A candlestick chart is one of the most commonly used financial charts today that represents that price movement of a security, currency, or derivative.
The candlestick is visually similar to a box plot but shows different information. It is mostly used to show changes in trading patterns over a short period of time and are most often used in technical analysis of price movements.
History
Candlesticks charts originated were invented by Munehisa Homma in 18th century Japan. The rice trader discovered that there was not only a link between price and the supply and demand of rice, but that markets were also heavily impacted by the emotions of traders. Over 100 years later the charts made their way to the western world in Steve Nison’s book, Japanese Candlestick Charting Techniques. They have since moved from rice to primarily stock market analysis to help forecast the short-term price movement.
Candlestick Basics
The candlestick has four main parts to it which are the opening price, closing price, low, and high for the period in question.
Body: The wide part of the candlestick is known as the body. This shows the range between the opening price and closing price for a given period. Traditionally a body that was shaded black or filled in meant a close that was lower than the open while an empty body signaled a close higher than the open. Typically modern trading platforms will shade their candles red and green for down and up, respectively.
Wicks: The high and low trading price are denoted by the ends of the "wicks". Longer wicks show a larger difference in the asset's open or close price to its low and high and are typically signs of higher volatility. A short upper wick on an up day indicates the close was near the high while a short upper wick on a down day represents the open was near the high.
One extreme, where the body is almost nonexistent, with a long wick is knows as a doji. A doji occurs when the open and close are almost equal and take the shape of a cross or plus sign. Doji are neutral patterns that often signal a reversal for technical analysts. Often they show indecision of both buyers and sellers where the price doesn't move and traders are in a stalemate. Analysts often see doji as either a sign of a reversal or a continuation trend.
Lastly, gaps seen on a candlestick chart show when the highest price of one day is lower than the lowest price of another day. If Apple (AAPL) closes at a high on a Monday and then opens trading on Tuesday at a higher price and never drops below Monday’s high, then there will be a gap between the candlesticks for those trading sessions. The bigger the gap the larger the overnight move represented.
Candlestick Patterns
There are many candlestick patterns that signal bullish or bearish continuations or reversals. Bullish patterns signal that the price is likely to rise while bearish patterns signal a likely downward trend. The patterns are based on price movement tendencies. A list of basic bullish and bearish patterns can be found here.
Doji are neutral indicators for price movement in isolation but can signal a price reversal or confirmation of ongoing trend depending on the previous price movement. The size of the doji wick can signal a lot of uncertainty, or a big intra-period change.
Two commonly analyzed trading patterns are inside day and outside day patterns for candlesticks. An inside day is a two-day trading pattern in which the second day has a price range completely inside the first day’s range. Essentially, the body of the second candle could fit inside the first candle. The inside day indicates a contraction in volatility and the stock will often continue moving in the same direction as before.
On the other hand, an outside day is when a price’s movement is more volatile than the previous day a higher high and lower low. The open and close of the second day are outside the range of the first and indicates future movement. If the second candlestick is headed lower, then sellers were in control and may continue downward. While if the second bar is positive, then buyers dominated and price may continue upward. Outside days are part of a continuation pattern in the direction of the last few bars meaning bullish outside days indicate the upward trend is expected to continue while bearish outside days signal continued downward movement.
