Section VI: Introduction to Candlesticks
Japanese candlesticks give us a better understanding of value, or more precisely, the interpretation of value given to any instrument by investors and traders than any other type of chart. They also help us have a better understanding of the psychology of traders and investors driven by fear, greed and hope, since all these characteristics are represented in price movements.
Before going through candlesticks patterns and how to trade based on them, we should first understand what different candlesticks represent by themselves.
Long candlesticks describe strong buying/selling pressure. Price had a sharp advance/decline from the open price (traders were aggressive).
When we talk about “long” candlesticks, we are referring to the body of the candlestick.
But, long compared to what?
We know it is long when we compare the action of any candlestick with the length of previous candlesticks. A “long” candlestick must be clearly identified in order to be a valid pattern, should there be any doubt, it is probable that the candlestick is not long “enough”.
Short candlesticks could represent two things: not much volume or periods of indecision (demand meets supply.)
Short candlesticks are also compared to previous action to assess the validity of the candlestick.
Marubozu candlesticks are strong candles. They have no shadows, this means that the open price equals the low/high of the period and the closing price equals the high/low of the period.
The interpretation of this kind of candlesticks varies depending on where it was formed. If a bullish marubozu appears in a downtrend, it could signal a short-term reversal (bulls took control of the situation from the first minute to the last.) If a bullish marubozu appears at the top the range, it could signal a final push up, it all depends on preceding candlesticks. The same is true for a bearish marubozu.
If the marubozu breaks through an important support or resistance level, the market is likely to continue on the way of the “break through”.
Doji candlesticks represent periods of indecision, or fierce battle between bulls and bears.
Doji candlesticks are formed when the open price and the close price are virtually the same (or very close). Ideally, the open and close prices should be equal, but remember, the important thing to capture here is the essence of the candlestick.
For instance, when the close and open price is similar, it shows us that as the price went up, sellers took control of the situation, and when prices went down, the buyers the control of prices.
Doji candlesticks alone are considered neutral, but should be a warning. If for instance, in a downtrend a doji candlestick is preceded by a long bull candlestick, then it could mean a possible reversal.
Spinning tops and bottoms have small bodies and long shadows usually larger than its body.
Spinning tops/bottoms, as dojis, represent periods of indecision and intensive action between bulls and bears, with no clear domination.
Spinning tops/bottoms are considered neutral until a long bull/bear candlestick appears after them.
Long upper and lower shadows, open and close prices are virtually the same.
These candlesticks also represent intensive action between bulls and bears, and no one was being able to take control over prices.
Dragonfly and Gravestone doji´s are Long-legged doji´s.
Long lower shadow with open and closing prices near the top of the range. Bears took control first, but then bulls were attracted by cheaper prices then taking control of prices.
This candlestick is more bullish than bearish since the bears were not able to drive prices lower because bulls took control over prices, pushing them up.
Long upper shadow with open and closing prices near the bottom of the range. Bulls took control of prices at the beginning, but then bears resurfaced gaining control taking the price near the low (and open) of the range.
This candlestick is slightly more bearish than bullish since bulls tried to take control over prices driving them higher first, but then the bears took control over them driving them back down.