How to Read Candlestick Charts: Understanding Price Action in Trading

Candlestick charts are a widely used technical analysis tool that visually depict price movements within a specific time frame using individual ‘candles’. Each candlestick represents four key data points: the opening price, closing price, and the highest and lowest prices during that interval. This compact format helps traders and analysts quickly interpret market sentiment and price momentum. By identifying patterns and formations, candlestick charts assist in detecting potential trend continuations, reversals, and short-term price fluctuations, making them a critical component of trading strategies.

Candlestick charts are a type of financial chart used to represent price movements of stocks or other assets over a specific time period. Each candlestick shows four key data points: Opening price, Closing price, High, and Low.

• The body of the candle shows the range between the open and close prices.
  

• The wicks (or shadows) represent the highest and lowest prices during the period.
  

• If the close is higher than the open, the candle is usually green or white (bullish); if lower, it's red or black (bearish).
  

Candlestick charts help traders visualize market trends, reversals, and patterns to make informed trading decisions.

Every candlestick has two main parts:

• Body: The rectangle between the opening and closing prices
  

• Wicks (Shadows): Lines extending above and below the body, showing intra-period highs and lows
  

Green (or hollow) bodies signal price rise, while red (or filled) bodies indicate a decline during that timeframe.

Key Candlestick Patterns

1. Doji
   The open and close prices are nearly equal, indicating market indecision and a possible trend reversal.
   

2. Hammer
   A small body with a long lower wick, seen at the bottom of a downtrend, signals potential bullish reversal.
   

3. Shooting Star
   A small body with a long upper wick, seen at the top of an uptrend, indicates a possible bearish reversal.
   

4. Bullish Engulfing
   A small red candle followed by a larger green candle that engulfs the previous one, signaling a bullish trend.
   

5. Bearish Engulfing
   A small green candle followed by a larger red candle, suggesting a bearish trend reversal.
   

These patterns help traders predict price movements and make informed entry or exit decisions.

Doji

A Doji forms when the opening and closing prices are almost identical, resulting in a candle with a very small or non-existent body. It signals market indecision, where neither buyers nor sellers have gained control. Dojis are often seen near potential reversal points, especially when followed by confirmation candles.

Hammer and Inverted Hammer

These are single-candle formations that usually emerge near the bottom of a downtrend. A Hammer features a compact real body and a notably extended lower shadow, indicating that the market initially moved lower but was met with strong buying interest that drove prices back up. An Inverted Hammer, on the other hand, has a long upper wick and a small body near the candle’s lower end. It appears after a downward trend and may suggest a potential bullish reversal, especially when confirmed by a follow-up bullish candle.

Engulfing Pattern

An Engulfing Pattern is a two-candle formation where the second candle completely covers the body of the first. In a Bullish Engulfing, a small red candle is followed by a significantly larger green candle, indicating that buyers have taken control and potentially marking the start of an upward move. Conversely, a Bearish Engulfing features a large red candle that envelops a smaller green one, which may suggest increasing selling pressure and a possible shift toward a downtrend.

Morning Star and Evening Star

These are three-candle patterns commonly identified at key reversal zones. A Morning Star begins with a large downward candle, followed by a narrow-bodied candle that reflects hesitation in the market (often a Doji), and ends with a robust upward candle. This sequence suggests that selling pressure is weakening and buying momentum is picking up, often indicating a potential bullish reversal. An Evening Star, in contrast, starts with strong upward momentum, pauses with a small-range candle, and is followed by a decisive bearish candle—hinting at the beginning of a downward shift.

Confirm Trends

Identify candlestick patterns at key support or resistance zones to validate potential reversals or continuations. These levels often act as critical turning points, and pattern formation near them adds weight to trading decisions.

Manage Risk

Implement stop-loss orders just beyond the wicks of the candle pattern to limit potential losses. This approach helps protect capital in case the market moves against your position after a signal.

Combine with Indicators

Boost the reliability of candlestick signals by pairing them with technical indicators such as the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), or moving averages. These tools provide additional confirmation of trend strength or momentum shifts.

Analyze Volume

Volume is a crucial supporting factor. A breakout or reversal pattern is more credible when accompanied by increased trading volume, as it reflects stronger participation and conviction among market participants.

• Day Traders: Use 5-minute candles to time intraday entry and exit points.
  

• Swing Traders: Prefer daily-timeframe patterns like engulfing or star formations.
  

• Long-Term Investors: Weekly or monthly candles reveal lasting market trends.
  

Candlestick charts offer a rich window into market psychology through visual patterns and price action. Learning to read and interpret them effectively empowers traders to make timely, data-backed decisions. With practice, candlestick methods become an essential part of any trader's toolkit.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.