Welcome to the third installment of our new introduction to trading blog series called Stock Market Made Simple. In last week’s post, which you can read here, we covered how a stock was traded in the marketplace. Today we are going to go a little deeper in our journey and cover candlestick charts.
The origins of a candlestick chart date back to a Japanese rice trader in the 18th century known as Munehisa Homma. He is widely considered to be the architect of the candlestick chart system, which was developed to track the price of rice contracts. Today’s candlestick chart, which is very similar in form and function to the original Japanese charts which were developed, is a graphical representation of the open price, the close price, the high price, and the low price of a stock for a defined set of time.
Let’s take a look at a chart example and see how the open, close, high, and low-price points are displayed on a candlestick.
For discussion purposes, the candlestick image above represents the time frame of one day of trading. The first arrow at the very top of the candle’s upper wick or shadow as it is called is the highest point the price went during the day. The next arrow down shows the price at which the stock in question open at the start of the day. While the third arrow down shows the price, the stock closed out at the end of the day. Finally, the very bottom of the lower wick or shadow represents the lowest price the stock traded at during the day. This candle is red in color because, during the course of the day’s trading, the price ended up closing lower than it originally opened, reflecting a drop in the price of the stock. Sometime, the color black will be used instead of red but they both represent a drop in the day’s price.
Let’s take a look at the same candlestick, but the opening and closing prices are switched. As with the red candlestick image, the first arrow at the very top of the candle’s upper wick is the highest price the stock traded during the day. The next arrow down shows the price at which the stock in question closed at the end of the day. While the third arrow down shows the price, the stock opened at the start of the day. Finally, the lower wick shows the lowest price the stock traded at during the day. This candle is green in color because, during the course of the day’s trading, the price ended up closing higher than it originally opened, reflecting an increase in the price of the stock. Sometime, the color white will be used instead of green but they both represent a positive gain in the day’s price.
Understanding candlestick charts is essential to understanding the sentiments of the stock market. Having a conversation with everyone to find out their opinions in the market is impossible; however, once you start using candlestick charts, you will have the a graphical representation of how most everyone in the world is reacting to the fluctuations of a stock in the marketplace at your fingertips.