Introduction to Candlestick Charts

Let me start by saying that the candlestick patterns in candlestick charts should be part of any stock buying or selling strategy. Steve Nison introduced the candlestick techniques to the Western world in his first book, Japanese Candlestick Charting Techniques in 1991. The advantage of using candles on charts is that single or multiple candle patterns can give you early and reliable reversal signals.

The horizontal reference points of the candle represent the opening price, the highest price, the lowest price, and the closing price of the considered period. The rectangular portion of the candle, or the body, represents the range between the opening and the closing prices. If the closing price is higher than the opening price, the body is white or not filled. If the closing price is lower than the opening price, the body is black or filled.

A candle consists of either just a body or a body with an upper and/or a lower shadow. A candle with an opening and closing price at almost the same price level is called a doji. The candlewicks are called shadows, and they extend up to the highest price and down to the lowest price. Looking at the format, the naming and the meaning, you will note a great variety of candle names. It starts with the very big candles with no shadows called white marubozu, a candle with a big white body to be interpreted as very positive. Or the black marubozu, a candle with a big black body which is very negative. Next you get the opening and closing marubozu candles, followed by the normal sized black and white candles with upper and/or lower wicks. Another family are the doji’s, the candles where the opening and closing price are at the same or almost the same price level. To finish with the hanging man and shooting star candles having a small body with large shadows on one side.

What is the psychological background of single candles with no shadows or with only upper or lower shadows? A white candle with no shadows is pure rising power. A black candle with no shadows is pure falling power. A white candle with an upper shadow shows weakening rising power. A black candle with an upper shadow shows that there is increasing falling power. A white candle with a lower shadow shows increasing rising power and a black candle with a lower shadow shows weakening falling power.

Looking at candles with an upper and lower shadow, we can say that candles with a larger lower shadow and a smaller upper shadow represent rising power and the same for a normal sized white candle with small upper and lower shadows. On the other hand candles with a larger upper shadow and a smaller lower shadow represent falling power just like a normal sized black candle with smaller upper and lower shadows.

Candles with reversal power are all of the doji formations indicating that price acceleration is slowing down with bulls and bears in balance. A doji at a top or bottom of a price move is often the first signal of a price reversal. The same is valid for small white or black bodies, mostly more of them together, indicating that buyers or sellers are trying to take power. A small body with a large lower shadow is a hammer and many times a reversal signal both for a downtrend or an uptrend reversal. A small black or white body with a large upper shadow is a shooting star at a top or an inverted hammer at the bottom. Again, probably the first sign of a reversal.

Candle sticks give you more information. When comparing the commonly used bar charts in Western technical analysis to the Eastern candle charts, it is evident that candle charts have a bigger visual impact. The bar chart on its own does not give you any clue about which side a price pattern will be broken. But a candle chart, showing for example almost only candles with rising power in the pattern is clearly showing signs for a breakout to the upper side of that pattern.

What is the influence of size, shape, position and volume on candles? One or more bigger white candles with no or just little shadows mean that the trend is accelerating up and that there is accumulation of the stock. One or more bigger black candles with no or just little shadows mean that the trend is accelerating down and that there is distribution of the stock. When you see an increasing number of smaller candles, after an up move or a down move, it means that the trend is decelerating and distribution is ongoing. It is possibly a first sign for a trend reversal.

Shape and size go hand in hand. Larger size has more meaning. An uptrend move with white candles and doji’s and even smaller black candles confirm the uptrend. A down move is confirmed with black candles; doji’s and even smaller white candles. At the end of an uptrend or a downtrend you will see many times candlestick reversal patterns composed of a number of candles, mostly 1 to 3 candles.

The place in the chart where a candle appears indicates whether it is a usable signal. A reversal pattern after an up-move is a strong reversal signal. The same pattern in a sideways price move has only limited meaning as a support or resistance level. Any pattern within a sideways move has no meaning at all.

There are some very exotic names for these bullish or bearish patterns like; harami, shooting star, abandoned baby, three river bottom, three white soldiers, two crows and much more.