Technical Analysis Blowout: How to Read Candlestick Stock Charts

Looking to identify chart patterns? Many traders would say there’s no need to read tea leaves, lunar cycles, or your palms—learn how to read candlesticks.  

Candlestick charts have been around since at least the 19th century (though some estimate the technique, invented by Japanese rice merchants seeking a way to predict price movements, to be much older).

But until 1991, they were all but unknown to those outside Japan. Author Steven Nison introduced the concept to Western traders with his book Japanese Candlestick Charting Techniques: A Contemporary Guide to the Ancient Investment Techniques of the Far East. Nowadays, candlestick charts are the default form of charting for many traders.

From Body to Shadow: Reading Candlesticks

The chart “candles” are made up of two parts:

• Real body: The candle body represents the range between the opening and closing prices of the period. The default on the thinkorswim platform is if the candle is green, the close was higher than the open, and if red, the close was lower than the open.
• Shadows: These thin, vertical lines above and below the real body—sometimes referred to as “wicks”—represent the price extremes (high and low) of the period.

The short answer on how to read candlesticks: The shape of each day’s candle can give you visual cues as to the possible strength and conviction of the price activity in the period. The size of a candle’s real body varies depending on the difference between its opening and closing price. When the opening and closing prices are the same, the body is represented by a single horizontal line called a doji. Not all candles have shadows; the opening and/or closing prices may be the extremes of a given day’s range (see figure 1).

Making Sense of Those Candlestick Patterns

Thanks to their unique presentation, candlestick chart patterns are readily visible. The patterns are generally described in two categories:

• Reversal patterns. When the direction of a prevailing trend changes from an uptrend (marked by a series of higher highs and higher lows) to a downtrend (marked by a series of lower highs and lower lows), or vice versa, it’s known as a trend reversal. Reversal patterns include the doji, reversal hammer, bullish engulfing reversal, and the morning star reversal.
• Continuation patterns. Sometimes there’s a pause in a market trend—the market might chop in a range for a while before continuing the trend. Candlestick chart watchers may look for patterns that could signal the prevailing trend may be about to resume. These are called continuation patterns and include names such as separating lines, gap three methods, and on neck.

Patterns can be bullish or bearish and can consist of a single candle or a group of candles. These patterns can be identified in any time frame—hourly, daily, weekly, monthly—and any asset class: stocks, commodities, currencies, and so on. A full rundown of bullish and bearish candlestick patterns can be found in the thinkorswim Learning Center. Or, if you’ve pulled up a chart in the thinkorswim platform, you can choose from more than 50 candlestick studies. Conduct your own experiments to see what might strike your fancy (see figure 2). 

Candlestick Patterns and Trader Education

As with any type of pattern recognition, there are no guarantees for which way price will go, but candlestick patterns can help alert you to possible outcomes. The thinkorswim platform allows you to scan automatically for traditional candlestick patterns or create your own using the candlestick pattern editor. And when you create a custom pattern, you get to choose a custom name.

The more you learn about technical analysis, the more you might see how it can potentially help you in your trading decisions. As a TD Ameritrade client, you can access a full range of education resources, including a fully immersive technical analysis curriculum. Or start with the video below.