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How to read candlestick charts

Candlestick charts

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 to describe the price moves of a currency, security or derivative. With the ability 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 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 in 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 we encounter everyday as Forex traders. 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.

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 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, 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 made up not with a simple line but of individual candlesticks. Forex traders prefer to read candlestick charts owing to the fact that they include considerably more information than a line chart and can be much more useful in making prudent trading decisions. A line chart uncomplicated and shows price moves in a line, whilst candlestick charts presents 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, then 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.

Let us use an example from the candlestick charting for dummies category. Imagine that we have two charts showing 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 get deeper into candlestick chart analysis. The two charts are representing the price action of the identical asset. Only the 30 minute time frame shows the price action over a considerably longer period than 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.

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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 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 it rises) or bearish (meaning 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, then the opening price is invariably at the top and the closing price is always at the bottom. Using various colours provide 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 than 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 lowest.

This example simply shows the OHLC for that particular day. If you wanted to see the price movement in more detail, then 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 show the price move 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.

We have one more example of candlestick technical analysis with the same currency pair. Imagine that we have the candlestick being 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 than 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 during that hour.

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Conclusion

As you can see, candlestick charts can really facilitate 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 to 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.