Trading with Candlesticks

Most of the traders use candlesticks on their charts but do not fully understand the signals given by candlesticks. The learning curve on how to correctly interpret a candlestick pattern obviously begins with studying what the shapes and shadows mean, and then seeing if a trend is indicated.

Long vs Short Candlestick

Long bodies indicate strong buying or selling. The longer the body is, the more intense the buying or selling pressure. Short bodies imply very little buying or selling activity.

The Shadow

If a candlestick has a long lower shadow and short upper shadow, this means there is a buyers rejection.

1. Sellers force price lower, but for one reason or another, 
2. Buyers came in and drove prices back up to end the session.

If a candlestick has a long lower shadow and short upper shadow, this means there is a sellers rejection.

1. Buyers force price higher, but for one reason or another,
2. Sellers came in and drove prices back down to end the session.

Long Vs. Short Shadows

The upper and lower shadows on candlesticks can tell a lot about the trading session. Candlesticks with short shadows indicate that most of the trading action was confined near the open and close, while candlesticks with long shadows indicate that the price extended well past the open and close.

Candlesticks with a long upper shadow and short lower shadow show buyers dominated during the session and pushed prices higher, but sellers later forced prices down from their highs before close. On the other hand, candlesticks with long lower shadows and short upper shadows show that sellers dominated during the session and drove prices lower, but buyers later bid prices higher by the end of the session.

Spinning tops 

Spinning tops are candlesticks with long upper and lower shadows with small bodies. These candle sticks are known for representing indecision. The small body shows little movement from open to close and the shadows indicate that both bulls and bears were active during the session but neither could gain the upper hand. Spinning tops can signal both the top of a run and the bottom of a decline.

Doji

The doji is formed when a stock’s open and close are exactly or almost equal. The length of the upper and lower shadows can be long or short, but the resulting candlestick looks like a cross or plus sign. Although a doji can help signal a reversal much like the spinning top, they should never be used alone. Any bullish or bearish signal using the doji is based on preceding price action and future confirmation.

Dragon Fly Doji
A dragon fly doji is made when the open, high and close are equal, but the stock’s low creates a long lower shadow, creating a candle that looks like a “T”. A dragon fly doji shows that sellers dominated trading and drove prices lower during the session, but that buyers came back and pushed prices back to the opening level and the session high. A dragon fly doji can be used to signal a potential reversal of a downtrend as well as a potential reversal of an uptrend.

Gravestone Doji

The gravestone doji is simply an upside down dragon fly doji. The gravestone doji shows that buyers dominated trading and drove prices higher during the session, but that sellers pushed back and drove prices back to the opening level and the session low. As with the dragon fly doji, the gravestone doji only indicates a reversal based on previous price action and future confirmation. Even though the long upper shadow shows a failed rally, the intraday high shows there is buying pressure, so bearish or bullish confirmation is required.

Understanding the psychology behind the candlestick is far more important than the pattern itself because in reality, when you are trading live at the right hand edge of the chart, the patterns are not so easy to see.

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