How to Read Candlestick Charts
Reading time: 9 minutes
In this article we will explore the art of reading candlestick charts properly - and explore how to understand them, so that they can assist you in your Forex trading. This article will provide professional traders with an explanation of what candlestick charts are, what they represent in currency trading, the structure of candlestick charts, and a detailed breakdown of how to read candlestick charts.
What Is A Candlestick Chart?
There are a lot of different Forex charts. However, there is a specific type which traders around the globe find useful - candlestick charts. What do they represent? A candlestick chart is a financial chart that is applied in order to describe the price moves of a currency, a security, or a derivative.
With the ability of being able to be used in various time frames, the candlestick represents four key pieces of information for the time frame in question - the open and the close, as well as the high and the low. It goes without saying that Forex candlesticks charts are frequently utilised in the technical analysis of currency price patterns.
Let's begin with a short history of candlesticks. The Japanese first started using technical analysis in order to trade rice in the 17th century. Whilst this early version of technical analysis was comparatively different from the US version initiated by the pioneer of American technical analysis, Charles Dow back in 1900, most of the guiding principles were very much alike. What is a candlestick chart? Let's outline some crucial facts to give you a basic idea.
- The 'what' (meaning price action) is more significant than the 'why' (i.e earnings, news, etc)
- All the present and available information is reflected within the price
- Sellers and buyers actually move markets based on anticipations and emotions such as fear and greed
- Markets tend to fluctuate
- The real price might not reflect the underlying value
Steve Nison, who introduced candlesticks to the western world, outlined that so-called candlestick charting first came to light sometime after 1850. A considerable amount of credit for the development of candlestick and charting goes to a legendary rice trader who was known under the name of Homma from Sakata town. It is most likely that his innovative ideas were consequently modified, and then refined over many years of trading, ultimately resulting in the system or model of candlestick charting that we encounter everyday as Forex traders.
What Do Candlestick Charts Represent in Currency Trading?
As specified earlier, candlesticks are a way of presenting the price action over an established period of time. Moreover, they can provide useful information like the market sentiment, or possible reversals in the selected markets, by demonstrating the price move in a particular manner. Understanding this is a good starting point in terms of how to use candlestick charts in trading.
When you trade something, especially Forex, you will apply price charts to observe price moves in the markets. If we compare line charts and candlestick charts for example, you will see some vivid distinctions. The line chart is a very easy method of demonstrating the price movement. It displays the information with a simple line, using a series of data points. It is the kind of the chart that you might be used to seeing in different magazines and newspapers, which present the price motion of stocks and shares.
By understanding candlestick charts, one should know that they represent price movement, though they are made up not with a simple line, but with individual candlesticks. Forex traders tend to prefer to read candlestick charts owing to the fact that they include considerably more information compared with a line chart, and can be much more useful when making prudent trading decisions. A line chart uncomplicated and shows price moves within a line, whilst candlestick charts present more information within each individual candlestick.
At the beginning of this article, we mentioned that candlestick charts are used in various time frames. Technically, if we set the candlestick chart to a 30 minute time period, each candle will actually form over 30 minutes. Similarly, if the chart is established in a 15 minute time period, then every candle will take 15 minutes to form.
Imagine that we have two charts displaying the price action for the EUR/USD currency pair. With 30 minute candles, you will see two big candles in the shaded area. This shows the exact identical period, as if we had the five minute chart with its 12 shaded candles. This leads us to the point that if the time period is established for 30 minutes, then every individual candle will take exactly 30 minutes to complete the formation.
Let's delve deeper into candlestick chart analysis. The two charts represent the price action of the identical asset. Only the 30 minute time frame shows the price action over a considerably longer period, compared with the five minute chart. Thus, a five minute chart means that every candlestick will take five minutes to form. However, with the 30 minute chart, you will gain a much broader time scale of the particular price action.
The Structure of Candlestick Charts
If you take a look at a candlestick chart, you will see a figure in the shape of a rectangular box. This is what is known as the body, and it is the widest part of the candlestick. This is the first step of how to read candlestick charts. This body demonstrates the open and the close of the specific period. This implies that if the chart is a one hour chart, then every candlestick body will demonstrate the opening price for that one hour period, as well as the closing price for that one hour period.
In addition, the wicks at the bottom and at the top of the candlestick present the lowest and the highest prices reached during that one hour period of time. In fact, a chart that represents the open, high, close, and the low price for a given period is actually referred to as an OHLC Forex chart. Furthermore, different colours of the body tell you whether the candlestick is bullish (meaning that it rises) or bearish (meaning that it falls).
People can set the colour of the candlestick according to their personal preferences with the help of trading software. How can you form technical analysis candlestick patterns? Logically, if the candlestick is bullish, then the opening price is most often at the bottom, and the closing price is nearly always at the top. If the candlestick is bearish, the opening price is invariably at the top, and the closing price is always at the bottom.
Using varying colours provides a good way for you to immediately tell whether they are bullish or bearish. Let's put this theory into the practice with another example, which will help show how to analyse candlestick charts. Imagine the candlestick has a period of one day (so it took one day for the candle to form). The EUR/USD currency pair will serve as an example once more. In our case, the bearish color is orange, and the bullish is blue. Imagine that you have the following candle: it is bearish as it has an orange color.
This means that over the course of one day the price of the EUR/USD pair dropped. Moreover, there were more sellers than buyers throughout that day. The price was actually lower at the close of the day compared to when it opened. If it started with a price of 1.38269, then at the end of the day it hypothetically could be at 1.34488. The wicks will indicate the highest price of the day, and the lowest.
This example simply shows the OHLC for that particular day. If you wanted to see the price movement in more detail, you would just go to a lower time frame. By using the example of Forex candlestick analysis above, in order to find out more about what occurred during the course that day, you could go to a one hour time frame Forex chart.
This chart would demonstrate candlesticks that more accurately display the price movement throughout that particular day. If you want to get more detailed information about the price behavior, then going to a 15 minute or a five minute time frame would be a wise decision. Let's finish with another final example:
Imagine that we have a candlestick which is bullish (as it is blue). This tells us that during an hour, the price of the EUR/USD increased. Moreover, there were more buyers than sellers during that hour. The price was much higher at the close of the hour, compared with when it actually opened. For instance, the price at the beginning of the hour opened at 1.3009, although at the end of the hour the price closed at 1.3171. Again the wicks indicate the highest and the lowest price of the EUR/USD pair during that hour.
As you can see, candlestick charts can really help with the trading process. They are a very comfortable structure to work with, and you shouldn't have any difficulties in applying them on a daily basis. How do you interpret candlestick charts? Simple. An ordinary candlestick can show you much more information than a line chart, as you have all the necessary price information displayed, even the bullishness and the bearishness of the market. If you would like to learn more about candlesticks, make sure to read our related article: Everything You Need to Know About Candlestick Trading
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.