Candlestick Charting Explained
Candlestick charts are a common way to visualize price movements in a stock or stock market index. They are an alternative method for stock charting, contrasting with bar or line charts. Traders around the world look at candlestick charts for insight into the financial markets. While these charts are not a foolproof strategy, they do offer a quick method for understanding market activity.
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History
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The Japanese first used candlestick charting hundreds of years ago, though the exact date of origin is not known. Up until the 1990s, this method of charting was foreign to most Western financial analysts and traders. Bar charts have been a common charting strategy for many decades and resemble some of the characteristics of candlestick charts. Steve Nison introduced these new methods for analyzing price movement based on Japanese strategies in his groundbreaking 1991 book, "Japanese Candlestick Charting Techniques."
Appearance
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Like a bar chart, a candlestick chart uses four pieces of information to create shapes on a charting grid. The opening price, high price, low price and closing price for a single moment in time are plotted as a singular shape called a "candle." The shape may represent an entire day of trading or any other period of time, such as a half-hour or a month. The "body" of the candle is a rectangle formed between the opening and closing prices. The "wicks" are thin lines that extend above and below the body to the highest and lowest prices of that candle. It is possible for just one or no wick to appear if the opening or closing price was also the highest or lowest price of the day.
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Candlestick Versus Bar Charts
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Like a candlestick chart, a bar chart also uses opening, closing, high and low prices to form the shapes on the graph. But a bar chart simply shows vertical price lines with short horizontal protrusions for the opening and closing prices instead of an entire rectangular body formed in a candle. Both bar charts and candlestick charts display the exact same information. The primary difference is the visual emphasis on the information. A bar chart emphasizes the trading range of the period, from its highest to lowest point, as one single long line. A candlestick emphasizes the opening and closing prices as the wide body. The wicks extend to the highest and lowest points but are not the most obvious feature of the candle.
Patterns
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While the appearance of a candlestick chart does not specifically provide greater insight into price movements compared to a bar chart, the Japanese methods for analyzing these price movements were a revolutionary concept. Candlestick charting compares the shape of a candle with the shape of previous candles to create recurring candlestick patterns. For example, an "engulfment," one of the most popular candlestick patterns, appears when a candle's body extends above and below the entire length of the previous candle, thereby "engulfing" it. This demonstrates considerable activity and volatility in the market as it exceeds the prior candle's range. Traders identify hundreds of complex patterns involving multiple candles to augment their predictions for future price movement.
Considerations
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While candlestick charting does offer some relevant insight into market activity, it is not foolproof. Critics of candlestick charting note that all you need to do is change the time frame of the chart to completely erase all patterns. For example, a chart made up of half-hour candles will no longer show the same patterns if it is changed to an hourly or 15-minute chart, yet the price movements are the same. Like any strategy, a trader should thoroughly test his methods before committing lots of capital to new ideas.
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