What do candlesticks have to do with stocks?

Candlestick charts show a concise picture of the price action on any timeframe.

Candlestick charts show a concise picture of the price action on any timeframe.

Developed in Japan as a tool to aid in rice trading, candlestick charts have been around since the 17th century and are one of the most popular type of chart used in technical analysis. In his book on the subject, Steve Nisson credits this popularity to features including:

-Easy to understand

-Provide earlier indications of market turns

-Increased efficiency of analysis because of the immediate visual information

How are they made?

The construction is very simple.

There are four price components in a candle; open, high, low, and close. Using these four prices candles are “drawn” to show a “real body” and “shadows.” The body shows the opening and closing prices. Shadows show the high and low for the time period. If the closing price is higher than the opening price then the candle will usually be green, white, or hollow. And if the opposite is true it will be black or red.

How do you read them?

Once familiar with the simple construction technique, candle charts give a clear picture of price action and movement in one quick glance. Long candles show an expanding price range while short ones show compression. Opening and closing prices that are the same, or very close signal indecision. Long shadows show a reversal.

The color of the candles indicates direction. The sequence of candles give an idea whether price is trending or not. Certain combinations of candles represent patterns that can further indicate momentum, reversal, or consolidation.

Elegance and efficiency. The simple construction and concise conveyance of information make the Japanese Candlestick chart an indispensable tool. While elegant and powerful, a candle chart is just one tool. Like all the other tools and techniques of the technical analyst its usefulness is enhanced when combined with other tools.

This post was created with Typeshare