How to Use Candlestick Chart to Buy/Sell Stocks?

Ganesh Adhikari  

Japanese candlestick charts or simply candlestick charts were discovered by a Japanese man named Munehisa Homma, a rice trader in the 18th century. The western world only adopted it only 100 years later after they were introduced by Steve Nison in the book, Japanese Candlestick Charting Techniques. Candlestick charts are often used by traders to make trading decisions. Candlestick charts provide far greater than any other type of chart, so it is used and appreciated by all the traders.

A Candlestick chart is a kind of financial chart that narrates the price movements of a security, asset, or currency. The major theory behind the candlestick chart is the influence of the emotions of traders on the demand and supply of securities. Candlestick charts are used to determine the upcoming price movements in the market based on the patterns formed in the past trading sessions. Candlestick charts look similar to bar charts but are densely contained with trading information. The charts consist of four main components: open and closing prices are represented by the candle body and high and low prices for the specific trading session are represented by the “candlewick”. The candlestick charts can be obtained for different trading sessions (minute, hour, day, week, month, etc.),

The candle body is filled with different colors to show if the closing was higher or lower than the opening. Traditionally when the body is black it means the close was lower than the open while the empty candle body represents the open being lower than the closing price.

As of now, often traders use green color to represent the up candle (price closes higher than the opening price) and red color to represent down candle.

Candlesticks often create patterns (repetitive models) that help the traders to analyze the movement of the stock and make effective trading decisions. There are two types of candlestick patterns: bearish candlestick patterns and bullish candlestick patterns.


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Basic Candlestick Patterns and Their Use in Trading Stocks

1. Bearish Engulfing Pattern

A bearish engulfing pattern is seen in a bullish trend when the sellers take control of the market. The bearish engulfing is the signal for a potential decline in price movement. The chary pattern consists of a small green candle (up candle) followed by a large engulfing or eclipsing the smaller candle.


 2. Bullish Engulfing Pattern

A bullish engulfing pattern is sighted when a small down candle (red) is engulfed by a large up candle (green) candle. The small red candle preceding the large green candle means the buyers are outnumbering the sellers or the demand is higher than the supply. This causes the market to take upward momentum. When the green candle is preceded by four or more down candles the reversal in trends is more likely to happen.

 Note: The smaller candle must be completely engulfed by the larger candle for the bearish and bullish engulfing pattern to complete the pattern.

3. Bearish Evening Star

A bearish evening star is a signal for a potential bullish reversal. The evening star is formed in candlestick charts by three candles: a large up (green) candle, a small-bodied candle (either red or green), and a large down candle (red). The bearish evening star is one of the rarest candlestick patterns but very reliable. The opposite of the bearish evening star is the morning star which is a bearish reversal pattern.


4. Bearish Harami

During an uptrend, when a small down candle is completely inside the preceding up candle. The pattern represents the indecision phase which results in a downtrend when it is followed by another red candle. But bearish harami followed by another green candle means the uptrend will remain.


5. Bullish Harami

A bullish harami is the opposite of bearish harami formed in the downtrend. The pattern is seen when a small red candle is seen inside a larger green candle. Conversely to bearish harami, the pattern must be followed by another green signal to confirm the trend reversal.


6. Bearish Harami Cross

A bearish harami is a reliable candlestick pattern. The bearish harami cross pattern occurs during an uptrend when an up candle (green) is followed by a Doji. A Doji is a pattern when is formed when a candlestick has virtually equal open and closing prices in the given trading session. The Doji must be within the body of the previous up candle. The bearish harami cross is confirmed if the doji is followed by a red candle.


7. Bullish Harami Cross

A bullish harami cross is seen during a downtrend which is the opposite of a bearish harami cross. The bullish harami cross occurs when the doji is inside the body of the prior down candle. This signals the trend reversal in the upward direction. The bullish harami is confirmed if the doji is followed by a green candle.


8. Abandoned Baby

A bullish abandoned baby cues the reversal of a downtrend momentum. The abandoned baby is composed of three candlesticks: a large red candle, a doji candle in the middle below the first down candle, and a green candle that opens above the doji and makes a sharp move upwards. Here, doji shows the sellers are being outpaced or losing momentum to the buyers. The long green candle following the doji confirms it. The opposite of a bullish abandoned baby is a bearish abandoned baby that indicates the reversal of an uptrend.


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Some of the other bullish and bearish candlestick patterns are:

  1. Hammer and inverted hammer
  2. Piercing line
  3. Three white soldiers
  4. Dark cloud cover
  5. Hanging man
  6. Three black crows
  7. Three line strike
  8. Two black gaping

Conclusion

Candlestick chart patterns are a must-know for a technical analyst to time the trading. Candlestick charts try to best describe the emotions of traders by tracing the price movements. As we know the biggest factor affecting the momentum of the market is the emotions of fear and greed, Japanese candlestick charts weigh the emotions and help the traders to predict the future price momentum of the assets or the securities. The candlestick chart patterns are certainly a very powerful tool for both the short-term and the intermediate-term traders. Termed as the ‘cornerstone of technical analysis’, the candlestick charts are very effective and aid the traders in profiting in the market at a glance.


From The Author:

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