A candlestick chart is a type of price chart that originated in Japanese rice trading in the 18th century.
Candlesticks are used to describe price action in a market during a given time frame
They are commonly formed by the opening prices, highs, lows and closing prices of financial instruments on an exchange
When combining candlesticks, they form patterns that serve to predict the short-term and long-term price movements of an asset
In this article, you will learn the basics about candlesticks in trading.
Where did candlestick patterns originate?
If you follow any news on cryptocurrency trading, you’ll have probably heard of something called “candlesticks” or “candles” for short, which form “candlestick patterns”, where the relationship of a minimum of two candlesticks is viewed.
Let’s journey back in time to the 1700s in Japan, when rice traders were looking for a way to better track the price movements of rice. What they apparently noticed during their analyses was that the price trends of rice were heavily influenced by market emotion, as well as the traditional measures of supply and demand.
These observations inspired the development of the first candlestick patterns and candlestick charts - highly effective trading tools that provide insight into market emotion. By the term “market emotion”, we mean the effect of general sentiment and feeling on the price of an asset, namely the reaction of market participants to changes in the market.
Careful study of candlesticks reveals a number of details on price action or the movement of a trading pair over a given time period, such as hours, days, weeks, months and so on.
In the Western world, traders have used data provided by candles since the 1990s to work on predictive models projecting how assets will grow in the future. When using candlestick patterns to make trading decisions, a trader needs to know what the key elements of candlesticks stand for and how and why they form certain patterns.
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The body of a candlestick
The most visible part of a candlestick is called the “body”. The body represents the price range between the opening price and the closing price over a certain period of time, like one day.
Don’t forget, like we said, it can also represent one month, one day or one hour, depending on the settings in the trading chart you are viewing.
You can look at candlesticks in terms of both short- and long-term.
Here again, the definition of “short-term” and “long-term” depends on your own perception. For some trades, 15 minutes can mean “long-term” and 1 minute “short-term”.
Lower wick and upper wick of candlesticks
The thin lines above the body and below the body are commonly referred to as the “wick” or the “shadow”.
The top of the upper wick indicates the highest price the asset reached during the time period specified. The bottom of the lower wick indicates the lowest price of an asset during that time frame. It is worth noting that a candle does not have a wick if the open or close price equals the high or low.
Consequently, the “opening” price of a trading pair indicates the price at which trading began during a certain time period, while the “closing” shows the price at which trading with it stopped, in the same time period. So, again, the wick itself just illustrates the difference between these two prices and the high and low for the trading pair that the candle is helping to map out.
Therefore, the body shows the entire price change of a trading pair, typically over the course of a day to even several months of trading. The represented time range presented in a price chart depends on what a trader has selected and wants to see. Most exchanges offer a variety of ranges for viewing on their user interfaces.
What is a candlestick pattern?
It goes without saying that there is a vast range of candlestick patterns, ranging from basic patterns to very intricate and detailed visualisations, which we will describe in more detail in the Expert section of the Bitpanda Academy. In this article, we just briefly want to describe the basics.
Every candlestick pattern consists of a group of candlesticks that illustrates whether price development of an asset is “bullish” or “bearish” - “bullish” meaning trending upwards in price, while “bearish” means trending downwards in price. To speak of a pattern, you need to analyse the relationship of at least two candles but usually the relationship of more candles than two yields a clearer analysis.
Thus, the more data that is available the better. A pattern that represents developments across one month or a longer period is usually more useful to analyse long-term trends than a pattern that represents just a day. Still, your choice always depends on your trading strategy - just ask any day trader. Now let us look at the details of the image shown below. To keep things simple, we will look at this illustration in a very basic sense.
This pattern would be considered part of a “bullish engulfing pattern.” Why?
In this image, you can clearly see that the open price is lower than the close price of the previous candle and the close price is higher than the previous open price.
Let us say that the pattern in this image represents a close-up of a price change of the BTC/EUR trading pair over a six-month period from January to June and that here we are just looking at the months March and April.
Bullish and bearish engulfing patterns - examples
If the small candle represents the month of March and the largest candle to its right represents April, the first thing we can conclude is that April represented a complete turnaround in terms of the price movement. We can see where the pattern gets its namesake: April’s candle literally “engulfed” the candle of March like a wave with regards to its positive movement - it sticks up further towards the top and lower towards the bottom.
Therefore, these patterns indicate that the sentiment of investors is about to change and that the asset is expected to have a bullish movement - the “bearish” trend was literally engulfed by a change in market emotion in April. Traders became more confident in its value and continued trading it upwards past May. Now take a look at this trend from a wider perspective in the image below:
When taking in the entire graph as a single trend, traders studying candlestick patterns would say signs indicate that the price movement will continue to be bullish past June as the price trend is up.
See the illustration of the reverse pattern below. It is a bearish engulfing pattern where a price decline can be anticipated:
Do your research
There are many important candlestick patterns for you to discover, including the “head and shoulder”, “bat pattern”, “ABCD pattern” and “Cypher pattern” among many others.
Whether or not you decide to use candlestick patterns in your trading decisions, always keep in mind that nothing can perfectly predict the future of any asset’s price movements. It is best to think of candlestick patterns, like other tools we have discussed in these trading-focused articles, as guides for making your trading decisions.
However, you have to do your own research before trading because no one else can make trading decisions for you. At this point, you have learned about all of the basic trading tools and terminology except for how to navigate trading fees.
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