Anatomy of candlestick charts, patterns, and formations: Part 1

Candlesticks charts are the most popular for technical analysts in financial markets, with many utilising candles alone to inform their trading decisions. Each candle can provide valuable information about price movements, market sentiment, and the chances of a continuation or reversal.

What are Candlestick Charts?

Candlestick charts originated in Japan, with 18th century rice traders utilising them to track prices. However, they have become synonymous with technical analysis across the spectrum of financial instruments since. Each candle displaysprice data for a given period (eg. day, week, or month), in the form of individual "candles." Each candle provides data on the opening, closing, high, and low prices within that period. As such, if you are looking at the one-hour chart, a single candle will show the initial price, end price, high, and lows over the course of that hour.

Anatomy of a Candlestick

A single candlestick consists of several components:

Body: The rectangular area between the opening and closing prices is known as the body. Coloured charts will typically show a green body for upward-moving markets, or red for a market that decreased in price over the course of the candle.

Wicks (or Shadows): The thin lines extending away from the top and bottom of the body are called wicks or shadows. The top of the upper wick represents the highest price over the period, while the bottom point of the lower wick represents the lowest price.

Traders will utilise the construction of each candle’s body and wick as a signal of sentiment, guiding investment decisions. Candlestick analysis is one of the purest forms of analysis, as it involves nothing more than the study of price itself (without indicators). Traders that trade using candlestick and pattern analysis alone are said to be focused on ‘price action’.

Single candlesticks:

The following candlesticks provide a message for traders taken on their own. It is worthwhile noting that the underlying outlook should also take into account volume and activity levels behind each candle. For example, a single 5-minute candle during lunch may simply be a sign that we are seeing a quieter period of the day rather than a signal of an impending reversal.

Hammer: A Hammer candle has a small body and a long lower wick. It traditionally forms after a downtrend, with traders seeing it as a potential bullish reversal signal. The underlying price action for a hammer sees the asset fail to maintainits losses, with price subsequently moving upwards to regain ground.

Attributes:

• Bullish reversal signal
• Found in a downtrend
• Body around the top of the candle
• Little to no upper wick
• Lower shadow at least double the size of the body
• Colour of the body unimportant

Shooting Star: A Shooting Star is very similar to the hammer candle, but instead signals a potential bearish reversal within an uptrend. It highlights a failure to maintain upward price momentum, with price falling back after making initial gains.

Attributes:

• Bearish reversal signal
• Found in an uptrend
• Body at the bottom of the candle
• Little to no lower wick
• Upper shadow at least double the size of the body
• Colour of the body unimportant

Inverted hammer: A inverted hammer candle looks much like a shooting star, but is instead found within a downtrend. This holds less value as a reversal compared with a hammer candle.

Attributes:

• Bullish reversal signal
• Found in an downtrend
• Small body at the bottom of the candle
• Little to no lower wick
• Upper shadow at least double the size of the body
• Colour of the body unimportant

Hanging man: The hanging man candle takes the same form as hammer, but this candle is instead a bearish reversal signal found in an uptrend. The fact that much of the sell-off has been recovered does highlight that this candle can be somewhat less powerful than a shooting star as a bearish reversal signal.

Attributes:

• Bearish reversal signal
• Found in an uptrend
• Small body at the top of the candle
• Little to no lower wick
• Lower shadow at least double the size of the body
• Colour of the body unimportant

Doji: A doji candle has a non-existent or small body, with the classic doji looking much like a cross. This means that the opening and closing prices are very close or equal. Traders will look at a classic doji as a sign of indecision, signalling either a pause within a trend, or a potential turning point that could see prices reverse. Taken on their own, a single doji may not tell you enough to take a trade. However, context is key. The placement of the body within the candle does highlight sentiment.

While the classic doji has a centrally placed body, denoting market indecision, you can also see different forms of dojis that are more geared as a reversal signal. A gravestone doji is essentially a pure shooting star candle, highlighting a potential market top. Meanwhile, a dragonfly doji is much like a hammer, signalling a possible market bottom.

Attributes:

• Small to no body
• Classic doji seen as an indecision candle, which could indicate a pause or reversal
• Gravestone doji is a bearish reversal candle, with a long upper shadow and minimal body
• Dragonfly doji is a bullish reversal candle, with a long lower shadow and minimal body

Marabuzo: This candle is the ultimate form of market confidence, with the strong of the move bringing little to no upper and lower shadows. With price continuing to maintain its trajectory throughout the entirety of the candle, it is often expected that the direction of the marabuzo candle will be continued after its completion.

Attributes:

• Long body, with little to no wicks
• Candle highlights strong conviction
• Traders typically expect price to continue in the direction of the marabous