Introduction to Candlestick Chart Technical Analysis of Stocks

Several months ago we wrote an article on the usefulness of technical analysis in your trading strategies. Now we take a more in depth approach to one of the tools used in technical analysis, Candlestick charts. This article looks at the goals of candlestick charts with some helpful advice on how to read the charts properly.

When we analyze the price of a stock, we can do so by using two of the analysis methods:

• Fundamental Analysis- it uses the price of stock based on the characteristics of stock, such as price/earning ratio, return on investment, and other economic indicators.
• Technical Analysis is influenced by the emotions and feelings of traders. It takes into consideration the psychological factors of trading a stock.

History of Candlestick Charts

Candlestick Technical Analysis was first introduced by the Japanese in the 17th Century for the trade of rice. This charting technique came into existence even before the point-and-figure analysis systems in the West. A Japanese trader named Homma who traded in the future markets realized that besides the link between supply and demand of rice, traders’ decisions were also highly influenced by emotionalism.

He discovered that he could earn more profits by understanding the sentiments of traders to better forecast the prices. He also found that there was a great deal of difference between the actual price of rice and the value put on it. The original ideas were tailored over the years and it resulted in the candlestick charting technique that we utilize today.

Components of Candlestick Analysis

The candlestick chart consists of an upper line, a body and a lower line. The upper line consists of the highest price of the day and opening or closing price of that day, usually the opening price. The lower line consists of preferably the closing price of a specific day and the lowest price of the day.  These lines are called shadows.

Between these lines is a wide part which is known as “the body” of candlestick chart. This real body represents the difference between the open and close of all the trading of that day. When the body is filled in black (or red), the close is considered to be lower than the open. However if body is empty (or white) it means the close for the day was higher than the open.

Basic Candlestick Patterns

In the chart there is a “long black line” (shadow) or the “long black body”. This long black line symbolizes a bearish period (period of downfall) in the market. In the trading season, price of stock went up and down in a specific range and finally it opened near the high and eventually closes near the low of the day.

In the bearish period (period of rising prices), “long white body”, or “long white line” represents the exact opposite of the long black line. Here, stock opened near the high and finally closed near the high of the day.

Other important things in this candlestick structure are:

• Spinning tops- These are extremely small bodies, which can be in black or white. They illustrate very tough trading among the open and close, and are usually considered as neutral.
• Doji Lines- They signify the periods in which opening and closing prices for that period are either the same or very close to each other.

The lengths of shadows vary as we look deeper into these patterns.

Similarities between Japanese Charting and American:

Many of the guiding principles of US based charting techniques and Japanese ones are similar:

• Price reflects all the known information.
• Markets fluctuations are part of each of them.
• The value placed on a stock might not reflect its actual price.
• Both people investing in stocks and those selling stocks make their decisions considering the expectations of market and emotions.
• The action of price is of foremost importance.
• News, earning and all such factors are least important.

Some of the benefits for this charting technique being used so widely are as follows:

• These charts show only the short term effects of trading, at most lasting less than eight to ten sessions.
• It is one of the oldest techniques of analysis which takes feelings and emotions into consideration.
• As this analysis considers emotions important, it helps traders make better forecasts about where the stock might be headed.

For more information on how to read Candlestick Charts please visit: Candlestick Chart Introduction and Candlesticks for Day Trading.

This contributor is an expert at technical analysis of stocks, commodities, and Forex. Please read his in depth and authoritative Forex broker reviews at FxEmpire.

Tagged candlestick charts, charting, japanese candlestick charts, technical analysis