Reading Candlestick Charts

Candlestick Charts are price sequences that are plotted over a specific time frame. For example – the following is a Price Chart for IBM:

Short-term traders will want to read to the price movement to understand where the stock is headed. They can read the price chart one of two common ways – Bar Chart or Candlestick Chart. To show you the difference, I want you to look at the same IBM Price Chart above – but now in a Bar format.

See the difference??

Ok..let me help. In both charts you see the overall trend of the stock price; however, you can see how much easier looking at the change in body color of the candlestick chart is for interpreting the day-to-day sentiment.

Because the Candlestick Chart is more commonly used, I will focus on Candlestick charts and not Bar charts.

Looking at a Candlestick Chart can be very confusing and hard to understand. So I will explain Candlestick Charting and hopefully make it easier to understand.

.. a little history.

The candlestick techniques used today go back to 1700 when a Japanese man discovered that although there was a link between price and supply and demand of rice, the markets (futures markets then), were strongly influenced by the emotions of the traders. Those same emotions exist today and are used to measure the market emotions of traders surrounding a stock.

The top three Candlestick Patterns

There are hundreds, maybe even thousands, of candlestick patterns that have been identified and used by investors to make trading decisions.

I will introduce you to three of the most common ones. It is important to mention that you will need to use Candlestick indicators with other analytical tools if you want to make effective trading decisions.

The Bullish Engulfingindicator is a two day pattern. The first day’s body is smaller than the subsequent candlestick, and they are both of opposite colors. If this pattern appears at the end of an uptrend, then this is a bearish trend. If the pattern appears at the end of a down trending stock, then it represents a bullish trend.The Psychology behind this is that if you do not see much volume occurring on the 1st day of this formation compared to the 2nd day, then this increases the strength of the pattern. The 2nd day will open low and below the close of the 1st day, and then quickly rally to close above the open of the 1st day. This prompts additional buying in the coming days.

The Morning Starformation is considered a three day bullish reversal pattern. The 1st day is a long bodied black first day.The 2nd day is a short gap down, below the 1st day’s close. The 3rd day is a long white bodied candle, which closes above the midpoint of the first day.The psychology of this formation is that the 2nd day gaps lower, but trades in a small range. The bullishness of this indecision is confirmed by the higher close of the 3rd day. As a trader you will be looking for higher prices.

The Bullish Hammeris another trend that signifies a reversal. First you should see a small real body at the upper trading range. This means that trading has occurred significantly below the open, but ends well above the low and closes as its high, the candlestick formed has only one tail below its body. When this formation occurs during a downtrend, it often signals a reversal.

Note that the color of the body is not important, and that the long lower shadow will be at least twice the length of the body. In addition there will be little or no upper shadow. Finally the previous trend should be bearish.

The psychology of this pattern is that the price has gone much lower than the open then closes near the opening price. This fact reduces the confidence of the bears. Ideally, a white real body Hammer with a higher open the following day could be a bullish signal for the days ahead. As with any single candlestick, confirmation is required.

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