How to read a candlestick chart.

In a lot of financial applications, you’ll see a chart like this:

A candlestick chart on cryptolazza.com

What does this mean? How do you read it? What kind of information can you glean from a quick glance at this chart?

This tutorial is an introduction to candlestick charts and why you might want to use them instead of straight line charts. It covers topics like:

Mechanics

A candlestick chart is a graph of time periods, where each time period shows:

  • The opening price of that time period
  • The highest price during the time period
  • The lowest price during the time period
  • The closing price of that time period.

Traditionally, the bars are either colored green for periods where the price went up, or red for periods where it went down. Some sites omit the color-coding or use non-standard colors, though.

For example, here’s a pair of bars from Cryptolazza’s chart, with the hovercards showing actual values:

Candlesticks from 8:47 and 8:48 AM

On the left is a red bar, indicating that the price dropped during the one-minute period of 8:47 AM. The solid area indicates the open and closing prices. Because this is a descending period, the top of the bar, at $7907.4697, is the price of the first trade within the period. The bottom of the bar indicates the closing price of $7904.616, the last trade in the period. There’s also a small red line (a “wick”) drawn upwards from the bar; this indicates that the high price during the time period was $7911.262 (i.e. at some point within that minute, a trade occurred for $7911.262 and then the price fell back down). There is no similar line below the bar, indicating that the closing price was also the low price. (Technically, if you look at the hovercard the low is slightly lower than the closing, but so close as to be indistinguishable visually.)

On the right is a green bar for the next minute, indicating that the price went up. The first trade is represented by the bottom of the bar, at $7906.7354. The last trade is the top of the bar, at $7912.699. In between, there’s a big low at $7889.414, and a smaller high at $7914.7397, indicating that there was a lot of volatility during this time period, with large swings in price within just that one minute. (In most cases, this is due to trades happening on multiple exchanges, which may have different prices at any given time.)

The way you find trends on a candlestick chart is to look for long areas where one color dominates and the general slope continues uninterrupted. For example, here’s an 8-hour period from October 20, 2019, in which the price of Bitcoin rose from $7960 to $8223:

Bitcoin rally on 2019-10-20

Notice the large amount of green on this graph, punctuated by only short periods of red. The general trendline on the graph is also up-and-to-the-right, and the size of the high/low lines outside the bars is quite small.

This indicates a broad-based rally, independent of any one actor. Since it continued for 8 hours, it showed a widespread turn in sentiment: many different traders believed that $7900 was too low a price for Bitcoin, and sustained demand pushed it up into the $8200 trading range.

If you look at the volume graph below it, you’ll also notice that volume was spread out across many different exchanges, and continued over much of the time period. This is another indicator of a broad-based rally.

Trading sideways

The next 8 hours on October 20/21 shows a good example of Bitcoin trading within a tight trading range:

There was a bit of a falling trend (indicated by the red) within the first hour, but even that was interspersed with several bars of green. A minor rally happened around 11:30 PM, right before Oct 21, but it soon reverted to alternating red and green candles. Notice also that the rally was on virtually no volume, which is often an indication that it won’t be sustained.

Things to watch for that indicate a market is trading sideways in a range:

  • Alternating red and green candles.
  • A horizontal trend: the graph looks flat.
  • Low volume.
  • Few wicks extending up and down from the candles.

Volatility

Here’s an earlier time period from the same day which looks fairly similar to the trading range above, but has an important difference:

A high-volatility period with extensive candle wicks

The difference between these graphs is the size of the wicks. In both time periods, Bitcoin was trading in a roughly $80 range. However, in the second of them, the high and low prices (represented by the wicks) were wildly outside the candle, indicating that prices had jumped around significantly within that one period.

If you look at the volume chart underneath, you’ll also notice that there’s virtually no volume during the period of greatest volatility. There are a couple interpretations of that. One is that arbitragers, market-makers, and other automated traders may not be operating – the effect of these market participants is usually to stabilize prices. Another is that the currency is close to the edge of its trading range, and it’s hard to find sellers who are willing to go much lower. The latter condition can be determined from the depth chart, and often indicates that they’ll be a big move to the upside soon.

Big Jumps

Here’s another pattern commonly seen on charts:

Big jump upwards on high volume

Here, Bitcoin was trading in a tight range before and afterwards, but in between there is a large jump: a single candle that’s much taller than surrounding candles. The open was right around the previous trading range and the close is at the new trading range, but in between, there’s a discontinuity. You also see large trading volume that trails off rapidly.

This is a whale – possibly an institutional buyer, possibly market manipulation – snapping up a lot of Bitcoin all at once. The price change was a discrete event, as a single order cleared out the order book. Afterwards, the price stayed roughly the same, with traders adapting to the new price.

In this case, the buy was likely on Bitfinex. How can we tell? Bitfinex is the exchange that is disproportionately represented in the volume bar. After any large price movement, it’s typical for arbitragers to generate a large amount of additional volume as they transmit the price movement to other exchanges. This is what’s responsible for the tail of additional volume bars following the big move. But this volume is usually in proportion with their ordinary amounts of volume as Bitcoin trades within its range. Here we see a disproportionate amount of Bitfinex volume on the trade itself, but very little on other time periods.

Up-and-down

This is another chart that has a large price move upward, but in this one the upward move was quickly followed by an equal (or in this case, even stronger) downward move:

This type of event is usually the result of a whale having a position that’s triggered by a price movement, either through a stop order or by algorithmically watching for when the market hits a certain price point. Sometimes it’s not a single whale, but rather a number of traders that have independently decided that they’ll sell at a certain price level. In this case, the move up to $8370 triggered a large sell-off that eventually brought the price even below where it started. The wick on the following (green) candle shows that the sell-off extended even farther, down to $8087, but then the market recovered and the following period closed in the green, followed by a long period of uneventful trading.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s