Candlestick Patterns: Basics

Candlestick charts originated in 18th-century Japan and remain the most popular charting method. Understanding candlestick patterns helps you read market psychology. [DEFINITION] Candlestick: A chart type showing the open, high, low, and close for each period. The body shows the open-close range; wicks (shadows) show the high-low range. ### Candlestick Anatomy **Body:** Rectangle between open and close - Green/White: Close > Open (bullish) - Red/Black: Close < Open (bearish) **Upper Wick (Shadow):** Line above body to the high **Lower Wick (Shadow):** Line below body to the low [TIP] Long wicks show rejection of prices. A long upper wick means buyers pushed higher but sellers pushed back. A long lower wick means sellers pushed lower but buyers pushed back. ### Single Candlestick Patterns **Doji:** Open and close nearly equal (tiny body). Shows indecision. - After uptrend: Potential reversal - After downtrend: Potential reversal **Hammer:** Small body at top, long lower wick (2x+ body length) - Forms at bottoms - Shows buyers rejecting lower prices - Bullish reversal signal **Shooting Star:** Small body at bottom, long upper wick - Forms at tops - Shows sellers rejecting higher prices - Bearish reversal signal **Marubozu:** Full body, no wicks - Bullish marubozu: Strong buying - Bearish marubozu: Strong selling [EXAMPLE] After a 3-week decline, a stock forms a hammer candlestick at support. The next day opens higher. This is a bullish reversal signal—buyers stepped in aggressively at the lows. ### The Importance of Context [KEY] Candlestick patterns are meaningful only in context. A hammer after a downtrend is bullish. A hammer at the top of an uptrend means nothing special. **Context factors:** - Prior trend (up, down, sideways) - Support/resistance levels - Volume on the signal candle - Confirmation from following candles ### Confirmation [WARNING] Never trade a single candlestick pattern without confirmation. Wait for the next candle to confirm the signal. **Hammer confirmation:** Next candle closes above hammer's body **Shooting star confirmation:** Next candle closes below star's body [EXERCISE] A stock has fallen 20% over two weeks. Today's candle has a small body near the top and a very long lower wick (3x the body length). What pattern is this, and what might it suggest? |ANSWER| This is a hammer pattern forming after a downtrend. It suggests buyers aggressively rejected lower prices. Combined with the prior downtrend, this is a potential bullish reversal signal. Watch for confirmation (next candle closing higher). [SCENARIO] You see a hammer form after a downtrend—bullish signal. But the hammer formed on very low volume, and the next day's candle is a small doji with no follow-through. Should you buy? The low volume and lack of confirmation weaken the signal. A hammer should ideally have volume and be followed by bullish confirmation. Without these, the pattern is less reliable. Wait for stronger confirmation or look for the pattern to develop further before committing.