Ajitansh Kar, Gurugram, 5 May 2023
The most popular type of chart used to represent price movements during trading periods is the candlestick chart. Today most traders and technical analysts prefer these to the traditional line charts or area charts. Candlestick charts were primarily used by Japanese rice traders and were introduced by a merchant named Munehisa Hommain the 18th century. They were popularized in 1991 when Steve Nison published his book, “Japanese candlestick charting techniques”.
The above picture is a representation of how candlesticks look like. A candlestick is called so because it looks like a real candle. It has three major parts, a body and two wicks. The body of the candle represents the magnitude of change in opening and closing prices of the security during the set interval of the trading period. The upper wick represents the highest price level achieved during the trading period while the lower wick represents the lowest price level achieved during the trading period.
Candlesticks are of two colors, red and green. The green candlesticks tell us that the price opened low and closed at a higher level than the opening price; while the red candle tells us that price opened at a higher level but closed below the opening level.
Candlesticks alone may not be able to give you much information about how prices will react in the future, but when multiple candlesticks, i.e., two or more candlesticks combine, we can interpret the data better. There are many types of candlestick patterns present; lets discuss a few famous patterns:
- Bullish / Bearish Engulfing Pattern – This pattern is formed by two candlesticks on a chart. If the first candle is a red candle whilst the second candle is a green candle and engulfs the body of the first candle, a bullish engulfing pattern is formed.This pattern suggest that buyers are in control and may push the price up in the future. If the first candle is green and the second candle engulfing the body of the first candle is red in color, a bearish engulfing pattern is formed. This suggests that the sellers are overpowering the buyers and want to push the price downwards.
- Piercing Pattern –This pattern is generally made on the bottom of the chart from where the reversal of the down trend is expected to occur. This candlestick pattern involves two candlesticks. The first candle is a red candle with a large body and little to no wicks on top. The second candle’s appearance is like the first candle, but the candle should open below the close of the previous candle and close by covering at least 50% of the body of the former candle. This pattern shows that the supply in the market has been overwhelmed and buyers are looking to gain control.
- Dark Cloud Cover Pattern –This pattern usually is found on the top of the chart and indicates signs of possible bearishness. This pattern also involves two candlesticks. The first candle should be a strong green candle (large body, small wicks) with the second candle being a red candle (large body, small wicks). The second candle should open above the closing level of the previous candle and close below 50% of the body of the first candle. This pattern helps in identifying potential points on the chart from where the trend can reverse and become negative.
I hope you now understood how to interpret the candlestick charts and would implement it in your trading. The above mentioned patterns may be confusing to understand at first glance, but with constant observations of the different patterns on the trading charts, you would be able to easily understand them and trade them.