Know Thy Candlesticks!

(Author's Note: I decided to write this article also to practise my HTML & CSS skills. All diagrams were drawn in HTML & CSS, so you'll realise you can't quite right-click on them and save them as diagrams.)

What is a Candlestick?

A candlestick refers to a diagrammatic element devised by Homma to clearly display multiple data points of a trading commodity. In today's stock market terms, these data points refer to the open, high, low and closing price of an asset:

With reference to the diagram above, a candlestick has 3 key portions:

• Real Body: the part of the candlestick that is widest, representing the price range between the daily open and close prices
• Direction: an up (green) candle means that the day ended with the close price higher than the open price; vice versa for a down (red) candle - colours often used in place of direction
• Wicks: referring to the daily high and low prices

Candlesticks are one of the languages of technical analysis, and give the trader some sense of understanding of present market sentiments. Whether or not a trend persists depends on current circumstances, and thus the trader should not take candlesticks to be a firm prediction of the future. Often, we use candlesticks to determine whether we should cut our losing trades short, letting our winning trades run, and deciding on short-term entry/exit points. Therefore, candlesticks and their patterns must be read in the context of the entire price chart - one should combine them with other technical analysis indicators as well.

Types of Candlesticks

The candlesticks shown above are what we call "neutral" candlesticks (i.e. a candlestick with no particular indication of market sentiment by itself). Some special candlesticks contain more information about market sentiment, and should be memorised by the aspiring trader. More often, these candlesticks form components in more complex candlestick patterns.

• The Doji: this is a candlestick where the open and close prices are practically equal. This results in a cross-like shape, leaving only the wicks visible. When one sees a doji, there is a market-standoff - it represents indecision on the side of both buyers and sellers. Although a doji is often taught as a trend-reversal indication in most textbooks, in isolation, a doji is a neutral indicator that doesn't mean much, and isn't reliable for predicting price reversals. Therefore, I won't be going too much into what each of the following dojis may mean.

• The Spinning Top: Similar to the doji, this is a candlestick where the real body is very short relative to its wicks, but still having some significant difference between its open and close prices. It also indicates market indecision. But like the doji, by itself, it's notoriously unreliable and needs to be read in the wider chart context. In fact, because it is so commonly occurring and paired with so many stock market patterns, it has very little predictive power and requires what we call "confirmation candles" to ascertain the permanence of a trend.

• The Marubozo: The Japanese kanji is written as 丸坊主, which literally translates to "complete dominance". This is a candlestick where the wicks are entirely absent, and the real body is long, much longer than its adjacent candles on a stock price chart. When an up Marubozo is found in an upward trend, it is a clear bullish signal indicative of continued upwards momentum. Since it is a very strong candle, when found at the end of a downtrend, it can suggest a trend reversal. The converse is true for down Marubozo candles. Generally, the strength of prediction increases with trading volume.

As you can see, single candlesticks by themselves are not very useful. Regardless, the aspiring trader should still familiarise themselves with them because they are important components of more complex candlestick patterns - it is the language of the trader after all. At the very least, candlesticks are more useful than a simple line graph because the four data points give us some sense of whether buyers or sellers were pushing the day.

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