Candlestick Pattern

A Candlestick Pattern is a visual representation of a security's price movements used in technical analysis. Originating from 18th-century Japanese rice traders, this charting method has become a staple for traders trying to forecast short-term market direction. Each “candlestick” typically represents a single day (or any other chosen time frame) and graphically displays the market's open, high, low, and close prices for that period. Technical analysts believe that the shape, color, and sequence of these candlesticks form patterns that can signal potential reversals or continuations of a price trend. For them, a chart is not just a record of past prices; it's a story of market psychology, depicting the ongoing battle between buyers (bulls) and sellers (bears). By learning to “read” these patterns, traders attempt to gain an edge by anticipating what the market might do next.

Think of each candlestick as a snapshot of a trading session. It has two main parts: the body and the wicks. Understanding these simple components is the key to interpreting the chart.

The thick, rectangular part of the candlestick is called the body. It tells you where the price opened and closed for the period.

• A green (or white) body means the closing price was higher than the opening price. This is a bullish sign, indicating buying pressure won the day.
• A red (or black) body means the closing price was lower than the opening price. This is a bearish sign, showing that selling pressure dominated.

The length of the body indicates the strength of the price move. A long green body shows strong buying momentum, while a long red body shows significant selling pressure.

The thin lines extending above and below the body are the wicks (also called shadows). They show the highest and lowest prices the security reached during the period, representing the extremes of the trading session.

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

Long wicks suggest that prices moved significantly during the session but were pushed back by opposing pressure before the period closed. For example, a long upper wick on a red candle suggests buyers tried to push the price up, but sellers overwhelmed them and drove it back down.

There are dozens of named patterns, each believed to have a specific predictive meaning. They are generally categorized as bullish (signaling a potential price rise), bearish (signaling a potential fall), or neutral.

• Hammer: A candle with a small body at the top and a long lower wick. It often appears at the bottom of a downtrend and suggests that buyers stepped in to reject lower prices, potentially signaling a bottom.
• Bullish Engulfing: A large green candle whose body completely “engulfs” the body of the previous, smaller red candle. This is seen as a powerful sign that buying momentum has overtaken selling momentum.

• Shooting Star: The opposite of a Hammer. It has a small body at the bottom and a long upper wick, appearing after an uptrend. It suggests that sellers have taken control and may push the price down.
• Bearish Engulfing: A large red candle that completely engulfs the prior green candle, indicating a potential trend reversal to the downside.

• Doji: A candlestick where the open and close prices are virtually the same, creating a cross-like shape. A Doji signals a stalemate between buyers and sellers and can indicate that a current trend is losing momentum.

Candlestick patterns are the bread and butter of technical analysis, a discipline that attempts to predict future prices by studying past market data, primarily price and volume. This stands in stark contrast to value investing, which focuses on fundamental analysis—evaluating a business's health, competitive position, and management to determine its intrinsic value. So, should a value investor care about candlesticks? The purist's answer is a firm no. Legendary investors like Warren Buffett spend their time reading annual reports, not charts. From their perspective, obsessing over “squiggles on a chart” is a dangerous distraction from what truly matters: buying a great business at a fair price. Focusing on short-term price action encourages speculation, the very opposite of the long-term, business-owner mindset that underpins successful value investing. However, a more pragmatic view is that candlesticks can serve as a minor, supplementary tool. After you've done your homework and identified a wonderful, undervalued company, a glance at the chart might help you choose a better entry point. For instance, seeing a strong bullish reversal pattern after a period of bad news could signal that market sentiment is finally turning, offering a timely moment to start building a position. The Bottom Line: For a value investor, candlestick analysis should never be the reason to buy or sell a stock. It is, at best, a footnote to a well-researched investment thesis grounded in fundamentals. Your primary focus should always be on the value of the underlying business, not the shadows cast by its stock price.