Figure 7
In Figure 7 is shown a diagram of a green candlestick. The green color of the candlestick indicates that the closing price of the stock at the end of the day is higher than the opening price at the beginning of the day.
As you will see, the candlestick's color and size provide very important clues regarding the TRADER'S SENTIMENT toward a given stock's future price.
Notice that 'trader's sentiment' is the key phrase here. In short term trading, it is critical for the trader to have a clear understanding of what other traders are thinking. As you will see, the most direct way to get that understanding is through proper interpretation of the candlestick.
Let's look at an example. In Figure 8 is shown a candlestick of XYZ Company, which opened at 25 and closed at 25 3/8.
Figure 8
The candlestick is green in color, which gives us a quick visual signal that the stock price has rallied higher during this period.
How can we use this information to help us understand what other traders are thinking? To answer this question, we will follow the candlestick's changes step by step to understand the mechanism which is driving the stock price to move higher.
In Figure 8, we see the stock opens at 25, and then quickly rallies to 25 1/8. The reason the price moves to 25 1/8 is because there is a high demand to buy the stock at 25 1/8, and a short supply of sellers offering stock at 25 1/8.
Once all of the stock available at 25 1/8 is snatched up, the next group of sellers steps up to offer their stock at 25 1/4. All of the 25 1/4 stock is quickly snatched up because there are still a larger number of traders willing to buy at 25 1/4 than sellers willing to sell stock at 25 1/4.
Once the 25 1/4 stock is gone, the next group of sellers steps up to offer their stock at 25 3/8. The 25 3/8 stock is quickly snatched up too.
This process will repeat itself until the buyers loose interest in buying the stock resulting in a reduction of demand.
The result of combining these steps is a green candlestick with an opening price of 25, rallying to a closing price of 25 3/8.
During the rally period; however, the astute candlestick reader will be able to observe the long green color of the candlestick, and deduce that buyer demand is high.
Figure 9
In Figures 9 & 10 we show an example of how the same principle in reverse applies to the analyses of a red candlestick.
The red color of the candlestick indicates that the closing price of the stock at the end of the day is lower than the opening price at the beginning of the day.
In Figure 10, we see the stock opens at 25 3/8, and then quickly drops to 25 1/4.
Figure 10
The reason the price moves to 25 1/4 is because there are many sellers looking to unload there stock at 25 1/4, and a low number of buyers willing to buy at 25 1/4.
Once all of the buyers have bought the stock at 25 1/4, the next group of buyers steps up to bid for stock at the lower price of 25 1/8.
The desperate sellers quickly sell all of the stock at 25 1/8, and then the next set of buyers step up at the price of 25.
This process will repeat itself until all of the sellers have unloaded all of the stock that they want to sell, resulting in a reduction of supply.
The result is a red candlestick with an opening price of 25 3/8, falling to a closing price of 25. During the stock's price fall; however, the astute candlestick reader will be able to observe the long red color of the candlestick, and deduce that demand for the stock is low.
Now there is only one reason why traders would increase the supply of stock to sell, and that is because they think that the stock will go down in the near future.
So by observing the candlestick color and size, the astute candlestick reader is able to deduce exactly what other traders are thinking, and that is that they think the stock price will go lower in the future.
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