11. Candlestick Trading
Candlesticks are one of the most important tools used in Forex market for technical analysis. The information provided by candlesticks are considered to be the most accurate. Now you see why we need to clearly understand its characteristics and patterns.
A Japanese rise trader named Sakata invented Candlesticks in the 17th century. Yes it is very old. Candlesticks are actually the oldest forms of technical analysis. Before we get into the characteristics, a few words about the market. You might be already knowing by now that the market is run by buyers and sellers. Or by the supply and demand. Candlesticks reflect these behaviours from the buyers and sellers and together with other tools such as Bollinger bands they are form very important trading tools.
A candlestick has a rectangular body which provides the following information in a time frame:
o HIGH – The highest price of the day
o LOW – The lowest price of the day
o OPEN – Opening Price
o CLOSE – Closing Price
Each candlestick represents the prices during a time frame. For example in a one hour time period, one candlestick forms every one hour. In a daily time period, one candlestick forms every one day or 24 hrs. So, in a one hour candlestick, each candlestick will mature after one hour. And the 4 characteristics are for that one hour period. If the opening price of a currency is 0.2345 and after one hour if the price goes down to 0.1234, this will be the closing price.
Also, when the closing price is lower than the opening price, the candlestick is Bearish. Which means price has moved down during that particular time period. Ideally a bearish candlestick has a black or red body. On the other hand when the close price is higher than the opening price, the candlestick is Bullish. A Bullish candlestick has a white or green body.
High price is the highest price during the time period represented by the candlestick and low price is the lowest price during the period.
Now, just imagine the shape of a candlestick when the open and low price are the same. You guessed it right. The shadow would be missing. Yes, the candlestick can take different shapes based on the prices. We will look at some of the basic candlestick patterns a bit later in this article. Before that let’s quickly understand what long and short bodies mean.
- Long Bodies
A typical candlestick has long bodies with four different prices indicating bullish and bearish market. A long body indicates more buying and selling activity. White or green long body indicates strong buying. On the other hand a long black or red body indicates strong selling. A long body indicates open and close prices are far from each other and hence trading activity was fierce.
- Short bodies
- Short bodies with long shadows
If a candlestick has a long upper shadow and a short lower shadow, it means prices went very high and towards the end there were more sellers which brought the prices down towards the opening price. On the other hand if a candlestick has long lower shadow it means, there were more sellers and hence prices went very low when compared to the opening price, but towards the end of the period, there were lot of buyers which resulted in prices going up near to the opening price.
Now that you understand candlesticks and its characteristics including its shape and size, let’s have a quick look at the basic candlestick patterns. Don’t worry! You will get to know what we meant by patterns.
- Spinning Tops
Candlesticks with long upper and lower shadows and small bodies are called Spinning tops. This actually means a neutral position between buyers and sellers. There was very little movement of price as indicated by the short bodies.
Candlesticks with no shadows are called Marubozu. So, in case of Bullish Marubozu this just means that open price is same as the low price and closing price is same as the high price. Hence indicates a strong Bullish market and prices are expected to go high.
In case of a Bearish Marubozu, the opening price is same as the high price and closing price is same as the low price. Also note that longer the candlesticks, stronger the market.
A Doji has no body. They come in various shapes. Three important ones are as shown below.
When the opening and closing price are the same, there will be no body for the candlestick and this pattern is called Doji. This simply means price uncertainty. Yes price can either go up or down. So typically Doji signals indecision.
- Hammer and Hanging Man
Hammer and Hanging Man look alike and both have short bodies with a long lower shadows and short or no upper shadows. When a Hammer is formed at the top of an uptrend it is called Hanging Man.
- Shooting Star
Shooting star looks like an inverted Hammer. An inverted hammer is formed at the bottom of a downtrend or when the price has been falling. On the other hand Shooting star is formed at the top of an uptrend.
Hurray!!! Lots of new terms and terminologies. Hope you enjoyed learning. Candlestick when combined with support and resistance provide the best trend. Also, don’t be hurry to predict based on a candlestick which is not yet formed or mature. Always wait for the candlestick to mature before making any decision as the shape, size and colour of a candlestick keeps changing several times until it is completely formed.