Technical Analysis - Candlestick Basics

Technical Analysis - Candlestick Basics

Technical Analysis - Candlestick Basics
By David Thorpe

Background

It is believed that Candlestick trading first appeared sometime during the 19th Century. The development of the Candlestick is credited to Japanese rice traders and it is more than likely that the concept evolved over many years into what we see on our charts today.

Formation

Just like the traditional Bar chart, each Candlestick displays an open, high, low and close over a given time period. Depending on the fill of the body you can tell at first glance whether the candle closed higher or lower than it opened.
It is also important to pay attention to the high and low formations displayed by the shadows/ wick/ tails. These can form the basis of important Candlestick patterns that can help predict the future market direction.

Candle Vs Bar Vs Line

Most people prefer using a Bar or a Candlestick chart over a line chart because of the extra information displayed to the user. A line chart is unable to show highs and lows during a set time period and therefore it often fails to display vital information about the price action. As you can see from the picture below the same data over the same time period can look very different depending on the chart you use.

The reason why an individual would generally prefer to use a Candlestick over a traditional Bar chart is completely aesthetical. After all, both are displaying the same data but the filled Vs hollow structure of a candle’s body is very easy on the eye and quick to interpret.

Basic Interpretation of Bull Vs Bear

A Candlestick is designed to draw you a picture of the battle between bull and bear, fear and greed and demand Vs supply. There are many different patterns, each with their own significant meaning but you can interpret the basics as follows:

a) Long hollow/ filled Candles indicate that there was strong buying/ selling pressure during the given time period and the bulls/ bears were in complete control.

b) Small hollow/ filled Candles indicate a lack of market volatility with neither the bulls nor the bears able to move the market. This could be due to an impending data release or lack of true market direction.

c) Long lower shadows/ wick/ tails indicate the market was unable to maintain the selling pressure and hold for a close at low levels. This could be due to strong buying at important technical levels with the new low representing good support for the market.

d) Long upper shadows/ wick/ tails indicates strong buying pressure that was unable to be sustained. As above it could be due to technical levels and represents good resistance for the market, especially if the candle printed with high volume.

e) Long upper and lower shadows/ wicks/ tails indicate major market volatility and an inability of either the bulls or the bears to control the market. This often occurs at major data releases where the figures are unable to provide a clear indication to the future movement of the market.

What a Candlestick Doesn’t Show You

With these basic interpretations in mind we must now consider what a candle fails to show us that might be relevant to your interpretation on the price data. A Candle cannot show you which came first, the high or the low, or the order of events that occurred in-between. For example, a long filled candle shows selling pressure clearly overwhelming buying pressure but it could not alert you to a 50% retrace that occured during the day.

There are multiple combinations of price action that could occur during the Candle’s set time period. One way to overcome this lack of information is to switch between time frames. For example, if you are observing a chart with Candlesticks on a one day time period you can change the period to one hour, fifteen minutes and one minute to get an increasingly detailed view of each days price action. The process of switching between time frames is a very popular and important one with technical analysts.

Blended Candlesticks

As you switch through the time frames you will notice that longer-term Candlestick patterns are made up of many smaller time framed Candles. This is known as blending. The example below shows the many fifteen-minute Candles that came together to form the long filled one-hour Candles.

Diagrams: http://www.passion-trading.munbuns.com and navigate to the Articles section.

David Thorpe is a senior contributor for http://www.passion-trading.munbuns.com a free educational resource centre for traders and investors. The site has a dedicated forex
trading and currency trading portal and its goal is to stimulate the minds of its users, enabling them to achieve a greater understanding the forex market, thus helping them to become more profitable.

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