What are candlesticks?

Basics of Candlesticks

Market action is more important than news

Candlesticks analysis are one of the most important factors when it comes to trading successfully, yet you'd be surprised that the majority of traders use, candlestick patterns incorrectly.

In this section, we are going to present Candlestick analysis to anybody with a working grasp of charting, from a complete beginner to an experienced market specialist. We'll discuss different types of Candlesticks that every trader must know.

Before we begin, it is important to mention that everything discussed in this section can be used for currency trading, stock trading, and cryptocurrency trading because price action is relatively consistent across different assets.



The first thing that we want to cover with you is What Candlestick Actually Is?

A Candlestick is a visual representation of the stock price movement during the session. Like a real-world candlestick, this true visual representation has a "body" and a "wick"

Candlesticks are used by technical analysts to determine when to enter and exit trades because they reflect the impact of investor sentiment on price chart.

Every trader/investor in the financial market tries to forecast the best possible price for entry and exit trades. To do so, they look for chart patterns, and these patterns are formed by grouping two or more candlesticks in a specific way.

Candlestick Chart Anatomy

stock market
Japanese Candlestick

In order to create a candlestick chart, you must have a data set that contains open, high, low and close values for each time period you want to display.

Open Price at the beginning of the period
Close Price at the end of the period
High The maximum price achieved during that period
Low The lowest price of the asset during the period

The high and low prices in stock trading refer to the highest and lowest prices of the stock in a given time period.
The open and close prices of a stock are the prices at which it began and ended trading in the same period.

A candlestick chart is one of the basic and well-known styles of financial charts used to show price movement. Depending upon the price movement there can be no upper shadow, no shadow, or a very small body. Traders use candlestick charts to forecast price movement based on previous patterns.

How to read candlesticks?

A bullish candle forms, When the close is higher than the open, and
A bearish candle forms, When the close is lower than the open.

A green (or white) body indicates that the price of an asset increased during the day's trading.
A red (or black) body indicates that prices ended lower than they were at the day’s opening.

There are various types of candles available in the financial market like Doji, Marubozu, Bearish Continuation, Three Side Down, and many more. Every trader tries to identify these candles and put their trading technique into action, in order to make a profit.



Have a look at the daily price chart of the GBP-USD pair
GBPUSD pair
GBP-USD [daily chart]

OPEN: 1.30007
CLOSE: 1.28046
LOW: 1.27783
HIGH:1.30388
The price chart above is a daily chart of the GBP-USD pairs. Each candle represents the trading activity during the day. In simple words, each candle represents how many shares/ securities have been bought and sold during the whole day.
Now, you can clearly see the closing price is lesser than the opening price (1.28046 < 1.30007). Hence a bearish- red candle has been formed.

Let us take one more example of the same GBP-USD pair for 15 min. chart
GBPUSD pair
GBP-USD [15 min. chart]

OPEN: 1.32323
CLOSE: 1.32393
LOW: 1.32290
HIGH:1.32480
The price chart above is a 15 min. chart of GBP-USD pair. Each candle represents the trading activity during the 15 min. session. In simple words, each candle represents how many shares/ securities have been bought and sold during the 15 min. time interval.
Now, you can clearly see the opening price is lesser than the closing price (1.32323 < 1.32393). Hence a bullish- green candle has been formed.

Components of Candlesticks

Now, we are going to discuss each component of candlesticks, i.e color, range, and body size.

  • COLOR—
    • The color is generally displayed as green and red candles (white or black candles). In this course, we are using green and red candles.
    • Green/white candles are bullish, closing higher than open.
    • Red/black candles are bearish, closing lower than open.
  • RANGE—
    • The range of a candle is the distance between the high to the low.
    • The range of a stock represents the volatility of the price during the trading session.
    • A wide range shows the increase in volatility.
    • A narrow range shows less volatility during the session.
  • BODY SIZE—
    • The body size shows the degree to which the bulls or the bears were dominating the market.
    • A large body shows an increase in momentum.
    • A small body shows a reduction in momentum.

It's important to understand these terms because we'll be using them throughout the course.

History

Origin: The idea comes from rice trading established in Japan in 1654. Japanese did a very good job of keeping candlesticks from the Western world, but in the 1980s, Westerners took over these nebulous charts.

Since then, candlesticks have been gaining in popularity throughout the year, and these days they seem to be the standard form most traders work from.

Until the late 1980s, bar charts were used by the Western world. A bar chart displays prices shown in the figure below:

Bar Chart
Bar Chart

Let's look at a real example: The figure below shows a bar chart, while the next figure is the same chart but uses candles instead of bars.

stock market
Bar Chart vs Candlestick
stock market
  • We can say clearly —
    • Candlesticks are easier to read.
    • Bar charts are factual but uninspiring.
    • Candlesticks chart are also factual and emotive as well.
    • Looking at the Japanese candlestick, it is easy to determine whether the period is bullish or bearish (by color).

Decoding Candlestick Formation

Trading is often driven by emotion, which can be seen in candlestick charts. Stock market price movement is a reflection of mass crowd psychology, which consists mostly of greed and fear. So to understand the greed and fear among the participants, traders use a price chart.

    • Candlesticks show the fight between bulls and bears during the selected time.
    • A long green candle indicates there is a strong buying pressure meaning the trading session was controlled by the buyer which indicates the market is bullish.
    • A long red candle indicates there is a strong buying pressure meaning the trading session was controlled by the seller which indicates the market is bearish.

Rules to follow with candlesticks

    • Don't trade solely based on any candlestick which means Along with candle always look for other price action signals before entering in trade.
    • A stop loss is an absolute must for every trade you take based on candles.
    • Use a candlestick in combination with an area of support and resistance.
    • Use candles to boost your trading setup.
    • Candles can generate false signals, don't expose your money unnecessarily to others.
    • Look for the longer candle. Long the candle wick, the better it will be.
    • One of the limitations of the candlestick is that waiting for confirmation can result in a poor entry point. Hence use other price action strategies or indicators for the best possible entry.
    • Candlesticks are a reflection of what buyers and sellers are doing in the market so if your strategy fails then immediately get out of the trade.
    • Last but not least, More candles tell a better story.

How do we use candlestick patterns?

Many traders try to forecast the best possible price for entry and exit trades. To do so, they look for chart patterns, and these patterns are formed by grouping two or more candlesticks in a specific way, which results in low-quality trades.

what we like to do is combine candlestick patterns with key levels, in areas of confluence to increase the quality of the trade, and the higher the trade quality, the higher the percentage chance of success.

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