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Understanding Candlestick Charts: Technical Analysis 101

Despite its advances over the line chart, the candlestick chart is hardly a new invention. This charting method was developed in the 18th century Japan by rice traders.

Reading the Candle Stick Chart

Taking a look at a candlestick chart like the one above, the stock's overall price movement is fairly easy to spot, much like in a line chart. Unfortunately, that's the extent of most investors' understanding of candlestick charts.

So how do you glean all of that other information from a candlestick? Take a look at the diagram below:

Must Read: How to Trade a Breakout

Source: Wikipedia

Essentially, the color of the candle's body determines the stock's direction for a given period. (Individual candles can represent any length of time -- we'll assume it's a day for simplicity's sake.) A filled candle body represents a down day, whereas an empty candle is a higher move. Most charts today are also coded by color.

On days where the stock moved higher, the bottom of the body is the open price, the top of the body is the close price. The opposite is true for down days. The shadows (also known as tails or wicks) represent the intraday price swings that fell outside of those two levels.

Naturally, for days when price action stayed between the open and close, no shadows will be present. (These candles are known as "marubozu" in Japanese charting lingo.)

Trading Tactics Using Candlestick Charts

Different traders use candlestick charts for very different trading techniques. While breakout or momentum trading is popular with the added information candlesticks provide, the practice of analyzing patterns formed by specific groupings of candlesticks is popular as well.

Clearly, understanding how to read candlestick charts is only one of the early steps toward undertaking technical trading outright. 

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.
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