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Candlestick charts offer notable advantages over standard line charts when it comes to analysing a stock – but many investors can find candlesticks confusing compared to the more straightforward line approach. 

So in today’s piece, we’ll run through how to understand basic candlestick charts. We’ll also look at four key patterns that can provide useful signals. 

How does a candlestick chart work?

Candlestick charting was first developed by Japanese rice traders in the mid-1800s.

Unlike a standard line chart (which simply plots the close price on each day), candlesticks show five key data points for each day:

1. Open.

2. Close.

3. High.

4. Low. 

5. The range of prices explored each day.

Just about every technical indicator ever created is based on mathematical derivatives of these five key data points.

The colour of each bar in a candlestick chart shows the price movement.

• Green bars indicate a net gain for that day. (i.e. the closer was higher than the open)

• Red bars indicate a net loss. (the close was lower than the open)

On Market Index, you can easily switch charts between line mode and candlestick mode.

Basic candlestick chart patterns:

While these price movements can often look random, sometimes they can form patterns that traders use for technical analysis. There are many candlestick patterns, and it’s important to note that no pattern works all the time. 

Generally speaking, patterns are broken into two categories:

• Bullish patterns: these suggest that a stock is about to move upwards. 

• Bearish patterns: these suggest that a stock is about to move downwards. 

There are tons of different patterns out there, but as a starting point, here’s three key patterns that can be found in candlestick charts:

1) Bullish engulfing pattern

What to look for: a long green body has engulfed a small red body. 

What this means: Selling has been exhausted and the balance between sellers and buyers has shifted. With the buyers now the dominant group, the price may now head higher. 

2) Bearish engulfing pattern

What to look for: a long red body has engulfed a small green body. 

What this means: Buying has been exhausted and the balance between sellers and buyers has shifted. With the sellers now the dominant group, the price may now head lower.

3) Bearish evening star

What to look for: the last candle has opened beneath the previous day’s body (of any colour) - followed by the last candle closing deep into the body of the candle from two previous days ago.

What this means: typically, this suggests a stock has ‘topped out.’ Buyers have stalled, sellers have taken control, and the stock could be set for further declines. 

4) Three-bar reversal

A 3-bar reversal pattern is a favourite of Chris Conway’s (Chris provides technical commentary for our Morning Wrap on Fridays). This shows a potential turning point in a stock or index. Compared to other reversal patterns out there, the 3-bar is one of the safer ones. Because it extends over three bars, it's considered a relatively safe pattern to trade.