When you’re first starting out learning how to trade stocks, you have probably come across something called Candlestick Charts. The chart shows these weird boxes with lines coming out of the top and bottom. And you ask yourself, “how could I ever possibly understand this thing?” Well, you’ll be happy to know that it’s not as complicated as it may seem. By the end of this article you should understand the basics of Candlestick Charts.
The Components of Candlestick charts
A Candlestick is composed of two parts, the body and the wicks. The body is the wider, square looking part of the candlestick and is formed by the range of price movement between open and close. The Wicks are the lines that extend upward or downward out of the body and is formed by the range the price moves from high to low.
The body of a candlestick can either be empty or filled, which indicates price movement. An empty candlestick body indicates that the close was higher than the open. A filled in candlestick body indicates that the open was higher than the close.
A lot of traders will also change the settings of their charts to make candlesticks different colors and different fill options. Personally, I chose to have all candlesticks filled with green showing price increase and red showing price decrease. Below is a screen grab of how I set up my charts in Think or Swim.
The Value of a Candlestick charts
My favorite part about candlesticks are that a single candlestick can provide you with seven important pieces of information for whatever timeframe you’re looking at. The seven components a candlestick can tell you are:
- Price Movement (up or down)
- Open Price
- Close Price
- High Price
- Low Price
- Price Range Between Open and Close
- Price Range Between High and Low
Not all Candlesticks are alike
When you start to use candlestick charts to monitor and trade stocks, you’ll notice that the candlesticks being formed aren’t all perfect like in the examples above. Some candlesticks won’t even have wicks, some have very small body’s and very long wicks, etc. This is because the formation of the candlesticks depends on the price movement of the stock within the timeframe you are viewing it.
Example: Let’s say you are watching a penny stock on a 15 minute chart. Fifteen minutes is a long time in the trading world and penny stock can often be volatile. Volatility can often form some really odd-looking candlesticks due to the large price swings that occur.
So in this example, let’s say the price opens at the beginning of the 15 minute window at $1. But a minute in, there is a large sell-off and the stock drops all the way down to $0.50 very briefly before recovering back to $0.80. The stock hovers around $0.80 for a few minutes before many large buy orders start to come through, which drives the stock up to $1.50 where it hovers for another few minutes. Then, 2 minutes before the end of the 15 minute window, the stock starts to decline again, closing at $1.30.
In this example, the price closed above the open, so the candlestick would be empty. The open was $1 so the bottom of the body would form at $1 and the close was $1.30 so the top of the body would form there. The upper wick would extend upward from $1.30 all the way to the high of $1.50 and the lower wick would extend all the way down from $1 to the low of $0.50.
Below is what that candle would look like for that 15 minute window:
The Final Word
Candlestick charts can be a very valuable tool for stock traders. A single candle, let alone multiple, can very quickly provide a lot of information on the price movement of a stock. It is important to not only understand how to read a candlestick chart but what the meaning behind it.
Many traders also look at the patterns that consecutive candlesticks make. Candlestick chart patterns can be indicators of bullish or bearish patterns. Traders who subscribe to the technical analysis style of trading rely on the patterns that candlesticks form to identify not only which stock to buy but also what their entry and exit points would be.
Here is a cheat sheet I found on Reddit about Candlestick Patterns. You may choose to use if you’d like.
Before you get started make sure you read our Quick Guide To Day Trading!