Before the West developers created the bar and point-and-figure charts, candlestick charts were first created in Japan more than 100 years ago. Although the price of rice and supply and demand were correlated, a Japanese man named Homma observed that trader emotions significantly impacted the markets.
Candlesticks express this feeling by using various colors to convey the magnitude of price changes graphically. Traders use candlesticks to make trading decisions based on recurring patterns that assist in predicting the approaching direction of the price.
What is A Candlestick Chart?
Traders use candlestick charts to comprehend price activity since they are simple charts made up of individual candles. Candlestick price action entails identifying the price highs and lows for a given time and where the price opened and closed for that period.
Traders in all financial markets may learn about trends and reversals through price activity. For instance, patterns made up of many candlesticks can appear on forex charts and may signal trend reversals or continuations. Candlesticks may also form unique patterns that could signify market buy or sell entries.
The timeframe the trader selects determines the timeframe that each candle represents. The candle will show the open, close, high, and low for the day because that is a common time span. The many characteristics of a candle can aid in predicting where the price may go; for example, if a candle closes substantially lower than it opened, this may imply future price reductions.
The Candle on A Candlestick Chart
The illustration that follows shows how a standard candlestick is made. A price candle is made using three distinct points: the open, close, and wicks. The open and closing prices of the candles should be considered initially. These points serve as the foundation for a candle’s body and show where an asset’s price starts and ends for a given time period.
When viewing the chart, you may select a certain time period for each candle to represent the price change. On a daily chart, each candle will show the open, close, upper, and lower wicks for that particular day.
Open Price
The initial price exchanged during the creation of the new candle is represented by the open price. The candle will turn green or blue if the price begins to move higher (colors vary depending on chart settings). The candle will turn red if the price drops.
High Price
The top of the upper wick/shadow shows the highest price transacted throughout the period. The open or closing price was the highest price transacted if there was no upper wick/shadow.
Low Price
If there is no lower wick or shadow, the lowest price traded is equal to the closing price or open price of a bullish candle or the price at the bottom of the lower wick.
Close Price
The closing price represents the final transaction made during the candle creation phase. If the closing price is less than the open price, the candle will often immediately turn red in charting tools. If the closing price is more than the open price, the candle will be green or blue (also depends on the chart settings).
The Wick
The wick, commonly known as a “shadow,” is the next crucial component of a candlestick. These details are crucial since they display the price extremes for a certain charting period. The wicks are easily identified since they appear to be thinner than the candlestick’s body. Here is when candlesticks’ durability is shown.
How To Read A Candlestick Chart
A candlestick chart may be used and viewed in many different ways. The timeframe and trading approach you pick will affect how you analyze candlestick charts. While some methods try to identify price trends, certain strategies try to profit from candle formations.
Single Candle Formations
Individual candlesticks may reveal a lot about the market’s mood at the time. Candlesticks such as the Hammer, Shooting Star, and Hanging Man provide hints as to the shifting momentum and maybe the direction of the market values.
The illustration below shows how the Hammer candlestick pattern can occasionally signal a change in trends. The Hammer candle structure features a short body and a long bottom wick. Prices increased from opening to closing. The idea behind the Hammer formation is straightforward: As the price attempted to fall, buyers joined the market, driving it up. To buy into the market, tighten stop-loss protection, or exit a short position is a positive indicator,
By entering a long trade after the Hammer candle closes, traders may profit from hammer formations. Trading with hammer candles is favorable since “tight” stop-loss orders may be used (stop-losses that risk a small number of pips). Take-profits should be positioned to guarantee a favorable risk-reward ratio. The take-profit thus exceeds the stop-loss.
Single Candle Formation (Source: DailyFX)
Price Patterns in Multiple Candles
Trading professionals can identify price patterns on the charts with the use of candlestick charts. Recognizing these price patterns, such as the triangle and bullish engulfing patterns, allows you to profit from them by using them as signals to enter or leave the market.
For instance, the bullish engulfing price pattern may be seen in the figure below. A red candle and a blue candle together ‘engulf’ the whole red candle to form a bullish engulfing. It is a sign that a currency pair’s long-standing weakness could be coming to an end. After the blue candle ends, a trader would profit from this by opening a long position. A price pattern only develops after the second candle closes, so keep that in mind.
A trader would set a stop loss below the bullish engulfing pattern, much like with the hammer formation, to guarantee a tight stop loss. The trader would then establish a take-profit.
Bullish Engulfing (Source: DailyFX)
Takeaways
- Traders use candlesticks to make trading decisions based on recurring patterns that assist in predicting the approaching direction of the price.
- Candlestick price action entails identifying the price highs and lows for a given time.
- The initial price exchanged during the creation of the new candle is represented by the open price.
- The timeframe and trading approach you pick will affect how you analyze candlestick charts.
