Candlestick

Candlestick is a visual tool that depicts fluctuations in an asset's past and current prices. The candle has three parts: the upper shadow, the real body, and the lower shadow. Stock market analysts and traders use this tool to anticipate future movement in an asset's price.

Market trends can be observed using a single candlestick or a combination of multiple candles—in a particular order. There are more than 40 technical candlestick patterns used in trading.

• A candlestick is a technical indicator used by market analysts, participants, and traders. Using this tool, traders predict future price movements of an asset. Analysts focus on the direction and size of the asset’s past and current performance.
• There are many different candlestick patterns—a shooting star, morning star, evening star, bearish engulfing, bullish engulfing, doji, bearish harami, bullish harami, inside bars, piercing patterns, etc.
• The technique was first used by a Japanese businessman to gauge the potential price of rice before entering into a rice contract. Munehisa discovered that rice prices vary according to demand, supply, and market sentiments.

The history of the candlestick can be traced all the way back to the 18th century. In 1750, Munehisa Homma invented this technical tool to gauge the potential price of rice before entering into a rice contract. Munehisa was a Japanese businessman. Munehisa discovered that rice prices vary according to demand, supply, and market sentiments.

This method is widely used in stock trading. Market participants, intraday traders, and investors use this tool to predict possible price changes and the performance of a particular security.

As shown in the diagram, the candle is divided into the following three parts:

• Upper Shadow: The upper wick or shadow indicates the high trading session. If the upper shadow is longer, the asset price surpasses the open and close price. At the same time, a short upper shadow reflects asset trading close to its opening and closing price.

• Real Body: The real body gauges the opening and closing price. If the candle body is a solid red or black, then the closing price is low. On the other hand, a hollow green or white candle represents a high closing price.

• Lower Shadow: The lower wick or shadow depicts the low trading session. If the lower shadow is long, then the asset price is on the lower side. On the other hand, a short lower shadow depicts asset prices that trade close to a low open or close point.

A candle has four different data points:

1. Open: ‘Open’ is the price at which the asset trades at the very beginning of the intraday (or the given period).
2. High: The top of the upper shadow or wick represents the high price point of an asset. However, if the asset opens or closes at its highest price, an upper shadow is not formed.
3. Low: Similarly, the bottom of the lower shadow reflects the low price point of an asset. Again, if the price opens or closes at its lowest, the lower shadow is absent.
4. Close: It is the closing price at which the last trade is made at the end of the intraday or the given period.

Many indicators use multiple candlesticks formed at regular intervals, say two days, a week, or every day of the month. This way, asset price predictions are more accurate.

In trading, there are around 35 to 42 candlestick patterns, but some of the best tools used for determining the asset price variations are as follows:

#1 - Bullish and Bearish Engulfing

Bullish engulfing is a candlestick pattern that emphasizes buying an asset when the price is at the bottom of the downward movement. The bearish engulfing is the polar opposite—the pressure is to sell the asset when the price marks the top of its upward trend.

The TradingView chart shows a perfect bullish engulfing pattern for Mafatlal Industries at the end of the chart. The green candle totally engulfs the previous red candle, indicating a highly bullish trend soon because the buyers have pushed the prices up further even though the sellers have tried to push it down to some extent.

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The chart given below for Tata Consultancy Services, shows the bearish engulfing pattern where the red bearish candle completely engulfs the green one, providing the indication for downtrend.

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#2 - Bullish and Bearish Harami

The bullish harami candle analyzes the upward price gap over two days; on the first day, the candle seems to be red, indicating a significant bullish trend. On the second day, it represents a smaller bullish price movement. The bearish harami candle, on the other hand, shows a downward price gap—on the first day, the candle is large (very bearish). But on the second day, the candle becomes smaller (less bearish).

The below given chart is of bullish harami, related to Kotak Bank, the pattern is clearly visible, and the small green candle is entirely engulfed by the previous day’s big red candle.

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The below give chart of Aurobindo Pharma shows a bearish harami pattern where a small red candle appears after the big green one and is entirely enclosed within the previous green candle.

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#3 - Evening Star and Morning Star

The evening star is a reversal pattern that can be observed at the top of an upward price trend. It is expected to be followed by a bearish pattern. The morning star, on the other hand, is observed at the bottom of the downward trend—it is often followed by a bullish movement.

From the chart of Cummins India given below the morning star pattern is clearly visible. And marked in green box. This shows a upward trend which is what exactly happened after the pattern.

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The chart of SBI Life Insurance shows the evening star pattern clearly identified.

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#4 - Shooting Star

When it comes to intraday trading, the shooting star is one of the most effective candlestick patterns. It is a bearish candle that follows the upward trend—the upper shadow is long, and the lower shadow is negligible. Also, it represents a small body—usually close to the value of the day's low.

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#5 - Inside Bars

It is a two-bar candlestick where one is the mother bar, and the other is the inside bar. The inside bar is shorter than the mother bar lying within the high and low range of the mother bar. The asset price follows market trends—the trader, therefore, can opt for a short position on the downward trend and a long position on the uptrend.

In the Nifty chart below, the inside bar appears at the end of the chart. It is a powerful trading signal, and the formation of the second candle shows a possible bearish trend in future.

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#6 - Piercing Pattern

It is a bullish reversal candlestick. It indicates an upwards movement closely preceded by a downtrend. The reversal occurs in the short term. Here, the price movement is observed for two days. On the first trading day, the asset price opens high and closes low; on the second day, the asset price opens low and closes high.

Given below is the piercing pattern of MARUTI SUZUKI, which is marked within a box in the chart. The pattern is clearly visible.

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#7 - Hammer

This candlestick pattern depicts a small real body but a long lower shadow. Since the trend follows an asset's price fall, it is considered the best time for investors to enter the market. However, the body can be bullish or bearish—investors prefer a bullish movement.

In the chart below, the hammers are marked in green with arrows.

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#8 - Dark Cloud Cover

This bearish reversal candlestick highlights a weak uptrend—it signals a reversal. Here the opening price is often more than the previous day's closing price. Also, the closing price is lower than the last bullish movement's midpoint.

The pattern can be seen in the chart of Edelweiss. At the end of the chart the pattern is formed.

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#9 - Doji

It is a transitional candlestick pattern that identifies a possible reversal of the ongoing trend. It signifies market indecisiveness. Also, this candle has a small body, a long upper wick, and a long lower tail. It is seen, at the top of uptrends, at the bottom of the downtrends, or right in the middle. 

In the chart below, there are several doji candles that are visible and marked with a plus sign above then. They are important and traders should note them because such patterns indicate indecision. It is better to wait and watch for the next market move.

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#10 - Long Wicks

It gauges market trend reversals and significant price movements—in the given period. Here, prices are tested and rejected, forming long wicks.

The chart below shows various candlesticks with long wicks, which are easy to detect.

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This has been a guide to Candlestick & its definition. We explain candlestick trading patterns, types, stock analysis, charts, & trends–reversal, bearish, and bullish. You can learn more about it from the following articles – 

• Technical Indicator
• Technical Analysis
• Technical Analysis Books