Patterns have played an important role in human evolution. The discovery of pattern of stars or constellation changed our understanding of the galaxy. A similar discovery of patterns has changed the way the world creates wealth. I’m referring to Candlestick Patterns.
The story of candlestick patterns started in the 17th century. A rice farmer, Homma Munehisa used candlestick patterns to predict uptrends or reversals in the rice futures market. It is said that his networth was equivalent to today’s 300 Billion Dollars!
However, Steve Nison introduced candlestick patterns to the western world in the 1980s. Since then, candlestick patterns have become a favourite among traders and technical analysts. One of the key reasons for the popularity of candlesticks is its simplicity and ability to display multiple information about a stock’s price. This is what sets candlestick apart from a line chart.
A line chart only shows the closing price of a stock on a particular trading day. You cannot make out whether the stock hit a high or a low or was flat. Hence, line charts are one-dimensional. But candlestick displays four key information about a stock at one go – OHLC.
- Open (O)
- High (H)
- Low (L)
- Close (C).
Understanding the OHLC of a stock is vital to predict trends or reversals in the stock prices or the overall market. By displaying these four components at one go, candlestick has become a crowd favourite.
However, retail investors have always shied away from candlestick as they think it is too complicated. But this is incorrect. In today’s article, we will understand what is candlestick and how candlestick patterns are created. We will also understand the eight basic candlestick patterns which can help you predict market trends and make money in the stock market.
Let us begin with the basics of candlestick.
What is Candlestick?
While the name sounds fancy, a candlestick is simply a type of chart used to display the open, high, low and close prices of a stock. It is named such because it resembles an actual wax candle. It has a body with wick on the top. And it casts a shadow below it.
The body of the candle is known as the real body or central body. The wick is known as the upper shadow. There are two types of candlestick –
- Bullish Candlestick
- Bearish Candlestick
[Watch this Video to Learn What is Candlestick?]
Constructing a Bullish Candle
The table below shows the OHLC of ITC Ltd on 16th September 2021.
Now we can clearly see that the bulls had a good day. ITC Ltd opened for trading at Rs 216.95 per share. The bulls then took it to a high of Rs 237.30. The bears tried to pull the stock price down to Rs 229.10. But eventually, the bulls gained the upper hand as the stock closed at Rs 231.15.
So, whenever a stock’s closing price is more than its opening price, a bullish candle is formed. It means the bulls won the day. A bullish candle is usually shown in green or white colour.
|Open Price < Close Price = Bullish Candle|
This is how ITC’s bullish candle will look like for 16th September 2021 –
In a bullish candle –
- The rectangular body of the candle connects a stock’s closing price (Rs 230.75) with its opening price (Rs 216.95).
- The wick or upper shadow connects the stock’s closing price (Rs 230.75) to its day’s high (Rs 233.65).
- The lower shadow connects the stock’s opening price (Rs 216.95) to its day’s low (Rs 216.30).
So, whenever you see a green colour candle, you must realise that the stock’s closing price is more than its opening price. This means the bulls won.
Constructing a Bearish Candle
Let us now look at how a bearish candle is constructed for ITC Ltd for 17th September 2021.
Notice that the closing price is less than the opening price. This means that the stock opened at a high price of Rs 233. At some point, it even made a high of Rs 237.30. But by the close of the day, it fell to Rs 231.15, which is less than the opening price. This means that the bears were victorious. A bearish candle is usually shown in red or black colour.
Remember, whenever a share’s closing price is less than its opening price, a bearish candle is formed.
|Open Price > Close Price = Bearish Candle|
This is how ITC’s (bearish) candle will look like for 17th September 2021 –
In a bearish candle –
- The rectangular body of the candle connects a stock’s opening price (Rs 233) with its closing price (Rs 231.15).
- The upper shadow connects the stock’s opening price (Rs 233) to its day’s high (Rs 237.30).
- The lower shadow connects the stock’s closing price (Rs 231.15) to its day’s low (Rs 229.10).
A bearish candle means that while the bulls tried to take the stock up, eventually the bears won the battle. This is why the close price is less than the opening price.
8 Basic Candlestick Patterns to Predict Market Trends
Now that you understand how a bullish and bearish candlestick is formed, let us understand the eight basic candlestick patterns. Candlestick Patterns can be divided into –
- Single Candlestick Patterns
- Multiple Candlestick Patterns
In this article, we are focussing on eight basic candlestick patterns. The other candlestick patterns are a variation or combination of these basic candlestick patterns.
Watch this Video and Learn a Simple Method to Identify Candlestick Patterns
An important thing to note about candlesticks is the length of the candle’s real body. This indicates the intensity of buying or selling by bulls and bears.
The first basic candlestick pattern that we will explore is the Long Day Candle.
A long day candle is formed when there is a substantial difference between the open and close price of a stock. It typically indicates a big upward or downward movement in the market. A long day candle can be both bullish (green) or bearish (red).
A green long day candle means the stock or market is bullish. This means that the bulls were in total control of the stock and hence there is a big difference between the stock’s open and close price.
The chart below shows a bullish long day candle formed in ITC Ltd on 16th September 2021.
When you look at this candle, you will be able to understand what happened to ITC Ltd on 16th September 2021 –
- ITC Ltd opened for trading at Rs 216.95.
- It hit a high of Rs 233.65 and a low of Rs 216.30.
- It finally closed at Rs 230.75.
The difference between the open and the close price is a mammoth Rs 13.80, which is 6.36% movement in a day! This is massive for a stock like ITC.
A red long day candle means that the bears were dominating the market. So, there is a big difference between the open and close price of the stock.
The chart below shows a bearish long day candle formed in Nifty 50 index in March 2020.
Candlestick Pattern #2: Short Day Candle
A short day candle shows a small movement in the market or stock. It is formed when there is a small difference between the close and open price of a stock. This type of candle is usually seen when there is less activity or volatility in the markets. A short day candle can be seen during December, which is a holiday season for the foreign institutional investors (FIIs).
A red short day candle means the bears were in charge but couldn’t drag the prices down much since there was less volume. A green short day candle means the bulls were in control but couldn’t pull the stock prices up due to low volumes. A short day candle typically shows a consolidation stage in stock prices after a rally.
The screenshot below shows the green and red short day candles in Reliance Industries Ltd between March – June 2018.
The next and a very important candlestick pattern is the Marubozu.
Candlestick Pattern #3: White / Green Marubozu
In Japanese, Marubozu means bald. This simply means a candle with no wick (high) or lower shadow (low). Only a real body. Marubozu can also be bullish Marubozu or bearish Marubozu.
In case of a bullish Marubozu;
|High Price = Close Price & |
Low Price = Open Price
This means that the bulls did not let the bears bring the stock price down at all. Hence, the stock’s open price is the same as its low price and the stock closed at day’s high. A green or white bullish Marubozu shows extreme bullishness in the market.
A bullish Marubozu could mean that the stock can go up in the next few trading sessions. Traders can buy at the closing price with the day’s low as the stop loss.
The candlestick chart below shows a bullish Marubozu in IndusInd Bank Ltd.
Candlestick Pattern #4: Black / Red Marubozu
On the other hand, a black or red Marubozu shows extreme bearishness or pessimism in the markets. Here the bears are in charge and don’t allow the bulls to take the stock price up since opening.
In case of a bearish Marubozu;
|High Price = Open Price & |
Low Price = Close Price
In a bearish Marubozu, the stock’s opening price is equal to its day’s high. This happens because the bears have immediately started dragging the prices down. So, the stock is unable to move upwards after opening. In a bearish Marubozu, the stock’s closing price is its day’s low.
The candlestick chart below shows a bearish Marubozu in Nifty 50 index during the Covid crash.
A Marubozu candle is often seen when a stock is in upper or lower circuits. A bearish Marubozu is a good opportunity for short selling. You can sell at the closing price with the day’s high as the stop loss.
Candlestick Pattern #5: Doji
Doji candlestick pattern is a sign of extreme confusion among bulls and bears in the market. A doji candle resembles a cross. In a doji, there is very little difference between the open and close price of a stock. Hence, a real body is not created.
In a doji candle:
|Close Price = Open Price|
A doji candle does have an upper and lower shadow. This means that both bulls and bears tried to take control of the stock. But in the end, both of them failed and hence the closing price is almost equal to the opening price.
If a doji is formed after an uptrend or downtrend, then chances for a reversal are very high. This is because the bulls and bears are not able to keep the stock price up or down for a long time.
Below is the OHLC of Mahindra & Mahindra Ltd on 2nd June 2021.
The stock opened for trading at Rs 806.30. The bulls tried to take it to a high of Rs 812. The bears also tried their best to bring it down to Rs 802.30. But eventually, they both failed. The stock closed at Rs 806.20, which is just 10 paise lower. So, the body is non-existent.
This is how a doji candle looks like –
Candlestick Pattern #6: Spinning Top
Like doji, even spinning top tells you that there is indecision and confusion in the market. Neither bulls nor bears are able to dominate the markets. Named after a toy, spinning tops have a small body (though bigger than body of a doji). The upper shadow and lower shadow of a spinning top are similar. The below candlestick chart shows the formation of a spinning top and Doji in Sequent Scientific Ltd.
Green Spinning Top in Blue Star Ltd.
In the below candlestick chart, a green spinning top can be spotted on 30th August 2021.
Here is the OHLC of Blue Star Ltd on the day –
In the case of Blue Star Ltd. –
- Real body = Close – Open = Rs. 769.75 – Rs. 768 = Rs. 1.75.
- The wick or upper shadow = High – Close = Rs. 777.80 – Rs 769.75 = Rs. 8.05
- The lower shadow = Open – Low = Rs. 768 – Rs 758 = Rs. 10
Recall the definition of spinning top… a candlestick with small real body (1.75) and almost equal shadows (8.05 and 10).
Red Spinning Top in Blue Star Ltd.
In the candlestick chart below, a red spinning top can be spotted on 27th September 2021.
Here is the OHLC of Blue Star Ltd on the day –
Let us do the same calculation and see if our definition of spinning top works.
- Real body = Open – Close = Rs. 904.80 – Rs. 902.05 = Rs. 2.75
- The wick or upper shadow = High – Open = Rs. 917 – Rs. 904.80 = Rs. 12.20
- The lower shadow = Close – Low = Rs. 902.05 – Rs. 885 = Rs 17.05
Since the wick and lower shadow are in the same range and the candle has a small body, we can conclusively say that a spinning top is formed. Like a doji, a spinning top also signals confusion among bulls and bears.
Candlestick Pattern #7: Opening Marubozu
The stock market is nothing but a constant fight between the bulls and bears to take the stock price up or down. Hence, in all the candlestick patterns we saw above, there is both an upper shadow and a lower shadow. This means that irrespective of the closing price, both bulls and bears tried to take the stock up or down. This is why the shadows are created.
But what if the bulls are so strong that the bears cannot take the stock price down? This is when an opening Marubozu is formed. Opening Marubozu can be both bullish (green) and bearish (red).
Now we know that a green candle is formed when the closing price is more than the opening price. In case of a green opening Marubozu, it means that the stock’s price did not go down after opening. The bulls were so aggressive that as soon as the market opened, the stock price shot up. The bears did not get the chance to bring the stock down.
A green (bullish) opening Marubozu is formed when –
|Open Price = Low Price|
So, a green opening Marubozu will have a decent sized real body and an upper shadow. It will not have a lower shadow. The below chart shows the formation of a green opening Marubozu in HDFC Bank Ltd on 20th August 2021.
Here is the OHLC of HDFC Bank Ltd. on 20th August 2021 –
Notice that the open price and the low price is almost the same. This means that after opening at Rs 1,486.50, the bulls were so aggressive that they did not allow the bears to take the stock price down. This shows extreme bullishness in the stock or market.
The exact opposite happens in the case of a red opening Marubozu. Here, the bears are so aggressive that they immediately drive the stock price down. The bulls do not get a chance to take the stock up after opening. In case of a red opening Marubozu, there is no upper shadow or wick.
A red opening Marubozu is formed when –
|Open Price = High Price|
The below candlestick chart shows a how a red opening Marubozu is formed in State Bank of India on 18th June 2021.
Here is the OHLC of State Bank of India on 16th June 2021 –
You can clearly see that the opening price is equal to the high price. This means that the bears were in full control and did not let the stock go up even slightly. A red opening Marubozu means extreme bearishness in the stock or the market.
Candlestick Pattern #8: Closing Marubozu
The last basic candlestick pattern is the Closing Marubozu. A green Marubozu candle shows that the stock’s closing price and high was the same. So, there is no upper shadow only a lower shadow.
In a green closing Marubozu –
|High Price = Close Price|
The below candlestick chart shows the formation of a green closing Marubozu in ICICI Bank Ltd on 1st August 2021 –
Here are the OHLC of ICICI Bank Ltd on 1st August 2021 –
As you can see, the high and close price are almost same for ICICI Bank Ltd. So, the stock opened, hit a low but closed at its high price. A green closing Marubozu is generally formed when stocks are close to their upper circuits.
In a red closing Marubozu, there is no lower shadow. This means that the stock’s closing price is the same as its low price. Hence, a lower shadow is not formed. This usually happens when there is extreme bad news about the stock or negative market sentiments.
In a red closing Marubozu –
|Low Price = Close Price|
Let us see a real-life example showing the red closing Marubozu.
On 1st July 2019, the OHLC of Reliance Industries was –
As you can see, there is very little difference between the low and close price (0.03%) and hence a substantial lower shadow is not created.
This concludes our discussion on what is candlestick and the eight basic candlestick patterns. These patterns form the base for the multiple candlestick patterns like Harami, Engulfing Pattern, Morning Star etc. which we will discuss in future articles.
Our Chief Market’s Editor, Apurva Sheth has created dedicated videos on the different types of candlestick patterns. Check them out now! You must also check out our playlist on the basics of technical analysis.
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