Wicks are one of the most interesting things about a candlestick because they provide good insights about the demand and supply of the asset. Wicks are observed when there is a high volatility in the price action of a stock or an index. Big wicks are generally observed during high volatility days when the India VIX index is pretty high (above 25). But what exactly do high wicks mean? What can traders infer from big wick candlesticks?
What is a wick?
A candlestick consists of three components – body, wick and colour. Consider an example of a bullish candlestick.
This candlestick consists of a big body and a small wick. These candles represent a clear movement towards the upside (bullish candle) or the downside (bearish candle).
On the other hand, some candlesticks have a long wick and a small body.
These long wick candles (long upper wick or long lower wick) are the main focus of the study. These candles present a great insight towards the movement of a stock or an index.
How to identify a long wick?
A wick is called a long wick when the size of the wick is more than 2 times the size of the body of a candlestick. The longer the wick is compared to the body of the candlestick, the more interesting information it provides about the stock or the index.
What does long wick represent?
A long wick represents a shift in the perspective of traders in the timeframe in which the candle is formed. Let’s suppose a long wick candle is observed in the daily time-frame, then this candle represents a shift in the sentiments of the traders from a bullish to a bearish sentiment or vice versa during the trading day. A hammer candlestick represents a situation in which the bulls took back control after relentless selling from bears!
On the other hand, a shooting star represents a situation in which the bears took back control after continuous buying from bulls!
One thing common between the two long wick candles is that these candles represent a change in perspective amongst traders. This change in perspective could be due to some news about a stock, announcement from the management, government policy, or any other reason. Whatever may be the reason, a change in the sentiment is observed during long wick candles. A long wick candle on the daily frame represents a change in the sentiment over the trading day.
What can traders learn from long wicks?
A long wick is generally an indication of a change in trend of the stock. A bullish stock can turn into a bearish stock or vice versa following the formation of a long wick candlestick pattern. To understand why a long wick can signal a change in trend, we look at an example.
Consider a stock which is in a downtrend.
A stock which is in a downtrend can shift to an uptrend (even if the uptrend is in the short term) after a long wick candlestick pattern is formed. This is true for both hammer or a shooting star which is formed at the end of a downtrend.
Similarly, a long wick candlestick formed at the end of an uptrend can signal the end of the uptrend and the beginning of a downtrend (even if the downtrend is in the short term). This is also true for both hammer or a shooting star which is formed at the end of an uptrend.
Long wick candles are often an indication of a change in trend irrespective of the current trend being an uptrend or a downtrend.
What is smart money doing when a long wick candlestick is formed?
Let’s understand the psychology behind a big wick candle. We need to focus on what the smart money could be doing during the day in which a long wick candlestick is observed. Let’s suppose that a stock is in a downtrend for a long time and a long wick candlestick is observed at the end of a downtrend.
This could be a signal that smart money is making a new long position in the stock. Now, let’s understand what happened during the trading day when the long wick candlestick was formed. Since the stock is in a downtrend, most traders are used to shorting the stock because the basic rule of trading is – Trend is your friend! Suddenly some bulls entered the stock & made long positions in the stock.
This buying which occurs during the day can be a signal that there is a high demand for the stock at the current market price which can lead to a short term change in trend. This could also mean that there is some corporate announcement or a change in sentiment which will now change the long term trend of the stock. As a trader, our goal is to follow the smart money! This candlestick gives an insight into the activity of smart money. To learn more, visit the article – Why do retail traders sell at support? Because markets trick them!
A similar thing could happen during the formation of a shooting star candlestick. Here the short term winners could be the bears who were able to drive the price down but it can signal that smart money has started their accumulation of the stock!
Both these candles, when seen in a downtrend, are signs that smart money is beginning their accumulation of the stock. Similarly, both these candles when seen in an uptrend are signs that smart money is beginning the distribution of the stock.
Is long wick enough to take a trade?
No, a long wick by itself is not enough to take a trade. A long wick should be one of the criteria which the traders look for when entering a trading position. Additional information such as the current trend, volume during the long wick candlestick formation, key support/resistance levels, etc. should also be focused by traders.
Additionally, simply a formation of a long wick candlestick can be just a coincidence! The actual activity of the smart money will become known in a few trading days after the long wick candlestick is formed. No trading position should be taken simply by looking at the long wick candlestick, however the traders should put the stock in their watchlist to observe the behaviour in the following days. To learn more about a profitable trading system followed by professional traders, visit this article!
Conclusion
A long wick candlestick pattern is a sign that a trend reversal can be nearby. A stock which shows a long wick candlestick should be closely observed by traders for the following days. The positions of the smart money will become clear after a few days (maybe even the next day) following the long wick candlestick. This can be used by traders to their advantage by following the smart money & taking trading positions respectively. However, the final decision of trading a stock depends entirely upon the reader!
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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