How To Read Candlestick Charts

Article Summary:

Knowing how to read charts is a valuable skill for traders. However, all the jargon can be intimidating. That’s why we created a comprehensive guide on how to read and understand charts that boils down all the technicalities in an easy-to-follow format.

Charts are primarily used to track the progress of a stock, cryptocurrency, or token over time. They give you a graphical representation of how assets change over time. Traders can use charts to identify trends and make educated predictions on how the asset will perform.

This guide includes everything you need to start reading charts.

What is a chart?

Charts are an investment tool that provides a graphic representation of the historical prices and volumes at regular time intervals. Charts help investors make educated decisions about when to buy, hold, or sell an asset.

Charts create patterns based on the price movements of assets over time. There are several types of charts, such as line charts, bar charts, and candlestick charts. Each chart is different, so we created a short guide for each one.

How to read a line chart

Line charts are the easiest to read because they simply plot the closing price of an asset for every given period. The line rises and drops with the closing price of the asset.

Bitcoin bubble crypto line chart
A crypto line chart of Bitcoin price bubbles

What are crypto bar charts good for? Crypto line charts only provide the closing prices of a cryptocurrency over time. Therefore, they don’t provide much information on the daily volatility of the market. However, you can use them to spot general trends.

How to read a bar chart

Bar charts provide a more detailed picture of how an asset is being traded. They are formed by a series of bars (no surprises there) that show the opening, highest, lowest, and closing prices over time. When you are looking at a one-year chart, each bar typically represents a day. However, each bar can represent shorter periods (e.g., 5 minutes or an hour) or much longer periods, such as a week or a month, depending on how the chart is set up.

Crypto bar chart

What are bar charts good for? Bar charts are good at showing the trend and volatility of an asset. You can determine volatility by looking at the difference between the highest and lowest price during the period measured. This is known as the bar’s range. The longer the bar, the larger the difference between the highest ad lowest price. If the closing price is lower than the opening price, the bar is colored red. If the closing price is higher than the opening price, then the bar is green.

How to read a candlestick chart

Candlestick charts are similar to bar charts. They provide practically the same data, but most investors prefer them to bar charts because they present the information more clearly.

Since candlestick charts are the most widely used charts by investors, we will use them as an example when digging deeper into how these charts work.

As with bar charts, each “candle” represents the period’s high, low, open, and close prices. The main difference is that it’s easier to differentiate open and close prices from the high and low prices.

Once you understand how candlestick charts work, you can easily spot patterns, which can help identify factors in an investment, such as price range, support, sentiment, and resistance. The graph below shows a summary of the key terms you must understand to read charts.

Bullish vs Bearish crypto candlestick patterns

How do candlestick charts work?

A Candlestick chart is just a visual representation of an asset price. To understand how they work, let’s break down what a single candlestick means.

Single candles represent the price movement during a certain period. So if you choose a five-minute chart, each of the candlesticks would represent one five-minute frame and the price movement within those five minutes.

A candlestick represents four points:

Candlestick basic elements

  • opening price (shows the current price at the moment the chosen time frame starts)
  • highest price (shows the highest point of a price detected in the chosen time frame)
  • lowest price (shows the biggest previous candle’s low in the chosen time frame)
  • closing price (shows the current price at the moment of closing the chosen time frame)

If the closing price is higher than the opening price, the body of the candle will be white or green (a.k.a hollow). On the other hand, if the closing is lower, then the candlestick is colored black or red (a.k.a filled). The lines that pop up above and below the body or wax of the candle are called wicks and tails and represent the respective highs and lows of trading during the period used.

What is a bitcoin candle?

A bitcoin candle is simply a candlestick used to describe the price action of bitcoin during a given time frame. As with any candle in a candlestick chart, a bitcoin candle shows the opening price, high, low, and closing price of bitcoin.

Now we understand the basics about how the main investment charts work and the data they include, we are ready to dig deeper into how you can use them to inform your trades.

How to read candles?

Investors read candles by interpreting the data provided by each candle and anticipating the price movement of an asset by identifying candlestick patterns.

What is a candlestick pattern?

A candlestick pattern is a graphic representation of changes in price on a candlestick chart that some traders believe can predict future price movements.

Bullish patterns predict increases in price, while bearish patterns indicate that the price may drop. It’s worth highlighting that no pattern works all the time (or even most of the time). Candlestick patterns show tendencies in price movement based on historical data. They are no guarantees they will predict future market changes.

How reliable are candlestick patterns?

Investors use candlestick patterns to predict future market changes. However, they don’t all work equally well. One of the reasons they are no longer as useful is their huge popularity. Major investors have incorporated them in their investment algorithms. These algorithms allow them to make lightning-speed trades that retail investors and traditional fund managers who rely on slower technical analysis methods, can’t compete.

However, candlestick patterns continue to appear, which provide opportunities for short- and long-term profit opportunities. Here are some patterns you should definitely consider learning.

What types of candlestick patterns are there?

Market analysts divide candlestick patterns into two main types: reversal patterns and continuation patterns. Reversal candlestick patterns are then divided into bearish and bullish based on the initial trend.

Here is a summary of the most widely used reversal and continuation patterns you should know.

Reversal candlestick patterns you should know

Reversal candlestick patterns are typically categorized as bearish or bullish reversal patterns. The image below shows some of the most widely used reversal candlestick patterns.

Reversal patterns in candlestick charts

Let’s dig a little deeper into how to read the most common reversal candlestick patterns.

Bearish reversal patterns

Bearish reversal uptrends indicate that a current uptrend will soon be over, and a downtrend is highly possible. The size of the candlestick’s bodies and wicks can tell us a potential direction an asset will take next.

Hanging man

Here we can notice a small body candlestick, which indicates a small distance between the opening and closing price. The lower shadow is as twice as long as the length of the body and the upper shadow is small or non-existent.

"The Hanging Man" candlestick pattern
“The Hanging Man” candlestick pattern

The hanging man occurs during an uptrend and signals prices could go down.

The evening star

This pattern has a large bullish candlestick, a small-bodied one, and a bearish candlestick combined. It typically signals that an uptrend is about to reverse.

Evening star candlestick pattern
Evening star candlestick pattern

First, the buyers are in control, later the sellers are. The evening star occurs at the top of the uptrend and signals that the uptrend is going to reverse to a downtrend.

Bearish engulfing

A bearish engulfing pattern signals lower prices to come. The pattern includes a green (or white) candlestick followed by a large red (or black) candlestick that swallows or “engulfs” the smaller up candle. This can be an important pattern because it may indicate that sellers have overtaken buyers and are pushing the price down quickly.

Bearish engulfing candlestick
“Bearish Engulfing” candlestick

The shooting star

In this pattern, you will notice that the body is small, and the upper shadow is at least twice as big while the shadow is very small or non-existing.

"The Shooting Star" candlestick pattern
“The Shooting Star” candlestick pattern

This pattern occurs after a price advance and indicates that prices could decrease. Bears (sellers) are overwhelming the bulls (buyers)

Three black (red) crows patterns

When you see three candles with long, red bodies, with little or non-existent shadow – you are looking at a three-crow pattern. With each candlestick, we can see the closing prices going lower because of the strong selling pressure.

"Three Crows" candlestick patterns
“Three Crows” candlestick patterns

This pattern occurs after an upward reversal when a downward reversal is on the way.

The dark cloud cover

This bearish reversal candlestick pattern includes a down (red or black) candle that opens above the close of the prior up (green or white) and then closes below the midpoint of the up candle.

The pattern is significant as it shows a shift in the momentum from the upside to the downside. The pattern is comprised of an up candle followed by a down candle. When this happens, traders will look out for the price to continue dropping on the third candle as confirmation of the trend.

"Dark Cloud Cover" candlestick pattern
“Dark Cloud Cover” candlestick pattern

Bullish reversal patterns 

Bullish reversal candlestick patterns indicate that the current downtrend is about to end and it may reverse to an uptrend. Here are some of the most famous bullish reversal patterns.

Hammer

The hammer pattern has a small or non-existent upper shadow, indicating that that the closing price is at the top of the candlestick, and the lower shadow is extra-long. The colors can be green and red, but usually, green hammers show us a stronger bull market.

"The Hammer" candlestick pattern
“The Hammer” candlestick pattern

It occurs after a decline in the price of the asset and indicates a possible reversal.

Inverted hammer

Opposite to the classic hammer, here we have a long upper and small lower shadow. When a selling pressure comes after a buying pressure, but it is still not strong enough to bring the price down.

Inverted hammer candlestick pattern
“Inverted Hammer” candlestick pattern

This pattern may indicate an upward trend reversal. Traders look for a long green (or white) candlestick and heavy trading volume after the inverted hammer as confirmation.

Bullish engulfing cross

In this pattern you will notice a large candlestick that moves in the direction of the trend, followed by a small cross (a.k.a as a doji), which suggests an imminent reversal. The pattern is confirmed by a price increase after the cross.

"Bullish Engulfing" candlestick pattern
“Bullish Engulfing” candlestick pattern

Piercing line

The piercing line pattern has two candlesticks. The first is red and bigger than the second candlestick. The second one is not small, but  it is smaller and it’s green (bullish) – this is a piercing line. This means that the sellers who came in pushed the price low, where it closed. Then the buyers came in and pushed the price but not as strong as with the engulfing pattern.

"Piercing Line" candlestick pattern
“Piercing Line” candlestick pattern

The piercing line occurs in downtrends, when buyers are in control, and it could end as a bullish engulfing pattern.

Morning star

Technical analysts consider the “morning star” as a bullish signal. It is made up of a tall red candlestick, a smaller red candlestick with a short body and long wicks, and a third tall red candlestick.

morning star candlestick pattern
“Morning Star” candlestick pattern

The morning star occurs at a start of a bullish reversal pattern when buying pressure is renewed.

Continuation candlestick patterns

Not all candlestick patterns indicate a change in a trend. Some patterns predict a sideways movement after an initial change. Continuation candlestick patterns help investors recognize a rest period when buyers and sellers fight for control, but no side prevails.

Continuation patterns in candlestick charts
Continuation patterns in candlestick charts

We know this as continuation patterns in candlestick charts. The “upside tasuki gap,” “falling three methods” and “thrusting line” are some of the best-known continuation patterns, but there are many more.

Support and resistance levels

Support and resistance levels are lines below or above which the price of the asset won’t cross during a certain time. Identifying support and resistance levels can theoretically help you anticipate a market trend reversal.

Support level

After a certain amount of patterns, you will notice where the price tends to bounce back. Sellers will push the price down by selling the asset. After a certain point – buyers will come back buying at a high volume to bring the price back up above the support level.

If the selling momentum is still stronger, the price will fall some more, breach the support level and create a new one.

Resistance level

The resistance level is where the price of the asset usually stops rising. When a price comes up to a certain put, it reverses. After it happens several times, we can define the resistance line. If the buying momentum is still stronger, the price will rise more, breach the resistance level and create a new one.

If we connect the support level to risk and the resistance level to profit, you will know at what point potential earnings could be possible. This information can be used to make high-profit and low-risk trades.

Popular technical indicators: RSI, Bollinger bands, MA and MACD

As mentioned before, reading charts is not an exact science, and you can’t focus on just one signal. Candlestick patterns can be helpful, but they need to be read in conjunction with other indicators. Here are some of the most widely used indicators in technical analysis.

RSI (relative strength index)

The relative strength index (RSI) is used to evaluate if an asset is being overbought or oversold by measuring the magnitude of recent changes in price. The RSI of an asset is usually represented as a line graph that moves between two extremes (a.k.a an oscillator), which is read conjunction with a candlestick chart.

Most software will produce the relative strength index automatically, but just so you know how to calculate it, here is the basic formula: RSI = 100 – (100/(1-RS))

We calculate it by dividing average gains (when the price of a coin goes up) with average losses (when the price goes down). For example, the RSI for a crypto coin ranges from 0 to 100.

If the RSI is 30 or below (so the price could soon bounce back) the market price is considered oversold. If it is 70 or over – it is overbought (and the price could bounce back down soon).

Bollinger bands

This is a type of train band or envelope that helps us decide if the price is high or low. We can calculate the bands using standard deviation from the average.

Bollinger bands are typically made of two standard deviations – one above and one below the moving stock market averages. When we use them in charts, they help determine when a market trend could reverse or continue.

Simple moving averages

SMA shows the average price of candles during a certain time you choose. When the points are plotted, the data helps in identifying new trends. You can calculate the SMA by taking the arithmetic mean of a given set of values.

The SMA formula: SMA n = (A1 + A2 + A3+…+An)/n.

“A” stands for the closing prices of the asset and the “n” is for the period over which they occur. Depending on the number of days we use and the type of trading that interests us, we can find different trends:

Short term trends – SMA 20

Medium trends – SMA 50

Long term trends – SMA 200

Exponential Moving Average (EMA)

Like the SMA, the exponential moving average (EMA) calculates the arithmetic mean of a set of values, but the EMA puts more weight on recent days. As with other moving averages, the EMA is used to help tranders identify buy and sell signals based on changes from the historical average.

EMA chart
Source: Fidelity Learning Center

Traders usually a variety of EMA lengths, such as 10-day, 50-day, or 200-day moving average. The EMA is also used to calculate the moving average convergence divergence (MACD).

Moving Average Convergence Divergence (MACD)

The Moving Average Convergence/Divergence indicator appears on charts as two lines that oscillate without boundaries. The crossover of the two lines provides trading signals.

The MACD is an indicator of trends and momentum. It is the result of subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. This is the MACD line.

MACD graph
Source: Fidelity Learning Center

Traders then plot a 9-day exponential moving average of the MACD on top of the MACD line. If the MACD crosses this line above the line, some traders view it as a sign to buy.

What is DOW theory and why do I need it?

Dow Theory is a collection of theories about typical financial market behavior. According to the theory, the market considers everything during its pricing of a certain asset: all existing, prior, and upcoming details are integrated. Price movements are not random according to this theory. The idea is that charts form patterns that traders can use to predict future market changes.

Why everyone talks about the 6 Tenets of Dow Theory?

The Six Dow Theory tenets are derived from 255 editorials by Charles Dow in the Wall Street Journal. Although the majority of the technical analysis has undergone some changes over the last hundred years, its core premises are still based upon these tenets.

1. Market movements are a result of three basic trends

  • Primary trend (main or primary movement) is a major trend that lasts from one to several years. The movement can be bullish  upward) or bearish (bear market: sellers known as bears take the price downwards by selling it).
  • Secondary trend (medium swing) lasts from ten days to three months.
  • Tertiary trend (short swing) rarely affects long-term movements, with a duration anywhere from a few hours to a month, and is not based on long-term market behavior.

2. Three phases of the major market trends

  • Accumulation phase – in this phase more skillful market participants (you can get there, but they are still a minority) sell or buy coins against the general perception of the market. Since they are a minority, this does not affect the asset price significantly.
  • Absorption phase (public participation phase) – now the rest of the market participants start to follow the new trend. Widespread market speculation happens.
  • Distribution phase – after high speculation, knowledgeable investors begin the redistribution of their holdings, and this results in a fall of the asset price and volume.

3. The stock market discounts new information

Hope, fear, or expectations from all the market participants, external factors like earnings expectations, interest rate movements, revenue projections, major elections… Once the information is “out”, it reflects as a change in the price movement of a certain asset.

4. Averages must mutually confirm each other

For example, if your favorite restaurant is working more, it will need the delivery service more. So, the incline in the restaurant business should mean the same for the business correlated, in this case, the delivery service.

If you would want to invest in your favorite restaurant, you should look at the performance of the delivery service as well as the restaurant. If there is an upward trend for just one business, it is a strong sign the market trend might be reversing soon.

Likewise, two stock market trends need to be moving in the same direction, to use them to predict the market’s price movement.

5. Volume confirms trends

If trading volume increases, it is that much more like that the prices will follow. During a downtrend, the prices should decrease as well.

In the crypto market, this means that low volume could mean that a trend is weak, while a large trading volume could signal a strong trend.

6. A trend exists until a reversal is definite

Despite the everyday market noise, Dow believed that trends in prices do exist. It would be best if we didn’t start trading against a trend before its reversal is clear, but this is not always easy to do.

Technical analysis of charts can help predict future price movements. However, using these patterns is becoming increasingly difficult because they are used by major investors who integrate them in their investment algorithms. These algorithms allow traders to make data-based trades faster than retail investors and fund managers who use regular technical analysis methods.

 

Key takeaways

  • A stock chart is a graph that displays the price of an investment over a period of time.
  • Price movements are not random, but a result of market trends, news, and human emotions.
  • Market cap is the total circulating supply of the currency multiplied by the price of each coin.
  • There are multiple types of charts, including line, bar, and candlestick charts.
  • Candlestick charts are the most widely used chart. They can help traders identify bullish and bearish reversal patterns.
  • Technical indicators like MACD and RSI are useful, but they need to be observed in context when reading charts.
View Article Sources
  1. Improving stock trading decisions based on pattern recognition – National Institutes of Health
  2. What to know about cryptocurrency and scams – Federal Trade Commission
  3. The basics about Cyptocurrency – State University of New York
  4. What is slippage in Crypto? – SuperMoney
  5. Cryptocurrency and scams – FTC