The Market Doesn't Speak English, It Speaks Candlesticks: A Beginner's Guide to Reading Price Charts
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You have probably seen them: red and green candles littering an asset’s chart.
If they all look confusing, you might have wondered why traders don’t just stick to line charts. With those, you can easily see when the market is going up or down.
Well, candlestick charts provide more important information that line charts can’t replicate: the intricate battle between sellers and buyers. As a result, they show when one side is dominating and when dominance is about to shift.
Once you understand them, you’ll easily see why traders rely on them (though not exclusively) to understand market movements and make informed decisions.
Below, we introduce you to the basic principles you need to work with candlestick charts.
Understanding red and green candles
Every candlestick contains four pieces of information:
Opening price: The price at which the asset starts trading in the relevant period. For a daily chart, it is the price at which it starts trading that day.
Closing price: The price at which the asset closes at the end of the trading period.
High price: The highest price the asset traded at during the period.
Low price: The lowest price the asset traded at during the period.
Whether a candle is red (bearish) or green (bullish) depends on which is higher: the opening price or the closing price.
As shown below, a red candle opens higher and closes lower, indicating bearish momentum. For a green candle, the closing price is higher, indicating bullish momentum.
Understanding wick length and body size
A candlestick has two main components: the wick and the body.
The body shows the opening and closing price, while the wicks show the highest and lowest price.
The size of these two components also matters.
A large body shows a significant gap between the opening and closing price. This means the battle was easily decided in favour of one side. In other words, price moved decisively in the direction of the buyers (green candle) or the sellers (red candle).
On the other hand, a small body shows there was a tense battle. Though either side still won, they couldn’t decisively control the momentum.
Similarly, a long upper wick shows buyers dominated at one time but couldn’t sustain the pressure to close near the high. At the opposite end, a long lower wick indicates that sellers dominated at one time but couldn’t sustain selling pressure to push price near the low.
Bearish and bullish candlestick patterns
Candlestick chart patterns are common formations that show price action and where it is likely headed.
These patterns can occur in a single candlestick or across multiple candlesticks.
Candlestick patterns can also be bullish (price will go up) or bearish (price will go down).
They can also be reversal or continuation patterns. A bullish candlestick pattern is a bullish continuation pattern in a bullish trend and a bullish reversal pattern in a bearish trend. A bearish candlestick pattern is a bearish continuation pattern in a bearish trend and a bearish reversal pattern in a bullish trend.
Once you understand the previous two sections, interpreting candlestick chart patterns becomes easy.
Let’s exemplify with the Shooting Star.
Notice the small body, which shows a close struggle between buyers and sellers.
Then look at the wicks. A long upper wick shows that buyers actually dominated at a point. And this makes sense since we are in an uptrend. But buyers couldn’t sustain the pressure as sellers asserted themselves, causing price to close far below the high.
This candlestick is bearish because it shows weaker buying momentum and stronger selling momentum.
Apply the same analysis to other candlestick chart patterns, and you’ll see how intuitive they are. You don’t need to cram anything.
Candlestick charts and sound trading
If you are learning how to begin day trading, interpreting candlesticks is one of the skills to learn.
As we have seen, they give you information about the relationship between buyers and sellers and potential changes in market momentum.
Even if you are learning how to invest in an IPO, waiting for candlesticks to form can help you make more precise entries when you are not fully confident about the IPO price.
Irrespective of your trading strategy, understanding candlestick chart patterns is crucial. But you must not use them in isolation. Combine them with price chart patterns, indicators, and key levels, and you'll be ready to gain a mastery of technical analysis.
