Candlestick charting is a market study tool dating back hundreds of years. It was developed in Japan to trade rice futures contracts long before our equity markets were ever conceived. The study has since transcended all financial markets with excellent results.

This style of charting offers a three-dimensional view with a better visual perspective to predict future market action.

Each candle-line body begins at the market open and ends at close. If the close was higher than the open, a clear or green candle is formed. A lower closing price than open creates a red candle instead. Prices that move outside the open/close range form thin lines or "shadows" above and/or below the candle's actual body.

There are numerous signals and formations with different versions of each, but we will focus on a few of the basic patterns that signal market reversals. They are as follows:

Bullish signals:
Tweezer Top
Morning Star
*Hammer
*Doji
*Engulfing white candle

Bearish Signals:
Tweezer Bottom
Evening Star
Shooting Star
*Hanging Man (hammer)
*Doji
*Engulfing red candle

*Denotes formations that are bullish or bearish depending
 upon where they form within price action 

(Daily chart of NASDAQ)

Here within this chart of NASDAQ exist numerous formations, but we'll focus on those outlined above. First you'll see clear "Shooting Star" candles near the market tops of March 13 and again on the 27th. This lone-candle signal is formed when prices open at one point, rally up for the day and fall back to close near the open once again. When formed at a price peak on the chart it suggests buying is drying up and the market may be nearing a correction.

Around April 12th we see a long red candle formation that exceeds or "engulfs" the clear bullish candle of the previous day. This suggests any bullish sentiment the day before was completely erased and then some by today's "Engulfing Candle" formation. A further move in the direction of the longer candle is expected, in this case to the downside following the bearish red candle.

April 24th shows a lone-day "hammer" pattern. This is formed as prices fell from the open only to rally back and close near the day's open. This shows buyers rallied the market up after sellers took it to the intraday low. The lone candle at the bottom of this pattern looks like an actual hammer, hence the name. It suggests the market may have found a bottom and will advance from there.

Incidentally, the same "hammer" style candle found near the top of a price range is called a "hanging man" formation instead. This is a bearish signal that indicates new buying above the open has exhausted and a move down is likely.

On May 29th we observe a curious candle formation called a "doji" or stalemate. It is formed by a complete shadow line with little if any real body in the middle. Daily prices opened, rose/fell and then returned to close almost unchanged. When found near a market high or low extreme it suggests a point of equality and indecision between buyers and sellers. Such indecision could mean the current price direction may be nearing a reverse.

(Daily chart of DOW)

This chart of the Dow is rife with clear candle formations. Extreme volatility created numerous reversals in short order.

Around March 15th we note a large white engulfing candle near support of a long decline. This indicates buyers have erased all the prior session's losses to drive prices higher. As indicated, the market indeed moved up from there in record fashion with a 499 point gain the very next day.

After this major rally we witness a pair of doji candles near 3/23 and 4/3 that warn of possible weakness in bullish sentiment. The doji near 4/3 spans an exceptionally large range one session after a long, engulfing white candle. This combination suggests extreme indecision after the big price rise and possibly a move down in the near term.

The "Tweezer Top" April 12th should have been confirmation that this market was on shaky ground. Those who moved to protect profits and/or played the downside with shorts or put options fared incredibly well. Several dominant bearish patterns warned of the massive decline days in advance.

In true volatile fashion, the Dow hit bottom three sessions later as a clear "Tweezer Bottom" complete with shadow line pinchers emerged. Again, fair warning that the bulls were now in charge of near-term price movement.

Late in May we notice a three-day pattern form called a "Morning Star" The first full session formed a bearish candle, the next day ended in a "doji" stalemate while the third day formed a new bullish candle. As you can guess, this suggests the sentiment has turned from bearish to neutral and finally bullish over three trading periods. Prices should advance from there.

Likewise the opposite of this, an "Evening Star" three-day pattern of sorts warned a pending market drop. A bullish white candle was followed by a doji, then met with a bearish red candle. This was matched with an equal white candle as bulls struggled to wrest control but were finally overwhelmed as proven with a longer red candle that sealed the new move down.

(Daily chart of GLW)

We've included a chart of Corning Glassware complete with a few more candle formation examples. There are "Engulfing Candles", "Hammers" towards the bottom of price dips, a decent "Evening Star" near one peak and a "Tweezer Top" complete with even 'pinchers'.

There are others unmarked in this as well. Can you find them? Hints: "dojis" one session before hammers suggest indecision after down move and possible rallies. How about a "hanging man" (opposite of "hammer" candle) near a price peak in late May?

For further study on this fascinating subject and powerful trading tool let me refer you to the website bookstore in the left margin of our home page. Enter "candlestick charting" in the topic search box and you'll find several excellent books that cover the subject in complete detail.

Enjoy your study and further candlestick education.