indicates a trend reversal.
A bullish engulfing pattern is a candlestick pattern that forms when a red candlestick is followed by a large green candlestick, the body of which completely engulfs the body of the previous candlestick.
Bearish Engulfing Pattern – This is a double candlestick pattern that occurs at the top of the trend. As the name suggests, this pattern indicates the power of sellers in the market and this pattern generally indicates a trend reversal.
A bearish engulfing pattern is a candlestick pattern that forms when a green candlestick is followed by a large red candlestick, the body of which completely engulfs the body of the previous candlestick.
Morning Star Pattern – The morning star pattern is formed by 3 candlesticks which occur at the time of downtrend reversal. This pattern is generally formed at the bottom of the downtrend and indicates a potential reversal of the trend.
As shown in this figure, in the morning star pattern, the first red candle indicates the power of bears in a downtrend, but the next Doji candle indicates the indecisiveness of the market. After that, one strong green candle is formed which closes above the 1st red candle indicating that the bulls have taken the charge and the potential trend reversal.
Evening Star Pattern – The evening star pattern is formed by 3 candlesticks, which occur at the time of uptrend reversal. Opposite to the morning star pattern, This pattern is generally formed at the top of the uptrend and indicates a potential reversal of the trend.
As shown in the above figure, previously markets were in an uptrend, which is indicated by 1st strong green candle. But the next Doji candle is formed which indicates the indecisiveness of the market. After that, one strong red candle is formed which puts bulls in panic indicating that the bears have taken the charge and the potential trend reversal.
I hope, through this article, you were able to understand the important concepts regarding candlesticks and some important candlesticks patterns. If you are interested in learning more about technical analysis, then you can definitely check out “Beginner’s Guide To The Stock Market | Module 06 | Basics of Technical Analysis Explained in 3 Simple Steps”. Also, if you have any queries regarding this topic, please post them in the comment section.
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