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Candlestick charts are something that all traders must master, as they form the foundation of all trading and are indispensable for any technical analysis strategy.
In this era of information overload, it's easy to find knowledge about candlestick charts in the market, but the problem lies in the sheer volume and disarray of information, which can sometimes lead to a loss of direction when learning.
The purpose of my article today is to summarize what I believe to be the most important and essential knowledge points for learning candlestick charts, allowing everyone to understand them in the shortest possible time.
The content includes the most important basic knowledge of candlestick charts, the most effective practical candlestick patterns, and some trading insights from practical experience with candlestick charts.
1. The most important basic knowledge of candlestick charts
(1) The origin of candlestick charts.
Trading profits are realized through price fluctuations; buying leads to rising prices, and short selling leads to falling prices. The core of making profits is to find the patterns of price fluctuations and analyze the direction of price movements.
But consider this: if I told you that the closing price was 1000 yesterday, it was 950 at 12 PM today, 980 at 2 PM, 990 at 6 PM, 1100 at 9 PM, and the closing price was 1200, what would be your understanding of the price changes?
It seems very chaotic and disorganized. This is because the fluctuations in price changes are inherently abstract. To conduct technical analysis and discover the direction of price fluctuations, it is necessary to concretize the prices, and candlestick charts serve as the tangible representation of prices on the chart.
Candlestick charts represent changes in price.Of course, the candlestick is just a concrete representation of price, and other common forms include line charts and bar charts.
Please see the images below, which are schematic diagrams of a candlestick chart, a line chart, and a bar chart, respectively.
On the left is a 4-hour candlestick chart of the US dollar against the Japanese yen, in the middle is a 1-hour line chart of the FTSE 50 Index, and on the right is a 1-hour bar chart of the Hang Seng Index.
(2) The four prices of a candlestick.
A candlestick is composed of four prices.
The opening price, the price at the beginning of the candlestick.
The closing price, the price at the end of the candlestick.
The highest price, the highest price during the period the candlestick represents.
The lowest price, the lowest price during the period the candlestick represents.
The image is a 4-hour candlestick chart of the US dollar against the Japanese yen, and I have marked the opening price, closing price, lowest price, and highest price in the chart.These four prices indicate that over the span of these four hours, the price started at 150.91 and eventually rose to 151.2, having once dropped to a low of 150.8 and reaching a high of 151.3.
(3) The body and wicks of the candlestick.
A candlestick is composed of a body and wicks. The space between the opening and closing prices is the body, with the upper wick above the body and the lower wick below it.
The upper wick represents that this candlestick reached this high point during its movement but failed to sustain it, while the lower wick indicates that the market reached a low point but also failed to maintain it.
Candlesticks are divided into bullish and bearish. A bullish candlestick, where the closing price is higher than the opening price, signifies a price increase. A bearish candlestick, where the closing price is lower than the opening price, signifies a price decrease. The larger the body of a bullish candlestick, the stronger the bulls; the larger the body of a bearish candlestick, the stronger the bears.
Of course, there are also instances where the closing price is equal to or close to the opening price, resulting in a candlestick with almost no body, known as a doji.
Additionally, there is a type of candlestick that has no upper wick, no lower wick, or even no wicks at all. Such a bullish candlestick typically implies strong bullish sentiment, while a bearish candlestick with no wicks implies strong bearish sentiment.
I have labeled the bearish and bullish candlesticks in the chart, with bearish ones in black and bullish ones in white, doji, and candlesticks with no upper or lower wicks, known as marubozu.
(4) The color of the candlestick.
Bullish and bearish candlesticks can have different colors. In the Chinese stock market, bullish candlesticks are usually red, representing an increase, while bearish candlesticks are green, representing a decrease. The term "stock market leeks" (green and lush), often used to describe inexperienced investors, originates from the green color of the bearish candlesticks.But in fact, the color of the candlestick can be set arbitrarily. In the chart above, you can see that the black ones are bearish candles, and the white ones are bullish candles. This is set according to my preferences, and I set it this way mainly because I feel more peaceful when I see black and white.
Everyone can also set the color of the candlestick according to their own preferences.
(5) The time frame of the candlestick.
The time frame is a very important concept for the candlestick. The candlestick is distinguished by the level of time, and the most commonly used candlestick cycles are 1 minute, 5 minutes, 15 minutes, 30 minutes, 1 hour, 4 hours daily, weekly, and monthly.
A 1-minute candlestick represents the change in price within 1 minute, and a bullish 1-minute candlestick indicates that the price has risen within this minute, showing the opening price, closing price, highest price, and lowest price within 1 minute.
A bearish 5-minute candlestick represents that the price has fallen within these 5 minutes, and the same principle applies to other levels.
Many 1-minute level candlesticks form the 1-minute trend, 5-minute candlesticks form the 5-minute trend, and daily candlesticks form the daily trend. With these trend charts, we can conduct technical analysis and trade.
The chart is a candlestick chart of the US dollar against the Japanese yen, and the four icons are 1 minute, 5 minutes, 1 hour, and 4 hours.
Up to now, from the basic knowledge of a single candlestick to the chart composed of candlesticks, we have finished talking. After having the chart, we need to conduct market analysis, judge the trend of long and short positions to trade, and then let's move on to the practical use of the candlestick.
2. Practical use of the candlestickOne can understand that the candlestick is the language and script of price, and the candlestick continuously writes on the chart, forming an unbroken candlestick chart. However, most of the time, the "script" displayed on the chart is chaotic and meaningless, only suddenly revealing significance at certain special moments, generating expectations and signals for the subsequent trend to rise or fall.
These signals are the trading opportunities we need to seize, and these opportunities are usually reflected in the form of special candlestick patterns.
Timely identification of these special candlestick patterns and formulating trading plans for transactions are the keys to our profitability.
As we mentioned earlier, a large-bodied bullish candlestick represents a strong bull market, and a large-bodied bearish candlestick represents a strong bear market, with a high probability of the trend continuing.
In addition, there are other candlestick patterns that represent the characteristics of the market trend, with expectations of rising or falling in the subsequent trend.
Next, I will talk about two reversal candlestick patterns that I think are the most useful and easiest to recognize in practice. After the reversal pattern appears, there is an expectation that the trend will reverse soon.
(1) Engulfing pattern.
This is a pattern composed of two candlesticks. Based on the literal meaning, everyone can understand that the latter candlestick engulfs and covers the former one.
The engulfing pattern is divided into an upward engulfing, where the bullish candlestick engulfs the bearish one (the market is about to go bullish), and a downward engulfing, where the bearish candlestick engulfs the bullish one (the market is about to go bearish).
Let me illustrate with an image.The chart shows a candlestick chart of the US dollar against the Japanese yen. After the upward engulfing pattern forms on the left side, the price begins to rise. After forming a downward engulfing pattern at a high level, the price starts to fall.
There are two key points to the engulfing pattern:
1: The bodies of the two candles in the engulfing pattern are similar in size, usually with very short upper and lower wicks.
2: The second candle must cover at least 4/3 of the first candle upwards.
(2) Hammer pattern.
This is a pattern of a single candle, as the name suggests, the shape of the candle resembles a "hammer". A hammer at the bottom usually has a long lower wick, which indicates that during the operation of the candle, the bearish force once reached a deeper decline but could not maintain it. The bullish force successfully counterattacked, closing at a high level, implying that the market will continue to rise.
The pattern at the top is the opposite, usually with a long upper wick, and is called an inverted hammer.
Let me illustrate with an image.
The chart shows a candlestick chart of the US dollar against the Japanese yen. After a hammer with a long wick forms at the bottom on the left, the market stops falling and turns up. On the right, the market forms a downward inverted hammer at a high level, and the market turns from rising to falling.
There are two common variations of the hammer pattern:1: The Doji star, structurally similar to the Hammer, has a very small body with the opening and closing prices being very close, resembling a "cross". Typically, the Doji at the bottom has a long lower shadow, while the Doji at the top has a long upper shadow.
2: The Morning Star and the Evening Star. They are patterns composed of three candlesticks, which are upgraded versions of the Hammer or Doji.
Taking the Morning Star as an example, the first candlestick is a downward bearish candle, the second candlestick continues to move downward to a new low, but the low does not hold, and the market closes in the form of a Hammer or Doji, indicating a reversal. The third candlestick is a bullish candle that essentially covers the first candle's shadow, confirming the pattern and increasing the likelihood of a market reversal.
The Evening Star pattern at the top is the mirror image of the Morning Star.
Let me illustrate with an image.
The image shows the USD/JPY candlestick chart, with the market reversing upward after forming a Doji at the bottom on the left. On the right, the market at the top forms an Evening Star pattern, and the market turns downward.
I would like to emphasize a few points about candlestick patterns:
1: There are connections between patterns; the Hammer and Doji are very similar in appearance and function, while the Morning Star and Evening Star are strengthened versions of the Hammer and Doji, using more candles to confirm the effectiveness of the reversal.
2: There is a wealth of knowledge and articles about candlestick patterns in books and online, including continuous patterns, exhaustion patterns, and reversal patterns. Here, we only discuss the simplest reversal patterns for two reasons. One is that reversal patterns are crucial as they can identify turning points in the market, allowing for the earliest possible order placement to maximize profits.Another reason is that these reversal patterns are all very simple, easy to learn, easy to use, commonly seen on charts, and effective.
When we trade, we are not doing academic research; we learn and use whatever is useful and practical. Practicality and effectiveness come first.
3: These patterns can be applied at all time frames.
4: No candlestick patterns can be used in isolation; they must be combined with other technical criteria, otherwise, the success rate will be significantly reduced.
It can be understood that these reversal candlestick patterns are our signals to start an attack, but before attacking, we must aim at the target. For example, in practical trading, reversal candlestick patterns formed after the market reaches important support and resistance levels have trading value.
3. My practical experience with candlestick patterns:
(1) The key to learning candlestick patterns is not quantity but depth.
The trading market is enormous, with different cycles and varieties, providing us with plenty of trading opportunities. Even mastering and using one candlestick pattern well can find enough trading opportunities in the market and earn a lot of money. As the saying goes, "Master one skill and you can succeed everywhere," that's the principle.
(2) Candlestick patterns are not difficult; practice makes perfect.
Today's content is the most simplified version of candlestick knowledge. I have chosen the easiest to understand and the most refined and practical for actual use, but some new traders may still find it difficult to understand, which is very normal.The use of candlestick charts is merely a technical skill. With regular observation and practice, one can become proficient through the use of simulation platforms and backtesting software. Initially, there is no need to be anxious.
(3) The spatial changes in candlestick charts are very important signals.
In all market trends, the oscillating market is more common, so the space of most candlesticks is relatively uniform. However, when the market is about to form a trend, it requires a greater force to buy or sell, which will produce candlesticks with a large spatial range. These large-space candlesticks are a clear signal that the market is about to change. They can be combined with candlestick patterns for practical use, which can lead to more efficient trading.
Today's discussion on candlestick knowledge ends here. I have also written many articles on the advanced practical application of candlestick charts in the past. Interested friends can search for them and read them on their own. By integrating and digesting this knowledge, one can elevate their trading skills to a higher level.