How to Analyse Candlestick Charts for Better Trading Decisions

Ever wondered how to analyse candlestick charts or how to study candle chart? You are surely not the first one to do so. You’re not alone, either! Japanese rice traders first used candlestick charts to visualise price data and spot potential trading opportunities. Unlike the traditional bar charts, the candlestick charts show the open, high, low, and close prices for a specified timeframe. They provide more insight into a security’s price movements. More and more traders are making efforts to understand candlestick patterns.

Analyzing candlestick patterns can help you better understand market psychology and identify the shifts in supply and demand. Understanding how to analyse candlestick charts and how the analysis can allow you to make more informed decisions about entries and exits. This article will cover how to analyse candlestick charts.

What are Candlestick Charts?

A candlestick chart is a type of financial chart that displays the high, low, opening, and closing prices for a particular security in a single vertical line. This line is called the “candle body.” Thin lines above and below this line, known as “wicks,” show the high and low price ranges.

If the closing price is higher than the opening price, the candle body is green or white. If the closing price is lower than the opening price, the candle body is red or black. The colour coding makes it easy to see whether the prices rose or fell over the specified period.

Candlestick charts are more visually appealing and information-rich compared to simple line charts. The body gives information about the opening and closing price range, while the wicks show the full range from high to low. A candle chart reveals valuable information about market sentiment and supply and demand dynamics.

Key Candlestick Chart Patterns

Different types of candlestick patterns can provide trading insights. It doesn’t matter how many types of candlestick patterns are there or how many types of candlestick patterns a trader knows; what matters the most is how well one knows them. Some of the most important candlestick patterns for beginners include the following:

1. Doji

A doji pattern is formed when the opening and closing prices are virtually equal, creating a cross-like appearance. A doji pattern signifies the market’s indecision regarding the concerned security and potential reversal after an advance or decline.

2. Hammer and Hanging Man

These patterns have small natural bodies near the top of a trading range with a long lower wick. A hammer indicates potential bottoming or reversal after a decline, while a hanging man suggests a potential flattening trend after an advance.

3. Bullish and Bearish Engulfing

Engulfing patterns happen when the current candle’s body fully engulfs the previous candle’s body. Bullish engulfing suggests potential bottoming, while bearish engulfing suggests a market high may be close.

Many more single, double, and triple candlestick patterns can provide clues about trend direction, momentum, support/resistance areas, and potential reversals.

How to Analyse Candlestick Charts

Ever wondered how to study candlestick charts? Here are the top 6 things to consider when analysing candlestick charts:

1. Candle Colour and Size

The colour and size of the candle body show the relationship between the opening and closing price. A long green candle signifies intense buying pressure, while a long red candle shows strong selling pressure.

2. Upper/Lower Wicks

The wicks display the price extremes in the concerned period. Long wicks above or below the body show rejection of higher or lower prices, while short wicks indicate less volatility.

3. Specific Patterns

Watch for reversal patterns like doji, engulfing patterns, and morning or evening stars after both an uptrend or a downtrend. Experts consider these specific patterns as warning signs of potential exhaustion.

4. Volume

Higher volume on candlesticks reinforces the credibility of the price movement. A low volume indicates weaker market commitment for the concerned security.

5. Support/Resistance Levels

Notice candlestick reactions around crucial support/resistance levels marked by prior highs/lows. This helps gauge buying/selling interest.

6. Trend Lines

Observe how the candles interact with ascending and descending trend lines. Breakouts and rejections should indicate shifts between bullish and bearish trends.

Tips for Analysing Candlestick Charts

Here are some essential tips you can consider when you analyse candlestick charts:

• Use longer timeframes (e.g., daily and weekly charts) to get a better idea of the overall trend. Then, use shorter timeframes to time the entry and exit points.
• Combine candlestick analysis with other indicators like moving averages to validate the analysis.
• Focus on candlestick patterns that form at swing highs or lows or essential support or resistance levels.
• The longer the candle body, the more intense the buying or selling pressure.
• Gaps between candle bodies signal urgency in buying and selling activity. Watch out for gaps after long candle patterns.

Essential Details on Candlestick Patterns you can’t Miss as a Trader

Let us explore some essential details for analysing candle stick patterns.

1. Types of Candlestick Patterns

Traders and technical analysts widely follow dozens of standard candlestick patterns. Some of the most important ones among them include doji, hammer/hanging man, engulfing patterns, and morning/evening stars. Other notable candlestick patterns include three-line strikes, tweezers tops/bottoms, and the ‘abandonment baby’.

2. Best Time Frame for Candlestick Analysis

Candlestick analysis can be applied to charts for time frames as short as 1-minute. Aggregators offer monthly candlestick trends as well. It is better to use a relatively longer time frame, like daily or weekly, to get a detailed idea of the overall trend. After considering the longer time frame, you can move down to shorter timeframes, like hourly or 15 minutes, to pinpoint entry and exit price levels.

3. Best Market Conditions for Candlestick Analysis

Candlestick strategies work best in volatile and trending markets with specific market movements and reversals. Low volatility or range-bound markets offer fewer tradable candlestick signals. Traders often utilise candlestick analysis and other indicators to improve their timing and entry confirmation.

4. Reliability of Candlestick Patterns

The reliability of candlestick patterns can depend greatly on the context in which you are considering them. Factors like the formation of patterns relative to prior support or resistance levels, the size of the candle bodies, and confirmation of the candles by other indicators. Experts highlight that volume, too, can impact the credibility of the signal derived from a candlestick pattern.

Conclusion

Learning to read and evaluate candlestick charts is essential for any active trader. Candlestick patterns capture important information about buying and selling urgency and potential turning points in the market sentiment. But what matters more than knowing all candlestick pattern names is knowing the most powerful candlestick patterns really well. By combining candlestick analysis with other technical indicators, you can expect to stay aligned with market conditions.

Frequently Asked Questions – FAQs

1. What are the most reliable candlestick patterns?

Some of the most reliable candlestick patterns are the doji, hammer, hanging man, engulfing patterns, morning/evening stars, three white soldiers, three black crows, tweezer tops and bottoms, island reversals, etc. Their reliability increases under certain conditions, such as forming at support/resistance levels or being confirmed by trading volumes or other indicators.

2. How do you read a candlestick chart?

To read a candlestick chart, note the colour first – green/white suggests the close was higher than the open,n while red/black means the close was lower. Next see the size of the body relative to the wicks – large bodies suggest stronger conviction, while long wicks indicate rejection of extreme prices. Finally, identify any candlestick patterns forming, especially at swing points.

3. What does a long wick on a candlestick mean?

A long wick on top of the candle body signals the rejection of higher prices, while a long wick below shows the rejection of lower prices. Long wicks indicate that buyers/sellers tried to push the prices higher/lower but ultimately failed, and prices retreated back towards the open/close.

4. What does a small candle body mean?

A small candle body signals indecision and consolidation, as there wasn’t much range between the open and close prices. Small candle bodies form when there is relatively equal buying and selling activity. They indicate either a pause or potential reversal in the existing trend.

5. How do you use candlestick charts for day trading?

For day trading with candlesticks, use 5-minute or 15-minute timeframes on very liquid stocks or indices. Look for reversal patterns like doji, hammer at support, or morning/evening stars. Use other indicators like volumes or momentum oscillators to confirm signals.

Author: All Content is verified by SMC Global Securities.