| |
| Candlestick Charts |
| | ||
| The Candlestick Format | ||
| Candlesticks are a unique way of charting share price moves. | ||
| The JSE Banking Index shows the difference between the formats of the more usual bar chart and the candlestick chart. There are numerous candlestick shapes and patterns that need to be studied. Candlesticks are another method of displaying price movement but are also used as an analytical tool in their own right. |
| |
| History | Candlesticks were invented in Japan in the 16th century where they were used to predict rice prices. They are probably the oldest form of technical analysis. | |
| Western analysis | They have only been used in western stock market analysis for about 30 years. | |
| Stand alone | They are frequently used, especially by currency traders, as a stand alone analytical tool. | |
| Bar charts | | Candlestick charts |
| Display the opening, closing, high and low prices on a vertical bar that joins the high and low price. Opening and closing prices are shown as small horizontal ticks at the side of the bar. No distinction is made between up and down price moves. The high and low are the more important points. |  | Display the opening and closing prices as a solid body with the highs and lows as additional vertical lines. A clear distinction is made between up and down price moves. The body of an upmove is shown as white and a down move as black. The open and close are the more important points. |
| Candlestick up moves | Candlestick down moves | |
|
| ||
| Candlestick real body and shadow | ||
| Candlestick bullish shapes have open real bodies that appear white. The thinner line at the top is the upper shadow and the one under the real body is called the lower shadow. |
| Candlestick bearish shapes have solid real bodies. The thinner line at the top is the upper shadow and the one under the real body is called the lower shadow. |
| The relationship between the real body and the shadow is important | ||
| Candlestick Shapes | ||
| Shaven Head A real body, white or black, and no upper shadow. |
| Shaven Bottom A real body, white or black, and no lower shadow. |
| Shooting Star A small real body at the lower end of a long upper shadow. It warns of a potential top reversal in a rising market. |
| Inverted Hammer A small real body at the lower end of a long upper shadow. It warns of a potential bottom reversal in a falling market. |
| Hanging Man A small real body at the top of a long lower shadow. It warns of a potential top reversal in a rising market. |
| Hammer The same format as the Hanging Man. It warns of a potential bottom reversal in a falling market. |
| Spinning Tops A small real body and long shadows. They imply equilibrium between buyers and sellers. They can be black or white. |
| |
| Doji Lines The opening and closing prices are the same and the shape has no real body. It signals indecision except when it appears as a Gravestone Doji (see opposite) |
| Gravestone Doji A Doji in which the opening and closing prices are at the low of the price range. It signals a top in a bull run and a bottom in a bear phase. |
| Common Candlestick Reversal Patterns | ||
| Top patterns | Bottom patterns | |
| Bearish Engulfing Pattern A long black body that engulfs a small white real body in an uptrend. The black body's opening price is above the closing price of the previous white body . A bearish trend reversal. |
| Bullish Engulfing Pattern A long white body that engulfs a small black real body in a down trend. The white body's opening price is below the closing price of the previous black body. A bullish trend reversal. |
| Dark Cloud Cover In an uptrend a long white body is followed by a black body that opens higher than the previous days upper shadow, but then closes more than half way down the white body. A bearish trend reversal. |
| Piercing Pattern (the opposite of Dark Cloud Cover) In a down trend a long black body is followed by a white body that opens lower than the past days lower shadow, it then closes more than half way up the black body. A bullish trend reversal. |
| Stars (Top Pattern) A Spinning Top of any colour that gaps away from a long real body in an uptrend. Gaps on candles are different to bar charts. Candle gaps work on the opening and closing price. Stars indicate a slowing of the current trend. |
| Stars (Bottom Pattern) A Hammer of any colour that gaps away from a long real body in a down trend. Gaps on candles are different to bar charts. Candle gaps work on the opening and closing price. Stars indicate a slowing of the current trend. |
| Doji Star (Top Pattern) In an up trend a Doji gaps away from a long real white body. An important reversal signal that is usually confirmed by a black downwards body in the next session. |
| Doji Star (Bottom Pattern) A Doji gaps away from a long real black body in a down trend. Generally regarded as an important reversal signal that is usually confirmed by a white upward body in the next session. |
| Evening Star A major top reversal formed by three candles. A Star top is followed by a black body that closes well below the first white bars closing price. |
| Morning Star A major bottom reversal formed by three candles. A Star bottom is followed by a white body that closes well above the first black bars closing price. |
| Evening Doji Star The same pattern as the Evening Star but the middle candle is a Doji. This pattern is considered to be even more bearish than the Evening Star. |
| Morning Doji Star The same pattern as the Morning Star above. But the middle candle is a Doji. This pattern is considered to be even more bullish than the Morning Star. |
| BOE (Banks) formed a double top pattern in February as a prelude to a major fall in price. Both tops were Evening Doji Star formations and gave a clear indication of events to come. Note that the upmove prior to the top contained several bullish Engulfing Patterns. |
| |
| Coronation Holdings (Financial Services) started its May upward move with a bullish Engulfing Patterns. More recently it has formed two Evening Star top patterns forecasting a downward move in the share price. Two Evening Stars together is particularly bearish as they reinforce the negative effect. |
| |
| First Rand (Banks) clearly illustrates the bearish implications of a preponderance of long upper shadows at the top of a bullish run. Buyers continuously push the opening prices upwards but are unable to hold them up for the rest of the session and the share price closes well under its highs. |
| |
| Liberty (Life Assurance) appears to have an affinity for Doji Star tops and bottoms. The first Evening Doji Star had a double Doji in the middle of the pattern. The resultant fall was reversed by a Morning Doji Star and recently Liberty has mapped out another evening Doji Star indicating that further downside is likely. |
| |
| Support and Resistance | ||
| Real body support Candlesticks do not use the high and low as the critical levels for support. They focus on the real body of the candle. Support lines are drawn under the real bodies of the candles. Any penetration of the support by the lower shadow is ignored. |
| |
| Real body resistance Again the resistance levels are drawn across the tops of the real bodies and ignore any minor penetration by the upper shadow. Both the real body support and resistance lines have the same floor and ceiling effects as already discussed. |
| |
| Upper Shadow Top Patterns When several candlesticks with long upper shadows occur at the end of an upmove it is a bearish signal. Buyers push the price up but are unable to hold onto the gains. The combination of upper shadows with the Doji and Shooting Star patterns indicate an imminent reversal for the Dow Industrial Average at this top resistance level. |
| |
| Lower Shadow Bottom Patterns When a series of candles with lower shadows occurs at the low areas of a bearish phase it signals a potential reversal into a bullish move. The sellers push prices down but are unable to hold them at the lower levels. ASA shows this support effect. |
| |
| Major features | The purpose of this module was to illustrate the major shapes and reversal patterns of Candlestick charts that will enable the investor to recognise significant potential trend reversal areas, especially when combined with other analytical techniques. | |
| Many patterns | There are too many other patterns to mention in this discussion of candlesticks. I have focused on the more common reversal patterns. | |
| Further reading | Steve Nison is generally regarded as the fundi on candlesticks and his books are well worth the read for those wishing to take this subject to a more focused level. | |
| Stand alone | Although candlesticks can be used as a stand alone analytical tool they tend to be short term orientated and give too many short term signals for the average investor. | |
| Combination | I find that the reversal signals discussed in this module are indispensable alerts when used in conjunction with oscillators. Especially as early warning signals combined with divergence analysis. | |
