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Candle Charts

Summary

Candle charts show in each candle the relationship between close and open prices. Two, three or more candles can offer a significant indication of market tops and bottoms. Candle charting techniques can be used with any kind of period: five minutes, one hour, one day, etc. In this first article on candle charts, we will look at the most common types of candles.

In a bar chart, each time period is identified by a bar, as in Figure 1. In candle charts, the bar is called candle, as in Figures 2 and 3.

Figure 1 – A bar in a bar chart

Each bar and candle have similar characteristics: the distance between the high and low of the period, and the distance between the open and close; however, in a bar, the emphasis is mainly on the distance between the high and low, while in candles, it is on the difference between the open and close, i.e. the “body.” Candle charting techniques are similar to those of bar charts: pattern recognition, trend lines, support and resistance, channel lines, pivot points and other typical features. They can be used with data from any time period we choose: five minutes, one hour, one day, etc.

Figure 2 – Close below open
Figure 3 – Close above open

The key feature of the candle is the body, the distance between the open and close. The conventional way is to have the body dark or colored (the color can vary) when the open is above the close price; it is an empty body when the open is below the close price.

A single candle doesn’t tell us if the high and low, or the close and open, are higher or lower than those of the previous period. It only indicates whether the close price is higher or lower than the open price in the same period.

Analysis of candle charts is not limited to a single candle. It is based on several candles forming a pattern or figure, and its position in relation to overall market behavior.

A candle is formed by a “body” and, usually, two “shadows.” The body is the rectangle linking the open and close prices. Shadows go beyond the body, above and below it. The body is more important than shadows in reading candle charts.

There are several kinds of candles, determined by the different positions of the open, high, low and close prices.

The most common are described below.

Figure 4 – Hammer

This pattern indicates a reversal or that the bottom is near after a downtrend. There is no upper shadow and the lower shadow should be at least double the length of the body. It is not important if the body is dark or hollow.

Its name changes to Hanging Man when the candle appears after an uptrend. In this case, it indicates that a top is near.

Figure 5 – Star

This candle appears near or at the top of an uptrend and indicates a reversal. This happens because the price, after the open, goes higher, but it does not have enough momentum to stay at this level and falls back near the open price. This is a clear indication that the uptrend is losing strength.

When this pattern appears at the bottom of a downtrend, it is called an Inverted Hammer; but it is less reliable than a Star: to be more dependable, it needs, in the following period, a hollow candle with the open higher than the body of the Inverted Hammer. It is not important if the body is dark or hollow.

Figure 6 – Spinning Tops

The bodies are small, with small shadows. They indicate a tense equilibrium between supply and demand, a hard struggle between buyers and sellers.

Figure 7 – Dojis

The word signifies uncertainty. A Doji has the same open and close and indicates a change in trends. At the top of an uptrend, after a long hollow candle, it is a very significant indicator of a market top. A Doji can also appear at the bottom of a trend, but this is usually a weaker signal without confirmation from other patterns.

  1. First kind
  2. Second kind
  3. Third kind
  4. Fourth kind

There are basically four kinds of Dojis. The first is called a Doji; the second is a Gravestone. The third is a Dragonfly, and the fourth is a Rickshaw. It is typical of the candle world to have many imaginative names. The names are exotic because candle charts are of Japanese origin.

Figure 8 – Evening Star

This is a first example of a configuration. It indicates a market top and is composed of three candles. The left candle has a long hollow body. It is followed by a candle with a small body higher than the close of the previous candle. The third candle is dark and its close price has to be well within the body of the first candle.

The Evening Star is just one of nearly sixty significant configurations. In a subsequent article, we will look at some of the most useful ones.

The author

Charles K. Langford

Charles K. Langford

PhD, Fellow CSI

Charles K. Langford is President of Charles K. Langford, Inc, Portfolio Managers. He teaches portfolio management at School of Management (École des Sciences de la Gestion), University of Québec (Montréal). He is the author of 14 books on portfolio management, derivatives strategies and technical analysis.

Until 2007 he has been vice-president overlay risk management for Visconti Venosta Teaspoon Approach Management, Ltd. Until 1990 he was portfolio manager for Refco Futures (Canada) Ltd.

He has received a Bachelor degree from Université de Montréal, a Master degree and the PhD from McGill University (Montreal); he is Fellow of CSI (Canadian Securities Institute).