Most people out there have no experience with one of the most interesting tools that you can use to estimate the future moves of a stock. Obviously, noone can estimate with 100% certainty which way a stock will move otherwise they would be knocking on Warren Buffet, the Oracle of Omaha’s, doorstop to take his place atop the ranks of successful mutual fund managers. Candlestick graphs are the closest most of us can get to being able to figure out which way a stock is going to move. Most people pay hundreds of dollars per year I am going to explain what a candlestick graph is, explain the different types of movements and how they are represented and how those movments should affect the stock in the near future.
Candlestick graphs are charts that plot the change in stock prices over a specified period of time at time intervals. For example the graph at the top of the graph is a 2 month candlestick graphed at 1 day intervals. Adjusting the length and intervals of your candlestick graph can help you more accurately notice trends and future actions a stock may take. Before we get ahead of ourselves we have to learn what each part of the candlestick graph means. Above is an example of the two most simple candlesticks in a candle stick graph. The one on the left is a advancing candlestick which means that the price of the stock was higher when it closed then when it opened. Conversely, the one on the right is a retreating candlestick, which means the price of the stock was lower when it closed then when it was open. All advancing candlesticks are green and all retreating candlesticks are red. The area between the opening and closing price of the day is called the real body of the candlestick. The real body represents the real gain or loss that happened during the course of the trading day. The to lines that extend both ways from the real body are called the shadows. The upper and lower shadows represent the highest price and lowest price respectively that the stock experienced through the course of the trading day. Implications of both of these types of candlesticks will be explained soon.
From this point on in the article I’m going to explain specific types of candlesticks and their implications on trading prices. The first I’m going to cover is the engulfing bull and engulfing bear. As most of you know a bull market is when the market as a whole is advancing (a bull throw things up with its horns) and a bear market is when the market as a whole is retreating (a bear pushes things to the ground with its paws). The engulfing bull is on the left and is charachterised by a green real body being larger than a previous days red real body. The engulfing bear is on the right and it is charachterised by a red real body being larger than a previous days green real body. This candlestick signifies confusion or correction which means you should wait to see the next candlestick to try and figure out which way the stock will move.
The next two candlesticks that we are going to cover are the hammer (bullish) and hanging man (bearish). They are both pretty easy to figure out because the name pretty much describes what they look like. Both of these are charachterised by a shadow that is about three times the size of the real body. The color of the real body doesnt matter as much size of the real body and shadow because both signifiy a change in direction despite what color it may be. Although they usually signify a change in movement of the price of the stock, you should wait to buy or sell because sometime they can be an incorrect indicator. The next candlestick can usually tell you if the hammer or hanging man was a true indicator or an outlier.
One of the strongest indicators or a change in direction of a stock is what referred to as a harami. The harami also comes in a bullish and a bearish form. A harami is charachterised by a real body that is completely contained by and is the opposite color of the real body of the candlestick before it. These usually specify a good time to buy or sell respectively because they often lead to huge gains or losses. If the trend is strong, meaning the stock usually rebounds when it falls to the price that the candlesticks are at, it increases the chances that you are buying or selling at the right point.
The morning star (bullish) and evening star (bearish) are basically the only candlesticks that don’t need comfirmation of trend to show that the stock is reversing trend. Both are signified by a candlestick (regardless of color) between two candlesticks of opposing color that have about equal real bodies.
The Inverted Hammer (bullish) and the Shooting Star (bearish) are hybrids of the Morning Star/Evening Star and the Hammer/Hanging Man patterns. The following day is critical for confirmation. The next day’s bar will confirm the pattern… it may even look like the Morning Star or Evening Star.
The Piercing Line (bullish) and Dark Cloud Cover (bearish) are similar to the engulfing pattern except the second candlestick should close at least halfway into the real body of the first… the further the close, the more valid the reversal. You may want to wait for the next day’s candlestick for verification.
Now that you have become educated in the game of the candlestick graph. You can go to www.finance.yahoo.com and select stock and practice on their excellent candlestick graphs. I endure Yahoo! Finance for candlestick graphs because they don’t charge and the graphs are supurb.
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