Reading Candlestick Charts
There are many different
kinds of stock charts in use, but candlesticks are probably the most
common form in Japan. The name candlesticks comes from the practice
of representing price movements with white and black sticks that
look like candles, particularly the form with a white box on the
bottom and a thin line extending upward. This style of charting is
considered to have its roots in the Edo-period rice markets of
Dojima (near modern-day Osaka). Historians estimate that they took
their present form in the latter half of the Meiji period (late
1800•. Originally, they were just sticks drawn in red or black.
What Are Candlesticks?
Let’s start by looking at how candlesticks are drawn. Figure 4.1 is
a list of fictitious intraday stock price movements.
If prices move in order from 1 to 30, they produce a line graph,,
which we can express as a candlestick,
If the movement were like the chart, the candlestick would be
coloured black. A black candlestick indicates that the opening price
was higher than the closing price. In other words, prices spent the
day more or less sliding downward. This is called a black
candlestick. The same charting technique can be applied to yearly
price movements as well.
The difference between a
white candlestick and a black candlestick is whether the opening
price (the first price of the session) was higher than the closing
price (the last price of the session). As Figure 4.4 shows, if the
closing price is lower than the opening price, a black candlestick
is used; if it is higher, a white candlestick. The lines extending
out from the
black or white bodies are called shadows and represent the price
extremes (highest and lowest price• during the day.
In a daily chart, a single black or white candle expresses price
movements for a single day; in a weekly chart, a single candle
expresses price movements for an entire week; in a monthly chart,
for an entire month. Chart* can be drawn in almost any increment.
Some
traders even use one-minute and live-minute charts.
Regardless of the time frame, the form of the candlestick and its
combination with other candlesticks can be used to identify the
market's direction and its relative strength or weakness. That is
the main purpose of candlestick charts.
How to Read Candlesticks
Candlesticks express stock price movements over a set period of time
(ordinarily either one day or one wee. Each stick will have a
different shape and colour (black equals a downtrend; white equals
an uptrend), and each means something different. For example, if
there is a long white box, one might surmise that the same price
trend will continue and prices will rise even higher the next day.
price as the opening price (the very first price of the day), one
might conclude that the market is having difficulty deciding on a
direction.
In other words, each candlestick has a meaning and tells a story.
There are twelve basic types of candlesticks. Let's look closer at
their meanings and what their combinations have to say about market
direction.
The twelve types of candlesticks break down into three basic
categories.
White candlesticks. The closing price was higher than the opening
price.
Black candlesticks. The opening price was higher than the closing
price.
Doji. The opening price
and the closing price were the same, forming a crossbar figure
Within these categories, there are many different shapes. For
example, a large white box with no shadows, called a marubozu
(shaved) candlestickindicates that the closing price was far higher
than the opening price.
Candlesticks also can differ in the length of their shadows, whether
they have shadows or not, and in the size of the real body itself.
Each candlestick offers a hint about what is likely to happen next.
Ordinarily, a white candlestick indicates that prices may be higher
the next day and is therefore bullish, whereas a black candlestick
is bearish and indicates that prices may fall.
Other shapes indicate reversal points. Examples include doji and
spinning tops, that is, very narrow real bodies, indicating a narrow
range between the opening and closing prices.
However, you have to be careful. Candlestick meanings are
contextual. The meanings of candlestick shapes differ depending on
whether they appear near the top of the range or the bottom.
Meanings will also differ if several candlesticks are clustered
together. In other words, a specific group of candlesticks can
indicate either an
extremely bullish market or an extremely bearish one.
Reversal Patterns
It is possible to use candlestick analysis to discover market
turning points—the tops and the bottoms. One approach is to look for
distinctive, easily seen patterns that mark a top or bottom. The
other is to examine whether tops and bottoms have predictable
patterns. In
practice, its difficult to make judgments from a single pattern. A
single* pattern may have* two, opposite, meanings, depending on
whether it comes after the market has made a substantial rise or a
substantial fall (in fact, the meaning is the same in that the
pattern indicates a market reversal, but it means the opposite in
the sense of going up or going
down). The key, therefore, is to examine not only the shape but also
the timing of the pattern.
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