Candlestick charts: how to read them, and why patterns often fail

A candlestick chart draws each day (or week) of trading in a share as one "candle". The candle shows four prices: where trading opened, the high, the low and where it closed. Green means it closed higher than it opened, red means lower.

Traders name shapes such as the doji, hammer or engulfing pattern and say they hint at a turn. Research finds these hints are weak and often wrong, and costs on quick trades add up. Learn to read candles so you understand charts and market news, not to time buys and sells.

One candle, four prices

Each candle covers one period. On a daily chart that is one trading session. It records:

• Open: the first traded price of the period.
• High: the highest price reached.
• Low: the lowest price reached.
• Close: the last traded price.

The thick part is the body. It runs from the open to the close. The thin lines above and below are the wicks, also called shadows. The top of the upper wick is the high, and the bottom of the lower wick is the low.

Worked example: one day of Share X

Share X is a made-up company. These prices are an example, not market data.

The close (21.00) is above the open (20.00), so the candle is green.

Read it as a story: sellers pushed the price down to $19.40, buyers lifted it to $21.50, and it settled at $21.00. The candle doesn't show the order of those moves.

Green, red and what the body tells you

A long body means one side dominated the period: buyers for a long green body, sellers for a long red one. A short body means the open and close were close together. Long wicks show the price travelled far and then came back.

Timeframes: a daily candle vs a weekly candle

The same share can look different on different charts. On a weekly chart, one candle covers a whole trading week, which on most exchanges runs Monday to Friday.

Say Share X opens the week at $20.00 on Monday and closes Monday at $21.00. That daily candle is green. Over the week it reaches a high of $21.50 and a low of $19.10, and closes Friday at $19.80.

Same week, two stories. When someone says "a bullish candle", ask which timeframe they mean. Patterns on short timeframes, such as 5-minute or hourly candles, are noisier still.

The patterns people talk about

Charting books list dozens of named patterns. Each meaning below is what traders say the shape suggests. It is not a forecast.

Notice two things. A hammer and a hanging man are the same shape; only the trend before them changes the name. And every meaning says "possible".

Worked example: a hammer on Share X

After a week of falls, Share X has this day (example, not market data): open $18.60, high $18.80, low $17.20, close $18.70.

• Body: 18.70 − 18.60 = $0.10.
• Lower wick: 18.60 − 17.20 = $1.40, which is 14 times the body.
• Upper wick: 18.80 − 18.70 = $0.10.

That is a textbook hammer. Now suppose the next day opens at $18.50 and closes at $17.90. The "turn up" never came. This happens often, which is why chart guides say a pattern needs confirmation first.

What the research says

Candlestick rules usually look at one to three days of prices and hold a position for days, not years. So they are a short-term trading tool, a form of speculation.

Marshall and colleagues concluded that trading on candlesticks alone does not seem sensible. Caginalp and Laurent found the opposite on an earlier sample. Results depend on the market, the years and the rules.

Even chart educators who use candlesticks say they work best with other evidence. StockCharts' guide pairs them with other chart tools and notes that candles alone give no price targets.

The limits you should know

• Context: a pattern only means something against the trend before it. The same shape can carry opposite names.
• Volume: a pattern on a day with very few trades says little. Thinly traded shares, with low liquidity, can print odd candles from a handful of orders.
• Hindsight: patterns look obvious on old charts. In real time you don't know which ones will fail.
• Costs: every trade can carry a commission, the bid-ask spread and small exchange or regulatory fees. Short-term trading multiplies them.

FINRA, the US brokerage regulator, notes that "zero-commission" trading does not mean free investing.

Worked example: what quick trading costs

Say Sam trades $10,000 at a time, four round trips (a buy and a sell) a month. Assume his total cost, commission plus spread, is 0.3% of each buy and each sell. That rate is an example, not a quote; check your brokerage's fee schedule and the spread on what you trade.

That is 28.8% of his $10,000 a year, before any gain or loss. Each trade must rise 0.6% just to break even. The US Securities and Exchange Commission warns that day traders typically suffer severe losses in their first months, and pay large amounts in commissions.

Your plan

1. Read candles to understand, not to act. When news says a share "formed a doji" or "a bearish engulfing", you now know what was drawn.
2. Check the timeframe. Ask whether a pattern is on a daily, weekly or hourly chart before taking it seriously.
3. Look at the trend and volume first. A pattern on a thin day or with no clear trend before it means little.
4. Count the costs. Before any short-term trade, work out the round-trip cost in dollars and the rise you need to break even.
5. Keep long-term money separate. If you want to try trading, use a small amount you can afford to lose, after your emergency fund and expensive debt are handled.

What to watch out for

• "Signals" for sale. Groups and channels that post patterns with "buy now" calls are selling excitement. Following them is herd behaviour.
• Borrowed money. Trading on margin turns a failed pattern into a bigger loss.
• Certainty. No pattern tells you what a share will do next. Treat every one as "maybe".

This guide is for education only. It is not advice to buy or sell any share, or to trade on any pattern.