A Candlestick Chart
Japanese candlestick charts form the basis of the oldest form of technical analysis
. They were developed in the 17th century by a Japanese rice trader named Homma and was introduced to the rest of the world in Steve Nison's book, Japanese Candlestick Charting Techniques. Candlestick charts provide the same information as OHLC bar charts, namely open price, high price, low price and close price, however, candlestick charting also provide a visual indication of market psychology, market sentiment, and potential weakness, making it a rather valuable trading tool.
Candlesticks indicate a bullish up bar, when the closing price is higher than the opening price, using a light color such as white or green, and a bearish down bar, when the closing price is lower than the opening price, using a darker color such as black or red for the real
body of the candlestick. Thus, on a green candlestick, the close price will be at the top of the candlestick real
body and the open price at the bottom as the close price is higher than the open price; conversely on a red bar the close price will be at the bottom of the candlestick real
body and the open price at the top as the close price is lower than the open price. For both a bullish and a bearish candlestick, the high price and the low and the low price for the session will be indicated by the top and bottom of the thin vertical line above and below the real
body. This vertical line is called the shadow or the wick.
The shape and color of a candlestick can change several times during its formation. Therefore the trader must wait for the candlestick to be formed completely at the end of the time-frame to analyze the candlestick, forcing the trader to wait for the bar to close.
Candlesticks and Market Psychology
Candlesticks are also good indicator
s of market psychology, i.e., the feelings of fear and greed experienced by the buyers and sellers, and the strength of those feelings. Thus a bullish (green) candlestick with no shadows (which is called a Marubozu) indicate strong bullishness, and the longer the Marubozu candlestick the stronger the bullishness. A bullish candlestick with a relatively long lower shadow, a relatively small real
body and a short or no upper shadow indicates that the buyers were able to drive the price up from the low. This is also a strong bullish candlestick. However, a bullish candlestick with a relatively long upper shadow, a relatively small real
body and a short lower shadow indicates that sellers were able to drive the price down from the high but were not able to defeat the buyers. Although this candlestick is bullish, it is weak; and the longer the upper shadow and the smaller the real
body, the weaker the candlestick.
Candlestick charts also indicate potential trend reversal patterns in only one to four candlesticks with subsequent candlestick patterns proving confirmation. When using a candlestick for confirmation of a potential trade signal
, it is important to take into account
the relative strength or weakness of that candlestick and its location overall in the trend lines on the chart. A weak candlestick should never be taken as a confirmation of a potential trade.
The following two charts of the EUR/USD illustrate the subtle differences between a bar chart and a candlestick chart. The first is the bar chart followed by a candlestick chart. Both charts have a 15-minute time frame and cover the exact same period.