Remember earlier in our price action charting when I did a post on Ten Candlestick Patterns You Need To Know? Well I have been having thinking deeply lately. How about we do a whole series on candlestick charting? I say this because I have this sick feeling of some readers saying ” Well it’s all well and good that you are giving us all these fancy candlestick patterns. But what the heck is a candlestick?”
I know it may be a bit late in the day.But it makes sense to get into the fundamentals of reading candlestick patterns. Because the last thing we want is readers pulling their hair out blowing steam out of their nostrils saying” I’ve no idea what you’re talking about.”
So here is what we’re going to do. We’ll get started with a definition of a candlestick and then we’ll delve in fun stuff such as the anatomy of a candlestick, and basic candlestick patterns.
But first things first.
What exactly is a Candlestick Chart?
Well, a candlestick chart is a graphical representation of traders and financial institutions that track the price range of currency pairs using a combination of a line and bar chart. The candlestick chart records the open high, low, and close of every trade for each specific time period. The figures making up the price chart are known as the candlesticks.
The candlesticks are very useful for visualizing price action patterns, from the 5 minute time frame all the way up to the 1 month time frame. Candlestick charts are also used by traders to identify simple trends as well as complex price patterns.
Which brings us to the next question:
How Did Candlestick Charts Originate?
Well candlesticks came about way back in the 18th century through a Japanese rice trader by the name of Munehisa Homma. Now at that rice had just been adopted as a standard currency of exchange. Some of you are probably wondering “Well, Why rice? Didn’t they believe in paper?” No. Because no standard currency existed at that time. And so they agreed to adopt rice as the currency of exchange. Subsequently all the rice barons stored their rice in huge warehouses in Osaka, one of the premiere cities of Japan at that time. The rice barons would then sell or trade their rice coupon receipts among themselves. Automatically this feverish trading made rice the first futures market.
Now Homma was a pretty smart guy. Not only did he make a huge fortune out of rice and dominate the rice market, but he also studied the entire spectrum of rice trading from the fundamentals to the psychology of trading. Homma’s trading techniques eventually morphed into the candlestick methodology, which was then adopted by Japanese market analysts round the same time that the Japanese stock exchange came into being in the 1870’s. It so happened that Charles Dow, inventor of the Dow Jones Average, himself stumbled on the candlestick methodology in 1900. He probably said to himself” hmmmm.. I think these candlesticks could be very useful for my business.”
However, the individual who really introduced Japanese candlesticks to the forex world was a gentleman by the name of Steve Nison in his book “Japanese Candlestick Technique s.” He learnt the candlestick methodology under the able tutelage of Homma Nihesa. The rest as they say is candlestick history. And as most of you know by now, candlestick charts remains the most popular technical analysis charts as far as financial instruments goes.
I guess the next question some of you want to ask is
Why Candlestick Charts?
Well unlike bar and line charts(Watching a line chart is like looking at a heart monitor) ,candlestick charts represent a more accurate thorough, and graphical description of the price action on the price charts. Candlestick Charts do a better graphical job visually, as far as letting the traders know who has the upper hand between the bulls and the bears. Candlesticks also show us another dimension of the a specific time frame’s price action through pictorial revelations of the strength(or lack thereof) behind each price movement.
Now these beautiful graphical representations makes it easier all those single bar and multiple bar representations. This improves your chances of catching high probability trade setups. Also because candle stick setups use the same data as bar charts(open high,low,close), you can also apply the same bar chart signals on a candlestick chart as well. You know the saying, anything a man can do,a woman can do better? The same dynamic applies to the relationship between candlestick charts. Anything a bar chart can do, a candlestick chart can magnify it a thousand times better. You get better clarity, not to mention additional trading signals.Candlestick charts are more exciting to look at.
Now that we’re done with the history lesson, let’s take a look at a few pictorial examples:
As you can see, we have two candlesticks – White one to the left, the dark one to the right. The white candlestick is bullish and is found on the uptrend. The white candlestick usually opens low and closes on a high. The black candlestick on the other hand is bearish and can be found on the downtrend. It starts on a high price and closes on the low. Here are a few things to take note off:
- The white hollow candlestick comes about when the close is above the open. In other words the currency pair starts on a low and finish strong on a high. This explains the huge bullish surge up the hill by the bulls.
- The full black candlestick on the right comes about when the bears start on a high and then dissipate on a low. This comes about around the same time the bulls run out or steam and the bears take over the show. This triggers the bears downward slalom down the slopes Consequently the bears depress the price to the consequent low.
- The “body” refers to the hollow section of the white candlestick and the filled section of the black candlestick.
- The skinny lines poking above and below the body are popularly known as shadows, or wicks. And they record the high and low prices of the currency pairs.
A Further Breakdown of The Candlestick’s Body Parts
Candlesticks are very similar to us humans. They have various body sizes,slim,fat,medium-sized, tall, short e.t.c. Let’s take a look at the various body types – starting with:
Anytime you see a long white candlestick, think bullish buying pressure. This tells you the bulls are in town and running amok. A long candlestick translates into a higher close above the open. This suggests an aggressive stance by the bulls, causing a strong price increase.In plain English, the bulls are all over the bears.
However, long black candlesticks suggests the bears are getting back at the white bulls. And it also suggests strong selling pressure on the part of the bulls. The longer the black stick, the further the closing price is below the open price. This causes price to plummet as a result of the bears open hostility. In plain English, the bull are galling the bears with their sharp horns.
Those Creepy Shadows
If you think I’m talking Halloween, get your mind out of the gutter. I’m talking about the upper and lower shadows you find in the anatomy of candlesticks. They drop important clues about the happenings during the trading sessions. Upper shadows suggest a stronger trading session while lower shadows reveal a weak trading shadow. Long shadowed candlesticks tell the story of trading action occurring completely outside the open and close areas. While short-shadowed candlesticks tell us that the trading action was centered close to the open and close arena. Let’s take a look at an illustration of the long shadows
If you see a candlestick with a long upper shadow and long lower shadow it can only mean one thing. That the bulls(buyers) are turning the screws on the bears(sellers), causing prices to jump sky high. But all of a sudden the bears(sellers) came out of nowhere and drove the price down, and ended the session back at open price.
On the flip side, a candlestick with a long lower shadow and short upper shadow spells doom for the bulls. That the bears have sharpened their horns and knocked the bulls off their perch and further depressed the price. But then the bulls mount a comeback, drive price sky high to end the session near the open price.
Next up is:
Basic Candlestick Chart Patterns
The first candlestick pattern we’re going to look at is:
The makeup of spinning tops are a long upper shadow, long lower shadow,and small upper bodies. Don’t worry too much about the character. Just remember the shadow and body types. By the, way The makeup of spinning tops are a long upper shadow, long lower shadow,and small upper bodies. Dont worry too much about the character. Just remember the shadow and body types. By the, way when you see a spinning top, just remember that the buyers and sellers are in a war of attrition. In other words they are in a state of indecision. They’re not sure whether to bu or sell. Let’s take a look at an illustration below:
As you can see there is little movement between the white hollow body on the left and the black filled body on the right. Even though the trading session opens and closes with barely a whimper, there is significant movement of price on both sides. Since both buyers and sellers are unwilling to budge, we end up with an eventual standoff.
There are a few things you need to take note off:
- If you see a spinning top in the uptrend, it means the buyers are losing steam and that the sellers are about to take over the show. In Forex trade speak, a reversal is about to start cooking.
- If you see a reversal in the downtrend, it’ the complete opposite. The sellers are also running out of breath and that the buyers are about to take them out for the count. In forex speak, it can only mean a bullish reversal is on the cards.
Next Up is:
If you’re thinking Marubozu is a Halloween chant, please get your mind out of the gutter. The Marubozu pattern has no creepy shadows sticking out of its body. Regardless of whether the candlestick is hollow or filled, the price’s open and close is pretty much the same. It’s always consistent. Let’s look at two types of Marabozus.
As you’d have noticed,the white Marubozu and long with no shadows sticking out of its butt(or body) The formula is simple as ABC:Open Price = Low Price. While Close Price = High Price. The fact that the White Marubozu is a bullish candle suggests that the buyers are pretty much running the show. And when that scenario is playing out, it can mean one or two things: Either a bullish continuation or a bullish reversal.
And just like the White Marubozu, the Black Marubozu has no shadows sticking out of its butt either. But since the Black Marubozu is bearish looking, it connotes the impression of bearish dominance of the price action by the sellers. You don’t need anybody to tell you that this scenario suggests one of two possibilities: Either a bearish continuation or a bearish reversal.
Next up is:
Now when you hear the name Doji you’d probably be thinking “Hmmm…Sounds like some exotic name in the South.” Nah, Doji is all Japanese.In fact there is nothing exotic about it when you see it for the first time on the charts. The Doji is so small and skinny it could be easily be mistaken for a scare crow. And just like the spinning top, The sight of a doji on the price chart spells war of attrition between the buyers and the sellers. In other words they are undecided whether to buy or sell.
Yes, prices do move above and below the open price. But it only happens at or close to the open price. And since neither side is unable to deliver the knockout punch we call it a draw. Now there are four types of Doji candlesticks that can be spotted on the price charts. Let’s see what they look like:
As can see there are four variants of the skinny Doji, depending on the length of the upper and lower shadows. On the far left is the long legged doji, shaped like a crucifix. Next is the dragonfly doji(No relation to the dragon fly) shaped like a T. Next is the gravestone doji shaped like an inverted T Last but not least is the four price doji. This only happens where all four prices(open close high,low are all the same). Usually the transactions in this scenario are ver little.So you need to break a sweat atall over this set up.
Now if you see a doji on your chart ,keep a close eye on the preceding candlesticks. If a doji appears after candlesticks with long hollow bodies(such as the White Marubozu), it tells us the buyers are losing stamina. Since there are no buyers around to shore up their offense, the sellers start sharpening their knives and look to depress the price further downwards. Now let’s look at a few scenarios.
As you can see, a Doji forms after a White Marubozu. And when that happens The Doji’s presence spells doom for the sellers as their resolve will start weakening. For price to continue dip, the sellers need reinforcements, but the these reinforcements are nowhere to be found.This will definitely be music to the ears of the buyers as they look to cash in on their breakthrough.
When you see a dark knight(or long black Marabuzu) being led by a doji, it can only mean one thing – trouble for the buyers. The buyers are losing momentum, and the sellers are just looking to swoop in like hawks catching their helpless prey. In plain English, expect a bearish reversal.
If you are a bit rusty about trading trends, just revist Trade Trends With Price Action Analysis
That’s a wrap for ”Fundamentals of Reading Candlestick Patterns.” Hopefully this post has helped demystify the mystery behind these candlestick patterns. And that you can recognize like the back of your hand the moment they show up on your chart.
Til next time take care.
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