Candlesticks

Here is a recap of the main components of a candlestick (using green bodies instead of blue).

Bulls and bears (bullish and bearish) are popular trading terms. A bull expects prices to rise. A bear expects prices to fall. To better appreciate those terms, think of how a bull attacks, and how a bear attacks. A bull butts in an upward motion; a bear claws downward. Hence, bullish = rising; bearish = falling.

The main part of a candlestick is the body (the part that forms the rectangular shape between the open and close points). Traditional Japanese candlesticks used black and white bodies, but most modern day analysts use green (or blue) and red. These colors better define the market direction, and are more visually attractive.

A green body means that the closing price is higher than the opening price. Therefore, the price has increased over the period. A red body means the closing price is lower than the opening price. Therefore, the price has decreased over the period.

The thin lines at the top and lower end of the candlestick bodies are called the 'wicks'. The top of the upper wick is the high price of the period. The lowest point on the lower wick is the low price of the period.

Sometimes there is no wick on the upper end of the candlestick body. This means that the closing price (in the case of a green candle) or the opening price (in the case of a red candle) is equal to the high price. Conversely, if there is no wick at the lower end of the candlestick body, it means that the open price (in the case of a green candle) or the close price (in the case of a red candle) is equal to the low price of the trading period.

A trading period can be a week, a day, an hour, half hour, ten minutes, five minutes, etc. Our trading strategy uses five-minute candlesticks.

There are several candlestick types, none critical to our strategy. But we'll nonetheless explain the more popular types as they will help you better interpret price movements on your charts.

Candlestick Types

Long Periods

Long periods show a significant gap (depicted by the long body) between the open and close prices during the trading period. Usually the wicks at either end of the candlestick body are short, indicating that the market moved primarily in one direction during the period.

Short Periods
Short period candlesticks with compressed bodies indicate that there was very little price movement during the trading period.

As with a long period candlestick, a short period candlestick has short wicks at either end. This indicates very little price fluctuation, for example between open price and low price and between close price and high price for a bullish (rising) green candlestick.

Doji

Doji candlesticks have the same open and close price.

A Long-Legged DojiA Long-Legged Doji has long wicks protruding from it. This indicates that during the trading period there was considerable fluctuation on both sides of the open price. But the period ended with the close price retracting back to the open price. It suggests indecision in the market.

A Dragonfly DojiA Dragonfly Doji has only one long wick, on the lower end of the open and close price. This indicates that all price activity during the trading period was on the lower side of the open price, but by the end of the trading period the price moved back up to the open price. It hints at a bearish trend reversal, i.e. price is expected to increase.

A Gravestone DojiA Gravestone Doji is the opposite of a Dragonfly and again has one long wick to the high side of the open and close price. It indicates that during the period all price activity was at the upper end, but that the price retraced back to open price by the end of the trading period. It hints at a bullish trend reversal, i.e. price is expected to decrease.

A 4-Price DojiA 4-Price Doji suggests that for the trading period, the open, close, high and low price points were the same. This normally happens when trading is suspended, or when the price feed to the chart is interrupted.

Hammer

A hammer is a very important indicator of trend reversal. It is called a hammer because the market is attempting to hammer out a market bottom. It suggests that a bullish trend is on the way, whether the body is green or red.

The hammer appears during a downtrend only. The body of the hammer has a long wick on the underside - at least 2-3 times the length of the body, and little if any wick on the upside. The color of the body does not matter.

Hanging Man

 

A Hanging man is so-called because it has the shape of a man in hanging position with his legs dangling underneath. It occurs during an uptrend only. It is a very good indicator of a trend reversal to a bearish market.

The body is at the upper end of the trend and has little or no wick to the upside. The body has a wick at least 2-3 times its length to the underside. The hanging man market period is preceded by uptrend periods. The color of the body is not important to the trend reversal, although a red hanging man is more bearish than a green hanging man.

Engulfing

Engulfing occurs when a candlestick's body completely engulfs that of the preceding candlestick. It indicates a trend reversal.

When a green body engulfs a red body from the preceding period, this indicates a bullish (upward) trend. Likewise, when a red body engulfs the green body of the preceding trading period, this indicates a bearish (downward) trend.

Inverted Hammer

The inverted hammer usually occurs at the bottom of a downtrend and can indicate a trend reversal.

The hammer has a smallish body at the bottom of the price range. It has a very long wick protruding upwards from the body. It is only evident on a downtrend. The body of the hammer is green and the opposite color of the larger body preceding it, which is red.

Shooting Star

A Shooting Star is a bearish pattern and occurs when a small green body with a long upside wick follows a long green body, during an uptrend. The star body indicates that the market price opened and rallied upwards, before falling back significantly by the close.

How to recognize a Shooting Star: It happens during an uptrend. The smaller body has a long wick pointing upwards. The smaller body is preceded by a much longer upward trending body.

Piercing Line

The Piercing line is a bullish indicator that indicates a trend reversal. A long green body follows a long red body, but the close price of the green body is above the midpoint of the preceding red body.

How to recognize a Piercing Line: It happens during a sustained downtrend. The opening price of the green body is below the close point of the red body; the green body pierces the mid-point of the preceding trading (red) period.

Dark Cloud Cover

The Dark Cloud Cover is a bearish pattern and an indicator of trend reversal. It is made up of a long green body followed by a long red body, where the price peaks on the red body, before falling extensively.

How to recognize a Dark Cloud Cover: It occurs in an uptrend only. A long green body is followed by a long red body, where the high price on the red body is above that of the green body, and where the red body pierces the mid-point of the preceding green body.