Unmasking The VooDoo: Candlesticks

I am not going to dive into how to make candles and define the basic shapes. There are too many resources online to help with that. But because this is supposed to make your life easier, here is my stock graphic of the basics. Remember, a black or red or filled candle means the close was below the open. A white or green or non-filled candle means the close was above the open.

The next question is, “What about the highs and lows?”

The answer is that they are represented by the shadows or tails of the candle – the skinny parts that project above and below the fat part – called the real-body, by the way.

Are they important? They can be. Most of the time it is the lengths of these shadows that we care about and not their absolute price levels. Why? Because is tells us how much of a rally or decline within the day (or another period covered in the candle) was reversed. There is meaning in that. A giant rally that gave it all up by the close suggests weakness. A rally that closes near the high with a little upper shadow suggests strength.

The best part is that we can get real meaning by patterns as small as 1-3 candles, as well as more traditional patterns comprised of dozens of candles/bars using traditional indicators, such as RSI. Again, you can find jillions of sources for these patterns online so I won’t cover them here.

The point here is that candlesticks are very useful in that they quickly reveal intra-period changes. Said another way, we can see intraday changes on a daily chart that might be hidden in regular bar charts.

That brings us back to names. Candle patterns, thanks to the Japanese, who invented this stuff, have great names. Abandoned baby, dark cloud cover, two black crows and gravestone doji all portend bearish things ahead. Hammers, morning stars, three white soldiers and two rabbits suggest bullish things ahead.

Beats an inside-day or a flag any day.

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Disclosure: No positions in anything covered.

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