The best way to explain candlesticks is by using a picture:
If the close is above the open, then a hollow candlestick (usually displayed as white) is drawn. If the close is below the open, then a filled candlestick (usually displayed as black) is drawn.The hollow or filled section of the candlestick is called the “real body” or body.
The thin lines poking above and below the body display the high/low range and are called shadows.
The top of the upper shadow is the “high”.
The bottom of the lower shadow is the “low”.
CANDLESTICK BODIES - Just like humans, candlesticks have different body sizes. Long bodies indicate strong buying or selling. The longer the body is, the more intense the buying or selling pressure. Short bodies imply very little buying or selling activity.
Long black (filled) candlesticks show strong selling pressure. The longer the black candlestick, the further the close is below the open. This indicates that prices fell a great deal from the open and sellers were aggressive.
Shadows - The upper and lower shadows on candlesticks provide important clues about the trading session. Upper shadows signify the session high. Lower shadows signify the session low. Candlesticks with long shadows show that trading action occurred well past the open and close.
Candlesticks with short shadows indicate that most of the trading action was confined near the open and close.
If a candlestick has a long lower shadow and short upper shadow, this means that sellers flashed their washboard abs and forced price lower, but for one reason or another, buyers came in and drove prices back up to end the session back near its open price.
Basic Candlestick Patterns
Spinning Tops
Candlesticks with a long upper shadow, long lower shadow and small real bodies are called spinning tops. The color of the real body is not very important.
The pattern indicates the indecision between the buyers and sellers.
Even though the session opened and closed with little change, prices moved significantly higher and lower in the meantime. Neither buyers nor sellers could gain the upper hand, and the result was a standoff.
If a spinning top forms during an uptrend, this usually means there aren’t many buyers left and a possible reversal in direction could occur.
If a spinning top forms during a downtrend, this usually means there aren’t many sellers left and a possible reversal in direction could occur.
Marubozu
Marubozu means there are no shadows from the bodies. Depending on whether the candlestick’s body is filled or hollow, the high and low are the same as it’s open or close. If you look at the picture below, there are two types of Marubozu.
A Black Marubozu contains a long black body with no shadows. The open equals the high and the close equals the low. This is a very bearish candle as it shows that sellers controlled the price action the whole entire session. It usually implies bearish continuation or bearish reversal.
Doji
Doji candlesticks have the same open and close price or at least their bodies are extremely short. The doji should have a very small body that appears as a thin line.
Doji suggest indecision or a struggle for turf positioning between buyers and sellers. Prices move above and below the open price during the session, but close at or very near the open price.
Neither buyers nor sellers were able to gain control and the result was essentially a draw.
There are four special types of Doji lines. The length of the upper and lower shadows can vary and the resulting candlestick looks like a cross, inverted cross or plus sign. The word "Doji" refers to both the singular and plural form.
When a doji forms on your chart, pay special attention to the preceding candlesticks.
If a doji forms after a series of candlesticks with long hollow bodies (like white marubozus), the doji signals that the buyers are becoming exhausted and weakening. In order for price to continue rising, more buyers are needed but there aren’t anymore! Sellers are looking to come in and drive the price back down.
If a doji forms after a series of candlesticks with long filled bodies (like black marubozus), the doji signals that sellers are becoming exhausted and weakening. In order for price to continue falling, more sellers are needed but sellers are all tapped out! Buyers are waiting for a chance to get in.
Reversal Patterns
Prior Trend
For a pattern to qualify as a reversal pattern, there should be a prior trend to reverse. Bullish reversals require a preceding downtrend and bearish reversals require a prior uptrend. The direction of the trend can be determined using trend lines,moving averages, or other aspects of technical analysis.
Hammer and Hanging Man
The hammer and hanging man look exactly alike but have totally different meaning depending on past price action. Both have little bodies (black or white), long lower shadows and short or absent upper shadows.
When price is falling, hammers signal that the bottom is near and price will start rising again. The long lower shadow indicates that sellers pushed prices lower, but buyers were able to overcome this selling pressure and closed near the open.
Word to the wise… just because you see a hammer form in a downtrend doesn’t mean you automatically place a buy order! More bullish confirmation is needed before it’s safe to pull the trigger. A good confirmation example would be to wait for a white candlestick to close above the open of the candlestick on the left side of the hammer.
Recognition Criteria:
•The long shadow is about two or three times of the real body.
•Little or no upper shadow.
•The real body is at the upper end of the trading range.
•The color of the real body is not important.
The hanging man is a bearish reversal pattern that can also mark a top or strong resistance level. When price is rising, the formation of a hanging man indicates that sellers are beginning to outnumber buyers. The long lower shadow shows that sellers pushed prices lower during the session. Buyers were able to push the price back up some but only near the open. This should set off alarms since this tells us that there are no buyers left to provide the necessary momentum to keep raising the price.
Recognition Criteria:
•A long lower shadow which is about two or three times of the real body.
•Little or no upper shadow.
•The real body is at the upper end of the trading range.
•The color of the body is not important, though a black body is more bearish than a white body.
Inverted Hammer and Shooting Star
The inverted hammer and shooting star also look identical. The only difference between them is whether you’re in a downtrend or uptrend. Both candlesticks have petite little bodies (filled or hollow), long upper shadows and small or absent lower shadows.
The inverted hammer occurs when price has been falling suggests the possibility of a reversal. Its long upper shadow shows that buyers tried to bid the price higher. However, sellers saw what the buyers were doing, said “oh hell no” and attempted to push the price back down. Fortunately, the buyers had eaten enough of their Wheaties for breakfast and still managed to close the session near the open. Since the sellers weren’t able to close the price any lower, this is a good indication that everybody who wants to sell has already sold. And if there’s no more sellers, who is left? Buyers.
The shooting star is a bearish reversal pattern that looks identical to the inverted hammer but occurs when price has been rising. Its shape indicates that the price opened at its low, rallied, but pulled back to the bottom. This means that buyers attempted to push the price up, but sellers came in and overpowered them. A definite bearish sign since there are no more buyers left because they’ve all been murdered.
Summary of Candlesticks
Candlesticks are formed using the open, high, low and close.
•If the close is above the open, then a hollow candlestick (usually displayed as white) is drawn.
•If the close is below the open, then a filled candlestick (usually displayed as black) is drawn.
•The hollow or filled section of the candlestick is called the “real body” or body.
•The thin lines poking above and below the body display the high/low range and are called shadows.
•The top of the upper shadow is the “high”.
•The bottom of the lower shadow is the “low”.
Long bodies indicate strong buying or selling. The longer the body is, the more intense the buying or selling pressure.
Short bodies imply very little buying or selling activity. In street forex lingo, bulls mean buyers and bears mean sellers.
Upper shadows signify the session high.
Lower shadows signify the session low.
Candlesticks with a long upper shadow, long lower shadow and small real bodies are called spinning tops. The pattern indicates the indecision between the buyers and sellers.
Marubozu means there are no shadows from the bodies. Depending on whether the candlestick’s body is filled or hollow, the high and low are the same as it’s open or close.
Doji candlesticks have the same open and close price or at least their bodies are extremely short.
The hammer is a bullish reversal pattern that forms during a downtrend. It is named because the market is hammering out a bottom.
The hanging man is a bearish reversal pattern that can also mark a top or strong resistance level.
The inverted hammer occurs when price has been falling suggests the possibility of a reversal.
The shooting star is a bearish reversal pattern that looks identical to the inverted hammer but occurs when price has been rising.
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