Understanding candlestick charts
Candlestick charts are probably the most commonly used charts by Stock, Commodities and forex traders. This is the preferred method of displaying price action because these charts provide a quick and easy way to size up the market. When looking at candlestick charts there are 3 elements that you should pay attention to.
Color of the candles
Just simply watching what color is prevalent at the moment you can get an instant feedback on who is in control of the market. More green then red candles indicate that we’re in a bullish move or uptrend. Reversely more red on your charts indicates that we’re most likely in a downward trend. A mix of green and red with no dominating color shows us that none of the players in the market is in control and we’re trading in a range.
Size of the candles
The size of the candles indicates the momentum of the price. Big candles indicate increasing momentum in price while small candles indicate indecision. See the chart below of some recent price action in the Euro.
Notice the big candles on the chart above and how whenever they start to pop up price “makes a run for it”. Momentum increases and trends starts to develop.
Shape of the candles
The 3rd element of the candles that you should pay attention to is the shape. The chart below marks shows a type of candle that is called a doji. A doji is a small candle with an opening and closing price that are almost equal. It indicates indecision in the market and a possible reversal.
The other candle shape type that you should look out for is is what is commonly called a Pin Bar. A pin bar is a price action reversal pattern. The chart above shows example of three of these Pin Bars on the Euro. Notice the long wicks at the bottom of the candles. The wicks indicate that sellers were quickly pushed back by the buyers as prices change direction. The longer the wicks are the more the odds increase that we might see a reversal in price.
Introduction
In the 1700s, a legendary Japanese rice trader named Homma used trading techniques that eventually evolved into the candlestick techniques that technical analysts on the Japanese stock market used in the 1870s. Steve Nison introduced these techniques to the Western world in his first book, Japanese Candlestick Charting Techniques.
The advantage of using candles on charts is that single or multiple candle patterns give earlier and more reliable reversal signals. Every candle shows the activity for the referenced period in hourly, daily, or weekly charts, for example.
In figure 6.1, the horizontal reference points of the candle represent the opening price, the highest price, the lowest price, and the closing price of the considered period. The rectangular portion of the candle, or the body, represents the range between the opening and the closing prices. If the closing price is higher than the opening price, the body is white (not filled). If the closing price is lower than the opening price, the body is black (filled).
Figure 6.2: Candlestick naming.
A candle consists of either just a body or a body with an upper and/or a lower shadow. A candle with an opening and closing price at almost the same price level is called a doji (figure 6.2). The candlewicks are called shadows, and they extend up to the highest price and down to the lowest price of the related period. Candlestick charts can be used in any time frame, including minutes, hours, days, weeks, or months.
Candlestick chart patterns are formed by one or more candles; they indicate a short-term trend reversal or a trend continuation. You must always take into account the previous trend when interpreting candlestick patterns. Candlestick patterns do NOT give price targets!Format, Naming, and Meaning Candlesticks Format Overview
Format description:
Sr. | Name | Interpretation |
1 | Big white body (White Marubozu) | Very positive |
2 | Big black body (Black Marubozu) | Very negative |
3 | White opening Marubozu | Quite positive |
4 | White closing Marubozu | Positive |
5 | Black closing Marubozu | Negative |
6 | Black opening Marubozu | Quite negative |
7 | White candle | No direction |
8 | Black candle | No direction |
9 | Dragonfly doji | Reversal? |
10 | Doji star | Reversal? |
11 | Gravestone doji | Stable/Reversal |
12 | Long-legged doji | Reversal? |
13 | Four price doji | Reversal? |
14 | Hammer (white) Hanging man | Bottom reversal Top reversal |
15 | Hammer (black) Hanging man | Bottom reversal Top reversal |
Psychological Background
Candlesticks psychological background 1.
The candlesticks demonstrate the psychological trading that takes place during the period represented by a single candle.
Rising power candles ------------------
Important Main Factor
- A big white body means buyers are in power, and the trend is up.
- A big black body means sellers are in power, and the trend is down.
- A small body means that buyers and sellers are trying to take power.
- A big shadow below is a positive sign and indicates strength.
- A big shadow above is a negative sign and indicates weakness.
- A doji is a candle with opening and closing prices that are close together.
- A doji means that price acceleration is slowing down and that bulls and bears are in balance.
- A doji at a top or bottom often is the first signal of a price reversal.