Candlestick charts are a popular way to display the price movements of securities. Such information includes open, high, low, and closing prices for each period, hence the name candlesticks.
Traders typically use this kind of chart because they are simple but convey valuable information about prices over time.
They are instrumental in day trading when lots of movement occurs very quickly.
There are two main types of candlestick charts:
- Japanese candlesticks – these have simple bodies with small upper and lower shadows giving only limited information.
- Open-High-Low-Close (OHLC). These have larger bodies with more enormous shadows, which provide more information.
In the UK, most traders use OHLC charts, but many prefer Japanese candlestick charts in the US, so beware of your audience when using these and make sure you know which is most commonly used.
Candlesticks can be applied to all time frames from intraday to monthly, depending on the desired frequency with which you want to view market activity over that period.
- 5-minute charts,
- daily bars,
- weekly candles and
- hourly line charts (candles).
Before we look into how candlesticks work, we need to understand what a candle represents in terms of price action.
What a candle represents
Each one consists of four components:
- low and
- close prices for the session.
The solid portion or body tells the trader whether the session closed higher or lower than before.
The line above and below the body is called a shadow.
It tells you how far the price moved from opening to closing during the session.
The thickness of a candle refers to how much trading has taken place over that period.
The more trading, or volume, that generally means there will be a more robust reaction in price action for that particular stock.
This way, candlesticks can help you pick out strong stocks from weak ones by their relative sizes, which can help you determine your entry points when entering a trade.
If a stock opens lower but still manages to close higher, it would be a bullish candle indicating strength and positive sentiment within the market. Conversely, it would be a bearish candle if it opens higher and closes lower.
In addition to gauging sentiment, they can pick out support and resistance levels when trading by spotting significant highs or lows within a particular period.
Open candlesticks form at the top/bottom of a trend, so if they start shooting up in price action, these often mean the stock will push even further in that direction.
When entering a trade, you can use this knowledge by looking for buy entries when the open is near the low, especially if you’re trading on the shorter term, like 5-minute charts.
Selling also works for this scenario, but you must look for multiple sell arrows (more than one) over your chosen timeframe.
The reason for this is that the stock may take a breather and push up in price before continuing with your trade.
For buy entries, it’s essential to wait until the candle has closed before entering your trade, as you need to confirm its direction correctly.
As always, use indicators such as RSI or stochastic alongside candlesticks to increase accuracy and reduce risk when trading
In addition, try using two time frame charts at once so you can view current activity against previous support/resistance to give you a better overview of what is happening
If bullish candles start appearing above previous resistance or bearish ones from below support, then that would be a beautiful buying location as the price should continue to move higher/lower, which would increase your chances of making a winning trade.
What should you look at when looking at candlesticks?
There are many other aspects about how a candle forms and how it may present itself in future trading opportunities
Still, there are three main factors to take into consideration:
- The length of the body,
- The last wick,
- Volume is represented by upside shadows and downside shadows, as highlighted previously
In short, these all represent different ways of assessing sentiment within market participants
For more information, link on Saxo.