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Making and Understanding Candlestick Charts

They can't tell the future, but they can serve as useful trendspotters

When custom homebuilder-turned-stock-trader Ryan Litchfield discovered candlestick charting, he saw the symbols as "a mystery that seemed full of secrets." If you understood the patterns, he thought, "it would be like a crystal ball." As he experimented with the charts, he realized the patterns didn't predict the future, but could indicate a change in trend. Context helps define their meaning, Litchfield says, much like interpreting a driver's use of brake lights.

Of the many forms of technical analysis, candlestick charts may be the most difficult for beginners to grasp. The charts use symbols to transform a standard stock price chart into a graph that tells at a glance the stock's opening and closing price, as well as the day's high and low.

The solid portion of each day's figure, created by filling in the space between the open and the close, is the candle's body; the thinner lines above and below show the high and low and are called wicks. Each shape has a different name. A long wick topped by a short body—which shows that there was a lot of trading, but that the stock closed near its opening price for the day—is called a "hanging man"; turn it over and it's a "shooting star."

What's the significance of the shapes? The appearance of a hanging man when a stock is rallying toward a 52-week high suggests that the bullish trend might be stopping, like a car nearing an intersection. It is accurate about 70% of the time, says Litchfield, co-author of Candlestick Charting Explained. If a stock is trending up, but isn't close to a significant point such as its 52-week high, then the sight of a hanging man is akin to a car braking on a highway—more likely signaling a change in speed than a reversal.

Levisohn is a staff editor at BusinessWeek covering finance and personal finance.

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