What is a candlestick chart?
A candlestick chart (also referred to as Japanese candlestick chart) is a style of technical analysis chart popular with traders and used to display price movements of a financial instrument such as securities, derivatives or currency. Each “candlestick” represents a period which is set by the user depending on their style of trading.
Like the popular OHLC charts, candlestick charts also require the same open, high, low and close price data to draw them for the period you wish to display, however it is believed by many that candle stick charts help to give an easy to interpret visual representation of the price action.
The origins of reading candlesticks for trading originated in Japan in the 17th century when they began using technical analysis to trade rice. With the introduction of computers and charting software the use of candlestick charts has gained huge popularity with technical analysts, especially among foreign exchange traders, and is now commonplace with chartists.
How to read candlestick charts
At the basis of technical analysis, and candlestick charting, is the principal that “all known information is reflected in the price” and that buyers & sellers move markets based on their expectations and emotions. Many Forex traders have learnt how to read candlestick charts and apply them to their trading.
The hollow or filled/colored portion of the candlestick is called the “body” and the thin lines above and below the body represent the high/low range and are called “shadows” (also referred to as “wicks” or “tails”).
The high price is marked by the top of the upper shadow and the low price by the bottom of the lower shadow. If the financial instrument closes higher than its opening price, a hollow (or sometimes green) candlestick body is drawn with the bottom of the body representing the open price and the top of the body representing the close price.
If the instrument closes lower than its opening price, a filled (or sometimes red) candlestick is drawn with the top of the body representing the open price and the bottom of the body representing the close price.
Candlestick patterns
Next, it’s important to familiarise yourself with various Candlestick patterns. These include individual candle patterns like Doji and Spinning Top, which indicate market indecision, as well as multi-candle patterns like Bullish Engulfing and Bearish Harami, which can signal potential trend reversals.
Candlestick charts also include technical analysis patterns that take into account several candles and hint at potential future movements. These include the ‘head and shoulders’ pattern, which is often seen as a reversal pattern after a major trend, and the ‘double top’ and ‘double bottom’ patterns, which signify strong resistance and support levels respectively.
However, despite being an insightful tool, candlestick charts should not be used in isolation. Traders should incorporate other forms of analysis such as Market structure and/or technical indicators (like Moving Averages or RSI), chart patterns, and fundamental analysis to confirm signals provided by the candlesticks. This can help reduce false signals and enhance the effectiveness of the trading strategy.
Additionally, it’s crucial to remain aware of the broader market context. Economic events, market news, and other macroeconomic factors can significantly impact price movements and should be factored into your analysis.
Learning to read candlestick charts can be a significant advantage for traders. However, it’s not a magic bullet. Successful trading involves a comprehensive approach that combines candlestick analysis with other technical tools and a keen awareness of the broader market context.
Remember, practice makes perfect – so keep honing your skills and refining your strategy.
