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Chapter 1 Introduction to Candlestick

Candlestick
Candlesticks are the most popular chart choice among traders as compared to line chart, bar chart and the point

& figure chart. It has gained popularity among the traders as it conveys wide range of trading information in one

go in a highly visual way. Candlestick charts are also simple to read and interpret. It consists of a body (rectangle

part of the candle) and shadow or wicks (lines above or below the body). Each candlestick also consists of an

open, high, low and close price. The trader based on his trading horizon sets the time frame of the candlestick

chart.

Interpreting Candlestick Chart

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Open - The open is the first price traded and is indicated by either the top or bottom of the body of the

candlestick.

High - The high is the highest price traded during the time period set for the candlestick, and is indicated by the

top of the shadow that occurs above the body (called the upper shadow).The high price could be the open, close

or a high hit within the time frame of the candle. If the open was the highest price then there will be no upper

shadow.

Low - The low is the lowest price traded during the candlestick, and is indicated by the bottom of the shadow that

occurs below the body (called the lower shadow).The low could also be one of the three prices open, close or a

low price hit within the time frame of the candle .If the open was the lowest price then there will be no lower

shadow.

The color of a candlestick is based on whether the closing price (or the last traded price, if the candlestick is

incomplete) is above (green) or below (red) the opening price. While the candlestick is the process of formation,

the candlestick could constantly alter as the price fluctuates. The open remains fixed, but the rest of the

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parameter i.e. high, low and close could constantly change. When the time period of the candle comes to an end
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the last traded price is taken as the closing price, after which a new candlestick is formed which continues to

convey the price movement over the next time segment.

Close - The close is the last price traded during the candlestick, and is indicated by either the top or bottom of the

body.

Range - The price difference between the upper and lower shadow indicates the range the price moved during

the time frame set for the candlestick. It is calculated by subtracting the high from the low of the candlestick.

Range indicates the volatility associated with the candlestick. Higher the range, higher is the volatility and vice

versa. (Range = High - Low).

Interpreting candlesticks charts is one of the very first steps in learning how to trade. Once a trader has gained

knowledge to interpret a chart he can then move on to the other aspects of technical analysis and develop trading

strategies as per his needs.

Use of Candlesticks
Candlesticks tend to form patterns which are interpreted by traders to indentify a continuation or reversal of the

existing trend. It is also used to spot short term trading opportunities. Different traders make use of candlestick

charts differently. Candlestick patterns should be used in conjunction with the prevailing trend.

Candlestick also tends to act as a unique leading indicator providing the trader an edge while entering and exiting

a trade. It also gives an early signal of a reversal in trend compared to the rest of the technical indicators. Hence

it is widely used in short term trading and in volatile markets.

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Candlestick compliments most of the other technical analysis indicators and works well with the western technical
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tools.

Candlestick patters also tend to act as support or resistance levels and indicate the start of a pullback or bounce.

Time frame
Most candlestick patterns form over a period of 1-3 days, which makes them short-term patterns that are valid for

10-15 trading sessions. For example hammers and hanging man require just one day. Engulfing patterns, bullish

belt hold and dark cloud cover patterns require two days. Three white soldier and evening stars require three

days for the pattern to complete.

Preceding Trend
Candlestick patterns gain significance based on their location within the trend, a reversal candlestick pattern has

validity only if it is formed at the end of the current trend i.e. there should be a prior trend to reverse. Bullish

reversals require a preceding downtrend while a bearish reversal requires a prior uptrend. The direction of the

trend can be determined using trend lines, moving averages, peak/trough analysis or other aspects of technical

analysis.

Tussle between bulls and bears.

Candlestick depicts the fight between the bulls and bears over the set time period.

Long green candlestick indicates that the trading session was

controlled by the buyer’s i.e. bulls.
Long red candlestick indicated that the trading session was
controlled by the seller’s i.e. bears.
A long lower shadow indicates the bears controlled the price until the
bulls took control and made a strong comeback.
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A long upper shadow indicates that the bulls controlled prices until
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Small candlestick indicates that neither the bulls nor bears could gain
control over prices during the session.
A long upper and lower shadow indicates a volatile trading session
with both the bulls and bears having gained control but unable to
sustain the advantage.

Color of Candlesticks
The color of the candlestick depends on the preference of the trader. The commonly used combinations are

+ ve Day (Open Higher than close) -ve Day (Close lower than open)

Green Red

Blue Red

Hollow Filled

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