Candlestick charts are one of the most popular tools used by traders when conducting technical analysis of currency pairs and other financial instruments. Beginner traders should focus on learning about candlestick charts before they start trading, especially if they intend to use technical analysis as part of their trading strategy.
How candlestick charts are formed
Each candlestick in a given candlestick chart contains four sets of data for whatever timeframe it represents; the opening price, the closing price, as well as the highest and lowest prices hit. A candlestick chart has a body, and two shadows or wicks. The body represents the opening and closing price, while the shadows, which are also referred to as tails and wicks, represent the highest and lowest prices in a period.
An example of a candlestick chart
Most traders find that candlestick charts are easier to interpret than normal bar charts as all the information relating to price action in a given timeframe is clearly displayed on the chart. One can also easily tell when the closing price was lower, or higher than the opening price. Filled candlestick charts, on occasion also shown as black or red, represent periods when the closing price was lower, while empty candlestick charts, shown on occasion as white or green, represent periods when the closing price was higher.
Interpreting Candlestick charts
There are numerous ways to interpret candlestick chart patterns and there are entire books dedicated to this practice. However, in this article, we shall look at some of the simple ways to interpret candlestick charts. Firstly, candlestick charts are usually plotted using the following periods, 5 minutes, 15 minutes, 1 hour, daily and weekly periods. However, there are other timeframes such as the 4-hour period that are less popular.
A long wick typically indicates that trading during the specific period went much further than the opening and closing prices, while a short wick usually indicates that trading was mostly restricted to the range covered by the opening and closing prices.
Long filled candlesticks typically indicated that the currency pair was under strong selling pressure, while long empty candlestick charts typically indicate that the financial instrument was under intense buying pressure.
Candlesticks without shadows or tails are known as the Marubozu brothers, which usually indicates that the lowest and highest prices are represented by the opening and closing prices. The black Marubozu typically indicates that buyers were in control from the start to the close of the trading period, while the white Marubozu indicates that buyers were in control for the entire period.
Common Candlestick Chart Patterns
The Spinning Top
The spinning top is a candlestick chart pattern that is represented by a candlestick with a small body and very long shadows. The small real body indicates that there was little change between the opening and closing prices. However, the long upper and lower shadows indicates that both sellers and buyers were quite active over the trading period.
An example of spinning tops
This pattern usually indicates that traders are quite indecisive and, in most cases, this results in a change in the direction of the prevailing trend. The appearance of a spinning top within an uptrend could signal the beginning of a downtrend, while the opposite is true of a spinning bottom appearing in a declining market.
An example of the spinning tops and doji patterns on a chart
The doji is a candlestick pattern that forms when the opening and closing prices over a given period are very close, or almost the same, resulting in a very narrow body. The doji usually indicates a lack of direction in the markets, but could also signal the end of a given trend.
The gravestone doji is a doji with a very long upper shadow and no lower shadow, which usually indicates that a bullish trend might be nearing its end; this doji rarely occurs in a downtrend. The long-legged doji typically indicates indecision in the underlying market and they are important when they occur in strong uptrends or downtrends as they indicate that the forces of supply and demand are balanced.
In summary, this is a brief introduction to candlestick charts covering the history of this extremely popular technical analysis instrument and the different types of candlestick patterns including the meaning assigned to each pattern. Beginners can benefit greatly from this article, but they should look to study this technical analysis tool in more detail. We will dig deeper into this topic in future articles.