A Candlestick is an illustrative way of reflecting Price Action over a given period of time.
Different time periods can be selected, typically ranging from 1m (one minute) through to 1y (one year) but the design characteristics of the candlestick are constant regardless of the time period or instrument to which they are applied.
The horizontal bars of a Candlestick represent the opening and closing prices and the box between these two levels is referred to as the ‘body’ or ‘real body’. If the closing price is in excess of the opening price the body of the candle is colored green which denotes price action was positive. Accordingly, if the closing price is lower than the opening price the body of the candle is colored red which denotes price action was negative.
The vertical lines represent the range of price action during the period. The highest point of the upper shadow reflects that period’s trading high and the lowest part of the lower shadow reflects the low of the time period.
Short shadows denote a price action to have been within a small range, longer shadows denote a greater price range.
Candlestick charts present a way to clearly and quickly convey price action and it’s important to understand what they are trying to tell you.
- The Bullish candlestick has a long lower shadow that suggests at some part of the trading period bearish traders sold short and drove prices down. By the end of the time period strong buying pressure had taken price back up above the opening price and up to new highs. The closing price being close to the high point of the period suggesting buyers finished up on top.
- The Bearish candlestick has a long upper shadow that suggests at some part of the trading period bullish traders bought heavily and drove prices up. By the end of the time period strong selling pressure had taken price back below the opening price and continued to make new lows. The closing price being close to the low point of the period suggesting sellers finished up on top.
Trading strategies based on Technical Analysis take things a step further and use Candlesticks as a guide to initiate and close out trading positions. It should be noted that trading solely off Candlesticks while possibly being profitable would not be taking account of other readily available market information. Many other signals, such as traded volumes, Pivots and Support and Resistance levels can be incorporated into your strategy. Moreover, the information is widely available for no charge so developing and testing a strategy based on a variety of signals may be more profitable.
It’s also important to consider what time frame you are analyzing. A Candlestick formed by data taken over a longer time period is considered to offer a more reliable signal on the basis that more market participants have contributed to the process of price action moving through time.
Some Candlesticks, such as Dojis and Evening Stars, are distinctive enough in shape and important enough to traders that they are given their own name. Extending the study to cover a sequence of Candlesticks moves analysis on to Candlestick Patterns.