Candlestick patterns play a key role in quantitative trading strategies owing to the simple pattern formation and ease of reading the same.

For using candlestick patterns, you only need to have a basic understanding of how the candlesticks are formed. Also having some idea about the various ways in which these candlesticks can be interpreted would be useful.

However, if you are new to candlesticks trading, this blog will help you gain a complete understanding of candlesticks. Let us begin with the basics as this blog covers:


What are candlesticks?

Candlesticks are used in quantitative trading for representing the Open, High, Low, and Close price movements of the tradable instrument (security, derivative, currency etc.). Candlesticks resemble the shape of a real life candlestick and hence, the name.

The candlesticks are distinguished by the following colours:

  • White Candlesticks or Green Candlesticks: Indicate an uptrend
  • Black Candlesticks or Red Candlesticks: Indicate a downtrend

Candlesticks have various sizes, shapes and even colours. The reason for this is that the candlesticks are based on prices. Since the prices keep varying, the size and shape of the candlesticks also vary due to the nature of their anatomy. And that makes them different.

These various shapes and sizes are indicative of market psychology but, at times, can be highly effective in helping you predict the future market direction.

History of candlesticks

Candlesticks were developed in the 17th century in Japan. This is the reason why they are also known as Japanese candlesticks.

After their invention, locals in Japan began using candlesticks while trading rice. This idea was gradually adopted by various people and across countries and kept evolving for the better. The evolution of the same led to what the candlesticks are at present.

Japanese Candlesticks are thought to have been introduced to the West in the book, ‘Japanese Candlestick Charting Techniques by Steve Nison. The West developed the bar point and figure analysis almost 100 years later.

In ancient Japan, the principles were applicable to Rice and today they are applicable to stocks.

Munehisa Homma, a renowned rice merchant from the Japanese town of Sakata, traded in the Dojima market in the 1700s. Further study of candlesticks mentions ‘Sakata’s Methods’ or ‘Sakata’s Rules’, that are based on the name of this particular market.

Homma is said to have developed candlestick charts during his lifetime by studying years of historical data and comparing them with weather conditions. This study also helped him understand the role of emotions on the value and pricing behind the trade of rice.

Anatomy of candlesticks

The anatomy of the Candlesticks has stayed almost similar throughout the ages to give us the current shape and meaning. It consists of 4 distinct values namely:

  • The opening price,
  • Closing price,
  • The highest prices for a given interval, and
  • The lowest prices for a given interval.

It’s like a combination of a line chart and a bar chart, where each bar represents all four important pieces of information for an interval.