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6 Basics You Need To Know About Candlestick Charts

Education / 8 Min Read
Desmond Leong / 17 Feb 2021

Japanese candlestick patterns date back to the 17th century, but Charles Dow developed the more popular version in 1900. A Candlestick is a form of displaying all the important information a trader needs for price. The opening, high, low, and closing prices are visible and easily recognized. They are usually preferred to the traditional bar chart because from a visual perspective, they are much easier to interpret (especially when combining multiple candlesticks together to form - candlestick patterns). Conceptually candlesticks (through patterns) measure market sentiment in the form of bullish vs bearish strength. Each of these patterns tell us a different story about what we could expect from the price chart.

We’ve outlined six basics all beginner traders should know about candlestick charts.

1) Know The Candlestick Chart Basics

Forex Candlestick patterns are a way of interpreting a type of chart. For the candlestick to be complete, you need to wait for a session's closing price. This would show us the full picture - with the open, close, high and low price of the currency pair in that specific time period. The area above the body is called the wick or the shadow. For this example, we use a green candlestick to signify a bullish candlestick and a red one to signify a bearish candlestick.

A candlestick bar has this name because it looks like a candle with a wick. Candlestick charts can show us several patterns, such as the doji, hammer, inverted hammer, shooting star, and morning star, which are important information that can help us in forming our trading strategies.

These patterns can be continuation patterns, reversal patterns, or consolidation patterns.

Other charts include line charts containing only one point (open, high, low, or close) or a Bar Chart (which consists of an open price, high low, and close).

  • Line Chart
  • Bar Chart
  • Candlestick Chart

2) Know Why Candlestick Charts Are Used

A Candlestick provides easily readable information. For example, when the close is higher than the open, you know immediately because the body is hollow. If this happens several days in a row, you can assume a short-term uptrend is in place. If you look at a bar chart, this information is not as easy to identify. You can also deduce more information from a candlestick chart as compared to other charts.   Just compare the amount of difference in information these 2 charts tell you:

These are the exact same charts. One shows you the candlestick chart while the other shows you a line chart. Notice how much more information you can interpret and decipher from a candlestick chart vs a line chart?

3) Know How To Read CandleStick Charts And Patterns

Candlestick charts tend to be in line with the previous day’s close, unless over the weekend. A candlestick chart can be used as a guide to understand traders’ decisions and activity from the previous day.

If the body of the candle is very narrow, traders were indecisive on that trading day, especially if the open and closing prices are at the same level. If you compare this with a bar chart, it's tough to determine if the open and close are at the same level.

The body and the shadows (wicks) also tell you a lot about prices and can have myriad meanings, too. It’s important to consider the context of the chart before making a decision. A long wick at a key support may indicate a lot more than at another time in the day.

4) ...And Then Know What The Key Candlestick Patterns Are

There are several different types of candle patterns that you can use to trade the markets. Today, we will primarily focus on single candlestick patterns. One of the most common single candlestick pattern is the Doji pattern.

Doji patterns provide data but are often used as part of other practices since they generally represent indecision.  A doji by itself is neutral as the open, and the close is at the same level. A doji with a long upper shadow, known as a gravestone doji, is different from a doji with a long lower shadow, known as a dragonfly doji.

The evaluation of a doji depends on the preceding candles or the trend of the market. When there is a doji after a rally, it tells you that positive momentum is beginning to weaken. When there is a doji after a decline, negative momentum is slowing. While a doji does not signify a reversal, it does tell you that supply and demand are becoming more evenly matched.

You will encounter both doji patterns with long shadows and short shadows. A doji with long shadows tells you that there has been a lot of market volatility but no clear direction. A doji with short shadows tells you there is very little volatility and market indecision.

The dragonfly and the gravestone doji patterns usually provide critical information after a rally or a decline. A dragonfly doji candle looks like a "T," and if this occurs after a decline, it is considered a reversal pattern. You might consider purchasing a currency pair after a dragonfly doji-pattern and  placing stop-loss below the lower-shadow (low of that Doji shadow). A graveyard doji candle can also be viewed as a reversal pattern if found following a rally. The graveyard doji-pattern looks like an upside-down "T" as the open, and the close is the session's low. In this scenario, you might consider selling the currency pair and placing a stop loss above the graveyard goji high.

Here are some examples of the various types of dojis in their ideal environments.

The gravestone doji - usually found at the top of bullish trends. It is a strong signal of a potential bearish reversal to come.

The dragonfly doji - usually found at the bottom of bearish trends. It is a strong signal of a potential bullish bounce to come.

A combination of candlestick patterns can also lead to finding high probability reversal setups. Here’s how we found 3 strong bearish reversal candlesticks lining up at the top of a trend, ultimately leading to a very nice bearish reversal.

5) Beyond Candlestick Patterns

Candlestick patterns are very useful - and they get stronger when combined with various other technical studies. For example, combining candlestick patterns with support/resistance, oscillators or Fibonacci can lead to really good setups.

Importantly, you need to learn how to read candlestick patterns properly. Below is an example of how combining basic single candlestick pattern (doji) with a popular momentum indicator (Ichimoku clouds) can give you a better idea of whether price might break out of reverse.

6) Keep On Learning

Candlesticks are one element of trading the capital markets. They are designed to be used in conjunction with other technical analysis tools. Now that you know the basics of trading with candlesticks keep your learning journey going by evaluating other concepts.

To explore more Forex Trading beginner content, check out our education hub here.

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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