Candlestick charting analysis is widely used in the world of currency trading. In this article, we’ll dig into them a bit deeper and understand how they can be used in forex trading.
First, let’s familiarize ourselves with the history of the candlestick charts.
It is said that candlestick charts were invented in Japan during the 1700s. During that time, there was no standardized means of trading currencies.
And, rice was the common instrument available for trading. Wealthy Japanese businessmen deposited rice in warehouses in major towns across the country and would then sell or trade the coupon receipts.
As a result, rice trading became the first futures market.
During the eighteenth century, the legendary Japanese rice trader Homma Munehisa investigated all aspects of rice trading and ultimately developed profitable trading techniques and principles that evolved into the candlestick methodology.
In the 1900s, a westerner by the name of Steve Nison “discovered” this secret technique and published it in his book Japanese Candlestick Charting Techniques.
Since then, this technique has arguably become the most popular form of trading the financial markets. Thumps up for Mr. Nison!
The basic structure of candlesticks
Candlesticks are formed using the open, high, low, and close of the chosen time periods, whether it is 15 minutes, 1 hour, 4 hour, 1 day etc.
- The larger central portion that represents the range between the opening and the closing price is referred to as the real body or simply as the body.
- The price distance between the open and the high for the chosen time period is referred to as the upper shadow. It may also be referred to as the “upper wick”. The highest price attained by the particular currency within the chosen time period is distinguished by the high of the upper shadow.
- The price distance between the close and the low for the chosen time period is referred to as the lower shadow. It may also be referred to as the “lower wick.”
- If the closing price is above the opening price, then a hollow candlestick (often portrayed as white) is shown. And, if the closing price is below the opening price, then a filled candlestick (often portrayed as black) is shown.
To make the candlesticks more attractive and easier to spot trading opportunities, modern candlestick charts usually replace the black or white of the candlestick body with red (bearish candle) and green (bullish candle).
It is of essence to note that depending on the price action for the chosen time period, a candlestick may be shown without a body or a wick.
The following illustration adds more weight to the above explanation:
a) Length of candlestick bodies
Just like in humans, candlesticks vary in terms of the body sizes. Therefore, if you are trading forex, it is of essence that you check the bodies of candlesticks.
If a candlestick has a long body, it signifies a strong buying or selling pressure. And, this implies that either the bulls (buyers) or the bears (sellers) were stronger and managed to control the movement of the pair.
On the other hand, if a candlestick has a short body, it signifies that there is very little buying or selling activity taking place.
The above bullish candles show different levels of buying pressure. Candle B has a stronger buying pressure than candle A.
If there is high buying activity, the closing price becomes further away from the opening price. In other words, bulls are move aggressive.
If there is high selling activity, the closing price becomes further away from the opening price. In other words, the bears are showing the bulls dust
b) Length of candlestick shadows
The length of the upper shadow and lower shadow on candlesticks give essential indications about the trading session.
The upper shadow gives the highest price attained by a particular currency pair. The lower shadow gives the lowest price attained by a particular currency pair.
If a candlestick has a long shadow, it signifies that the trading activity has taken place well beyond the open and close price.
On the other hand, if a candlestick has a short shadow, it signifies that the trading activity has been confined near the open and close price.
The above candlestick has a long upper shadow and a short lower shadow. This implies that at one time the bullish pressure was intense and it made prices to rise higher.
However, this pressure was not sustainable as the bearish pressure became more intense and made prices to go back to end the session back near its open price.
The above candlestick has a long lower shadow and a short upper shadow. This implies that at one time the bearish pressure was intense and it made prices to sink lower.
However, this pressure was not sustainable as the bullish pressure become more intense and made prices to go back to end the session back near its open price.
c) Timeframe of candlestick patterns
The higher the time frame in which a candlestick pattern has formed, the more authentic it becomes.
For example, a pattern that has formed on a 4 hour graph will probably provide you with more reasons to enter a trade than a pattern that has formed on a 15 minutes graph.
Japanese candlestick charts are loved by most forex traders around the world because of their ease of use and better representation of the happenings in the market.
When correctly mastered and fused with other technical tools, Japanese candlestick charts can make you enjoy your trading experience, and, most importantly, reap big returns in this business.