Whether you are reading a book or scanning a stock chart, you first need to know the alphabet in order to understand the information that you are looking at. In the English language, we use letters. In the financial world, we use candlesticks.
Just as there are different fonts or slightly different ways of writing the same letters in the alphabet, there are slight variations of candlesticks on a price chart. To keep things simple—and because every financial site that offers charting will offer basic candlesticks—we will focus on the basic candlestick as shown in the below illustration.
A quick glance at a candlestick provides a ton of information. It tells you what price the stock opened, closed, how high and low the price traded, and whether it rose or fell during the time frame that the candle represents. Charting software allows you to adjust the time-frame that each candle represents. This can be anywhere from one minute, all the way to one candle representing an entire year for very long-term charts. Buy-and-hold investors who are in it for the long run will often view weekly or monthly charts. Day traders, on the other hand, often look at minute charts to see the extremely short-term fluctuations that take place during each trading day.
A daily chart, where each candle represents one day, is what you will most often see. In general, the time a candle represents is adjusted to the time-frame you intend to trade, and for us, it will most often be a daily chart. For simplicity of explanation, we will assume each candle below is a daily candle, meaning it illustrates all of the price activity that took place on one trading day. Now that we know it is a daily candle let us dig a little deeper. Notice that one candle body is green, and one is red? See on the green candle the “close” is above the “open”? That means the price closed higher than it opened. If we look at the red candle, we see exactly the opposite. The top of the candle body represents the price when the market opened for the day, and the bottom of the candle body shows where the price closed for the day. A red candle means your stock went down during the trading day, and a green candle means it went up. Simple stuff, right?
Now let’s take a look at the wicks on the candle. The wicks show the highest and the lowest price that the stock traded that day. The wicks can also reveal a lot of information. For example, if the body of the candle was very short, and the wicks very long, it would suggest the bulls and the bears had quite a battle that day, and ended about even, with neither side gaining, since at the end of the day, the price closed around the same price that it opened. On the other hand, if a green candle had no wicks at all, it tells you that the bulls took charge as soon as the stock opened and they were in charge right until the close. We know this because the price opened at the very bottom of the candle, and closed at the very top. If it were a red candle, it would mean exactly the opposite, where sellers took control as soon as the market opened and the price didn’t stop dropping until the close of the day. Now that we understand what a candle is telling us, let’s look at a few charts of Apple to see how different time frames can reveal a different picture. First, let’s look at the last three years of Apple on a monthly chart.
In the chart above, each candle represents all of the transactions that took place in Apple stock for one month time. Notice on the bottom of the chart are the months to show the progression of time. The candle on the farthest right is always the most recent. Also, notice on the far right of the chart are numbers. Those represent the price of the stock. Now that we understand how candles work, and how a chart works, let’s see what the above chart tells us. First, we can see that the price of Apple drifted down until it bottomed in May of 2016. After that, it began an uptrend even though it had some down months (remember, the red candles closed lower than they opened).
When we zoom into a shorter time frame, we set the chart to daily so that each candle represents a single day’s activity. For example, go back up to the top chart and look at the last three candles—August, September, and October. From the monthly chart, we can see that the bulls were firmly in control during August. Notice, there is almost no wick at the bottom or the top of the candle body. That means that the month began at the bottom of the candle, and closed at the top of the candle. No doubt, August was a good month. After a strong month like that, it is no surprise that the next candle, September was much less decisive. The candle is red, so we know the month ended slightly lower than where it began, but we also see a long wick at the bottom. That means that sometime during the month, the price dropped all the way to the bottom of the wick, but then it recovered the majority of its drop by the time the month ended. We see that because the bottom of the candle body is quite close to the top of the candle body, meaning the month ended only slightly lower than it began. Now let’s move on to the last candle, October.
From that candle, we see the top wick is the highest part of the entire chart, meaning a new high, in this case, it happens to be an all-time high was reached in October. We also know that since the candle is red, it is lower today (as of this writing, the month of October is not yet over) than it was on October first. We can also tell by looking at the length of the wicks that it has been a rather indecisive month. The price went up, the price went down, and currently, the price is a little lower than where it began.
Since we understand what the bodies, wicks, and color of a candle represents, we were able to get a quick read on what happened during August through October simply by looking at three little candles. But if we switch to a daily chart, we get to see the price action of each day. Now we can see exactly when the stock was weak, strong, or indecisive. Remember the big green August candle? The daily chart below confirms what the monthly candle told us. The price began to rise as soon as the month began, and didn’t stop rising until the month ended. In fact, Apple announced its earnings on July 31 which impressed the market, so when the stock opened for trading on August 1, it gapped higher and began to rally with very few down days right up until it peaked at the beginning of September.
After that strong rally, the monthly candles of September and October showed bigger wicks, meaning more indecision and less trend. A look at the daily chart below confirms, but in more detail. Now we can see it was the first three weeks of September where the bulk of September’s decline occurred, and then we see the strong rally into the all-time high on October 3. Since then, we see that the price declined for about a week and has since been trading sideways, preparing for its next trending move.
By understanding the basics of how candles work, you can see the battle between the bulls and the bears unfold on a chart, and more importantly, see who currently has the most momentum and if there are any trading opportunities available.
Candlestick Recap:
- Candles represent the High, Low, Open, and Closing prices of a stock for a particular time period
- Red candle body means the stock closed lower than it opened
- Green candle body means the stock closed higher than it opened