Candlesticks

Candlesticks (also known as Japanese Candlesticks) are a visual representation of a security's price movements and are a cornerstone of technical analysis. Originating with 18th-century Japanese rice traders, each 'candle' packs a wealth of information into a simple shape, showing the high, low, opening, and closing prices for a specific time period (e.g., a day, an hour, or a minute). A series of these candles forms a chart that analysts use to identify patterns, gauge market sentiment, and try to anticipate future price action. Unlike a simple line chart that only connects closing prices, a candlestick chart tells a much richer story about the battle between buyers (bulls) and sellers (bears) within each trading session. For many, learning to read these charts is like learning a new language—the language of the market's mood.

To understand candlestick patterns, you first need to know the two basic parts of a single candle.

This is the wide, rectangular part of the candlestick. It represents the range between the security's opening and closing price for the period. The color of the body is crucial:

• A green (or white) body indicates that the closing price was higher than the opening price. This is a bullish or “up” candle.
• A red (or black) body indicates that the closing price was lower than the opening price. This is a bearish or “down” candle.

A long body suggests strong buying or selling pressure, while a short body (sometimes called a “Doji” when the open and close are nearly identical) suggests indecision or a weak trend.

These are the thin lines extending above and below the real body. They represent the highest and lowest prices reached during the period.

• The Upper Wick shows the session's high price.
• The Lower Wick shows the session's low price.

Long wicks can indicate significant volatility and a reversal of direction within the period. For example, a long upper wick on a red candle shows that buyers tried to push the price up, but sellers ultimately took control and drove it back down.

Individual candles are informative, but the real magic for technical traders lies in the patterns formed by one or more candles. These patterns can offer clues about potential trend reversals or continuations. Here are a couple of classic examples:

• Hammer: A candle with a short body, a long lower wick, and little to no upper wick. It often appears after a price decline and can signal that sellers pushed the price down, but a strong wave of buying drove it back up, suggesting a potential bottom.
• Bullish Engulfing: A two-candle pattern where a small red candle is followed by a larger green candle whose body completely “engulfs” the previous red body. This powerful pattern suggests that buyers have decisively overpowered sellers.

• Shooting Star: The opposite of a Hammer. It has a short body, a long upper wick, and little to no lower wick. It tends to appear after a price advance and can signal that buyers lost steam and sellers took over, hinting at a potential top.
• Bearish Engulfing: A two-candle pattern where a small green candle is followed by a larger red candle that completely engulfs the green one. This suggests a significant shift in momentum from buying to selling.

At first glance, candlesticks and value investing seem to belong to different universes. Candlesticks are the poster child for technical analysis, which focuses on price patterns and market psychology. In contrast, value investing, championed by figures like Warren Buffett, focuses on fundamental analysis—understanding a business's health, competitive advantages, and intrinsic value. So, should a value investor care about these little colored bars? The answer is a pragmatic yes. While a value investor's decision to buy a stock is based on the company being great and its price being cheap, candlestick charts can be an incredibly useful dashboard. They are not a crystal ball, but a tool for context. Here’s how a value investor might use them:

• Visualizing Volatility: A quick glance at a candlestick chart shows a stock's price history and volatility far more effectively than a table of numbers.
• Timing an Entry: Let's say your fundamental research tells you that Company X is undervalued and you want to buy it. By looking at the chart, you might notice the stock is in a steep, panicked downtrend (a series of long red candles). You might decide to wait for the selling to show signs of exhaustion (e.g., smaller candles, or a Hammer pattern) before establishing your entry point. You're not using the pattern to decide if the company is a good investment, but rather to choose a better moment to act on your research.

In short, for a value investor, fundamental analysis tells you what to buy. A candlestick chart can help you see the market's mood and offer context for when to buy it. It’s a supplemental tool, not the main navigation system.