What are candlesticks?
A candlestick is simply a way of communicating information as to how the price is moving. These charts are available on every trading platform. The Japanese developed candlesticks and they are big technical traders. They use a combination of western charts and candlestick techniques to analyse the market. Hence, it becomes compulsory for us to learn this method of trading.
You must have across terminologies like “hanging-man”, “dark-cloud”, and “evening-stars” but don’t know what they are. Don’t worry; this article series will explain to you everything about candlesticks and their patterns. You also know how to use these charts. It will open a new way of analysis for you and will show how Japanese candlesticks can “enlighten” your trading.
Why are candlestick charts used by traders and investors around the world?
There is extensive interest for candlesticks by top traders. There are many reasons for that, and few of them are listed below:
- Candlestick charts are flexible. This is because they can be used as standalone or in combination with other technical indicators. The most significant advantage to charting is that they can be used in addition to other technical tools. Candlestick charting provides an extra dimension to the analysis.
- This technical approach is an age-old tradition of analysis, which has evolved from centuries of trial and error.
- There are attractive terms used to describe the patterns. Terms like “hanging-man” will spark interest among traders, and there are hundreds of such names. Once you get an understanding, you will not be able to trade without using them.
- Any technical analysis can be used with candlestick chartings, such as moving averages, trend lines, Elliot waves, retracements and more. Candlesticks charts can give signals not given by bar charts. Candlestick charts provide a unique way of analysis not provided by other tools.
Basics of Candlestick charting
This chart shows the price on the vertical axis and time on the horizontal axis. The chart is made up of lines going from top to bottom. These are known as candles. The candle gives you four pieces of information:
- The open price 3. The high price
- The close price 4. The low price
Candlesticks refer to that information for a specific unit of time. For instance, in a daily chart, each candle represents one day. And thus, each candle is comprised of, the open, close, high and low for that given day. The horizontal axis can be used to understand which day corresponds to which candle. Below is the image which gives all the information described above.
Almost every candle has a wick that goes outside the body of the candle. They represent the high and low price during that time period.
The colour of the candle is an essential part of any candle. It determines whether the open price was higher or lower than the close price. If the candle is red, it is a bearish candle, and this means that the open price was higher than the close. On the other hand, if the candle is green, it is a bullish candle, and this means that the open is lower than the close.
Limitations of using Candlestick charts
- As with all other charting methods, candlestick pattern depends on the interpretation of the trader. This could be one of the limitations. As you gain experience, you discover which candlestick pattern suits you the best.
- Every candlestick has a close. Therefore, you have to wait for the close to get a valid trading signal. You may have to try and anticipate what the close will be a few minutes prior to the close.
- The opening price is also important in candlestick. Traders who do not have access to live market data might not be able to get the opening price of a stock in newspapers. As candlesticks become common, more and more people will learn to use it.
- Candlestick chart provides trading signals but not price targets. You need to use other methods to forecast targets such as support or resistance levels, retracements, highs, lows etc.
- With hundreds of charts throughout the world, you might miss some of the patterns. There will be chart patterns that will not work at times. Candlesticks are not an error-free tool.
Candlesticks and market emotion
The names given to candlestick patterns are a colourful way to describe the emotional health of the market. When you hear of words like “hanging-man” or “dark-cloud cover” you would never think of the market in an emotional state. These are bearish patterns, and their names clearly convey the unhealthy state of the market. These are in no way giving trading signals, but just an indication. You need to consider other factors while initiating a trade.
Without knowing what these patterns are, just by hearing their names, you get an idea of the type of market. For example, let’s take “evening star” and “morning star” candlestick pattern. The evening star which comes out before darkness sets in sounds like a bearish signal and so it is. The morning star denotes a bullish state of the market since the morning star appears just before sunrise.
The other emotional price point is the close of the candle. Margin calls from brokers while trading futures markets are based on the close. We can thus expect heavy emotional involvement when the market closes.
In upcoming articles, we discuss many of such amazing candlestick patterns which are going to be very interesting. Keep following us, and we show you how to profit from candlesticks.