Understanding Basic Candlestick Charts

Candlestick charts originated in Japan over 100 years before the West developed the bar and point-and-figure charts. In the 1700s, a Japanese man named Homma discovered that, while there was a link between price and the supply and demand of rice, the markets were strongly influenced by the emotions of traders.

Candlestick charts show that emotion by visually representing the size of price moves with different colors. Traders use the candlesticks to make trading decisions based on irregularly occurring patterns that help forecast the short-term direction of the price.

Candlestick Components

Just like a bar chart, a daily candlestick shows the market's open, high, low, and close prices for the day. The candlestick has a wide part called the "real body." 

This real body represents the price range between the open and close of that day's trading. When the real body is filled in or black (also red), it means the close was lower than the open. If the real body is white (or green), it means the close was higher than the open.

Traders can alter these colors in their trading platform. For example, candlesticks can be any combination of opposing colors that the trader chooses on some platforms, such as blue and red. On many platforms, you can select the colors you want to use.

Candlestick vs. Bar Charts

Just above and below the real body are often seen the vertical lines called shadows (sometimes referred to as wicks).

The shadows show the high and low prices of that day's trading. If the upper shadow on a down candle is short, it indicates that the open on that day was near the day's high.

A short upper shadow on an up day dictates that the close was near the high. The relationship between the days open, high, low, and close determines the look of the daily candlestick. Real bodies can be long or short and black or white. Shadows can be long or short.

Bar charts and candlestick charts show the same information, just in a different way. Candlestick charts are more visual due to the color coding of the price bars and thicker real bodies. Highlighting prices this way makes it easier for some traders to view the difference between the open and close.

The above chart shows the same exchange-traded fund (ETF) over the same time period. The lower chart uses colored bars, while the upper uses colored candlesticks. Some traders prefer to see the thickness of the real bodies, while others prefer the clean look of bar charts. 

Basic Candlestick Patterns

Candlesticks are created by up and down movements in the price. While these price movements sometimes appear random, they often form patterns traders use for analysis or trading purposes.

Patterns are separated into two categories, bullish and bearish. Bullish patterns indicate that the price is likely to rise, while bearish patterns indicate that the price is likely to fall. No pattern works all the time, as candlestick patterns represent tendencies in price movement, not guarantees.

Bearish Engulfing Pattern

​A bearish engulfing pattern develops in an uptrend when sellers outnumber buyers. This action is reflected by a long red (black) real body engulfing a small green (white) real body. The pattern indicates that sellers are back in control and that the price could continue to decline.

Bullish Engulfing Pattern

​An engulfing pattern on the bullish side of the market takes place when buyers outpace sellers. This is reflected in the chart by a long white real body engulfing a small black real body. With bulls having established some control, the price could head higher.

Bearish Evening Star

​An evening star is a topping pattern. It is identified by the last candle in the pattern opening below the previous day's small real body. The small real body can be either black or white (red or green). The last candle closes deep into the real body of the candle two days prior. The pattern shows a stalling of the buyers and then the sellers taking control. More selling could develop. The morning star is the bullish opposite of the evening star.

Bearish Harami

​A bearish harami is a small black or red real body completely inside the previous day's white or green real body. This is not so much a pattern to act on, but it could be one to watch. The pattern shows indecision on the part of the buyers. If the price continues higher afterward, all may still be well with the uptrend, but a down candle following this pattern indicates a further slide.

Bullish Harami

The bullish harami is the opposite of the upside-down bearish harami. A downtrend is in play, and a small real body (green or white) occurs inside the large real body (red or black) of the previous day. This tells the technician that the trend is pausing. If it is followed by another up day, more upside could be forthcoming.

Bearish Harami Cross

A bearish harami cross occurs in an uptrend, where an up candle is followed by a doji—the session where the candlestick has a virtually equal open and close. The doji is within the real body of the prior session. The implications are the same as the bearish harami.

Bullish Harami Cross

A bullish harami cross occurs in a downtrend, where a down candle is followed by a doji. The doji is within the real body of the prior session. The implications are the same as the bullish harami.

Bullish Rising Three

This pattern starts out with what is called a "long white day." Then, on the second, third, and fourth trading sessions, small real bodies move the price lower, but they still stay within the price range of the long white day (day one in the pattern). The fifth and last day of the pattern is another long white day.

Even though the pattern shows us that the price has been falling for three straight days, a new low is not seen, and the bull traders prepare for the next move up.

A slight variation of this pattern is when the second day gaps up slightly following the first long up day. Everything else about the pattern is the same; it just looks a little different. When that variation occurs, it's called a "bullish mat hold."

Bearish Falling Three

The pattern starts with a strong down day. This is followed by three small real bodies that make upward progress but stay within the range of the first big down day. The pattern completes when the fifth day makes another large downward move. It shows that sellers are back in control and that the price could head lower.

The Bottom Line

As Japanese rice traders discovered centuries ago, traders' emotions have a major impact on that asset's movement. Candlesticks help traders to gauge the emotions behind an asset's price movements, believing that specific patterns indicate where the asset's price might be headed.