Technical Classroom: What is Candlestick Chart Pattern?

Each "candlestick" typically shows one day; however being densely packed with information, candlestick tend to represent price action and trading patterns over the specific time frame.

History

The candlestick chart is a chart variant that has been used for around 300 years and discloses more information than your conventional line chart. Much of the credit for candlestick development and charting goes to a legendary Japanese rice trader named Homma Munehisa from the town of Sakata.

It is likely that his original ideas were modified and refined over many years of trading eventually resulting in the system of candlestick charting that we use today. Lately, they were properly documented & explained by Steve Nison in his book, Japanese Candlestick Charting Techniques.

Formation of Candlestick

A candlestick depicts the battle between Bulls (buyers) and Bears (sellers) over a given period of time. All known information is reflected in the price. The relationship between the open and close is considered vital information and forms the essence of candlesticks. Hollow candlesticks, where the close is greater than the open, indicate buying pressure. Filledcandlesticks, where the close is less than the open, indicate selling pressure. One can find below explanation of the important terms in candlestick chart.

• Upper Shadow: The vertical line between the high of the day and the close in case of bullish candleor high and the open in case of bearish candle is called as “Upper Shadow”. The high is marked by the top of the upper shadow.

• Lower Shadow: The vertical line between the low of the day and the open in case of bullish candleor low and close in case of bearish candle is termed as “Lower Shadow”. The low is marked by the bottom of the lower shadow.

• Real Body: The difference between the open and close; colored or hollow portion of the candlestick is called “the body” (also referred to as “the real body”). This real body represents the range between the open and close of that day's trading. When the real body is filled in or black, it means the close was lower than the open. If the real body is empty, it means the opposite: the close was higher than the open.

• Bullish Candle: Formation of the candle, when the close is higher than the open price on candlestick chart is called as ‘Bullish candle’ and that candle is indicated by green or white in colour.

• Bearish Candle: Formation of the candle, when the close is lowerthan the open price on candlestick chart is called as ‘Bearish Candle’ and that candle is indicated by red or dark in colour.

• Prior Trend: The direction of the trend can be determined using trend lines, moving averages, peak/trough analysis or other aspects of technical analysis.Bullish reversals require a preceding downtrend and bearish reversals require a prior uptrend.

Interpreting Candlestick

The relationship between the day's open, high, low and close determine the look of the daily candlestick. Interpreting candlestick is very important to understand price action.

• Open Price- Start (low) of the real body (in case of bullish candle) or end (high) of the real body (in case of bearish candle).
• High Price– High of the upper shadow.
• Low Price– Low of the lower shadow.
• Close Price-End (high )of the real body(in case of bullish candle) or Start(low )of the real body(in case of bearish candle)
• Direction– Looking at colour of real body, direction of price action is defined.
• Range- The candlestick is a thin vertical line showing the period's trading range or difference between high or upper shadow and low of lower shadow is called as “Range”.

Candlestick Patterns

Candlestick patterns can be made up of one candle or multiple candlesticks, and can form reversal or continuation patterns. Some of the most useful & popular patterns are mentioned below, we will be understanding them in details in coming sessions.

1. Bullish Engulfing
2. Bearish Engulfing
3. Evening Star
4. Morning Star
5. Hammer

6. Hanging Man
7. Harami
8. Dark Cloud Cover
9. Dragonfly Doji
10. Gravestone Doji

Simple patterns are depicted in the section above, there are more complex and difficult patterns which have been identified since the candlestick charting method's inception.

Conclusion

• The daily candlestick contains the stock's value at open, high, low and close of a specific day.

• Candlestick provides an easy-to-decipher picture of underlying price action.

• A hollow body signifies that the stock closed higher than its opening value shows bullishness. A filled body signifies that the stock closed lower than its opening value suggests bearishness.

• The longer the body is, the more intense the buying or selling pressure; however short candlesticks indicate little price movement and represent consolidation or range bound movement.

• The long thin lines above and below the body represent the high/low range and are called “shadows” (also referred to as “wicks” and “tails”).

• They are often used today in stock analysis along with other technical analysis tools such as Fibonacci retracement, moving averages etc.

Disclaimer: The author is a Head – Technical & Derivative Research at Narnolia Financial Advisors. The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.