If you’re new to advanced charting and you want to start building foundational skills in technical analysis, you’ll need to be able to read candlestick charts. However you like to trade, this skill is essential.
It’s normal to be put off by the visual complexity of candlestick charts, but it isn’t nearly as complicated as you might think. This quick guide will teach you how to understand and read candlestick charts.
What is a candlestick chart?
Before we jump into how candlesticks work, let’s discuss what they are.
A candlestick chart is a type of financial graph that displays price action over a period of time in the form of a candlestick. This means that the chart consists of many individual candlesticks, each representing a timeframe and its movement in price. A candlestick can represent anywhere from one second to one year of price action.
The candlestick chart is said to date all the way back to the 1700s, being used by a Japanese rice trader named Homma Munehisa. Munehisa utilised this chart to gain insight into the market he was a part of, along with other Japanese rice traders. It is said that these early findings are what has shaped the candlestick charts we see today. The use of this chart has stayed the same however: to allow traders to determine future price action based on previous analysis.
How does a candlestick chart work?
OHLC
A full candlestick represents four prices: an open, high, low, and closing (OHLC). In the demonstration below, you will find that the open and close are at opposite ends of the red and green candle.
At the beginning of a candle’s time frame, the first recorded trading price is recorded as the open price. The opening price of the new candle will begin directly next to the closing price of the previous candlestick.
As shown in the image below, the bottom wick represents the lowest price reached within the time frame. And as you might have already guessed it, the top wick represents the highest price reached within the time frame.
At the end of the candle’s time frame, the close price is the last recorded trading price.
The cycle then repeats itself.
Colouring
The red candle represents a negative price movement. Therefore, the opening price of this candle begins higher than the closing price.
The green candle represents a positive price movement. Therefore, the opening price of this candle begins lower than the closing price.
Note: The coloured area between the open and closing price is called the body. The distance between lowest/highest price and the body is referred to as the wick or the shadow.
Reading candlesticks
Candlestick charts offer important information on price action that can be analysed at a glance. After you have an understanding of how candlestick charts work, you’ll find yourself analysing these graphs with ease.
Each candlestick will reveal important information about an asset’s price action. For example, a candle with a long body may have been pressured by large amounts of buying/selling pressure within that period.
As previously mentioned, each candle represents a period of time. If you were to open up your Digital Surge TradingView chart, it would show the default time frame of 1 hour. This means that each candlestick represents 1 hour of price movement. See the chart below:
You will notice the option to change the time frame of each candle on the top left of your chart. From here, you will be able to analyse the price action of the particular asset you are viewing. The above example is of the 1 hour ETH/AUD chart. Right away, you can begin to notice trends and patterns. If you wanted to understand this from another perspective and possibly gain further insight, you could change the time frame from anywhere between 1 minute to 1 week.
Limitations
Like all graphs, candlestick charts have their limitations. For example, candlesticks cannot show traders exactly what was happening in between the opening and closing price. Furthermore, you are also not able to see whether the high or low in a candlestick came first. To understand these candles better, traders may consult other indicators or even change to a smaller time frame.
Once you have mastered the basics, you might find yourself exploring some of the technical indicators that these charts have to offer.
Final thoughts
It goes without saying that understanding candlestick charts is the foundational skill to technical analysis. This chart form has been utilised for centuries, by traders and investors across dozens of diverse markets. Not only do they offer a detailed representation of price movement, but it also acts as a tool for research. With this knowledge of the basics, you’re able to now explore what else candlestick charts have to offer.
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