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How candlestick trading helps you understand the market

Stock prices are influenced by a number of factors. These include industrial performance, employee layoffs, political instability, and so on and so forth. But it all really comes down to the individuals who are trading shares. The emotions and tendencies of these traders should not be taken for granted. Rather, they should be analysed and acted upon. This is what a Japanese man named Homma believed in the 1700s. He realised that the movement of price in the rice market is affected by not only supply and demand but also the emotion of the traders. Candlestick charts are the visual cues to these emotional trends.

Read more: Intraday trading rules

What is candlestick trading?

A candlestick is a visual representation of the movement of stock prices during a day on a chart. Try looking at a candlestick chart that showcases price movements over a few days. You will soon infer patterns that reveal the trend. Now, you can base your own trade on those inferences. That is the basic idea of candlestick trading.

What are the components of a candlestick?

Pretty much like a real-world candlestick, these visual representations have a body and a wick. The wick, however, is visible from both the ends. The wick is also called a shadow. The body—that is, the wide part of the candlestick—is referred to as the real body.

  • The real body:

    The height of the real body represents the gap between the opening price and the closing price of a stock. A real body can be large. This means there is a substantial gap between the opening and the closing prices. A short real body suggests that the difference between the opening and the closing prices was small.
  • Doji:

    If the opening and the closing price are almost the same or exactly the same, you have a doji. A doji looks like a cross.
  • The wicks or the shadows:

    The top of the wick refers to the highest price of the respective stock during the day. The bottom of it shows the lowest price.
  • The colours:

    If the closing price of a stock is more than the opening price, it indicates an uptrend. Here, the candlestick is left white or coloured green. But if the closing price is lower than the opening price, the candlestick is coloured black or red.

Read more: Fibonacci trading

Some basic candlestick patterns and how you can recognise them

The candlesticks on a chart are often too randomly spread to read. But in some cases they create highly suggestive patterns. Your ability to read these patterns and act accordingly determines your success at candlestick trading. Before understanding the patterns, you need to familiarise yourself with two terms.

  • Bullish:

    It refers to the situation where the prices tend to move upward.
  • Bearish:

    It refers to a situation where the prices tend to fall.

The terms bullish or bearish can be used for the whole market or for any particular stock.

Bullish engulfing pattern

This occurs when a large green candlestick follows a small red one. The small red candlestick usually stands around the middle of the green candlestick. That is why it is called an engulfing pattern. This pattern shows a considerable hike in the prices, which means many buyers are interested in that stock. This may indicate the beginning of an uptrend.

Bearish engulfing pattern

In this case, a large red candlestick engulfs the entire green candlestick which it follows. This indicates falling price, an increasing number of sellers, and a resultant downward trend.

Read more: Forex day trading

Bullish rising three

Sometimes, a long green real body is followed by three small red real bodies which do not move beyond the range of the long green real body. Then, on the fifth day, there is another long green real body. This pattern is called a bullish rising three. It shows how deceptive these patterns can be at times. But whenever you are looking at a couple of small red real bodies lurking around a large green one, you know what to expect.

Bearish falling three

This is the same phenomenon as the previous one, just with long red candlesticks on the first and the fifth days of the cycle. It starts with a long red day, followed by three days of slight uptrend and another day with a steep fall in the price.

Bullish and bearish harami

The harami occurs when the price trend suddenly changes after a few consecutive days of rise or fall. The real body showing the shift is usually small and does not go out of the range of the previous real body. This suggests that buyers are hesitant. The trend could go either way on the next day.

Read more: Day trading options

Summing up

The patterns show you a path but do not guarantee your success. Candlestick trading is guided by your experience and educated inferences from the patterns. If you wish to benefit from it, start by opening a trading account. Practise regular trading to gain the experience to read candlestick charts with ease.

Read more: How to be a successful day trader

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