Content
Introduction
What are candlestick charts?
How do candles work?
How to read information from candlestick charts
What information candlestick charts cannot convey?
Heikin-Ashi candles
Summary
Introduction
For those new to trading or investing, reading charts can be quite a daunting task. Some people rely on their intuition and are guided by it when investing. This strategy may work during a bull market, but is not suitable for long-term planning.
Trading and investing is a game of probability and risk management. The ability to read information is critical in almost any type of investment. In this article we will talk about what the Japanese Candlestick chart is and how to read information from it.
What are candlestick charts?
A Japanese candlestick chart is a type of financial chart that displays the price movements of an asset over a certain period of time. As the name suggests, it consists of candles, each representing the same length of time. This can be almost any period - from a few seconds to several years.
Similar charts appeared in the 17th century. The creation of such a charting tool is often credited to a Japanese rice trader named Homma, whose ideas served as the basis for modern candlestick charting. They were improved several times, in particular by Charles Dow, one of the fathers of modern technical analysis.
Candlesticks can be used to analyze various types of data, but they are primarily designed to make price movements in financial markets easier to understand. When used correctly, this tool helps traders correctly assess the likelihood of price changes. It also allows traders and investors to formulate their own ideas based on their market analysis.
How do candles work?
Each candlestick consists of the following elements, displaying the change in the value of an asset over a certain period of time:
Opening is the first recorded trading price of an asset for a given period.
Maximum – the highest recorded price for a given period.
Minimum – the lowest recorded price for a given period.
Closing – the last recorded price for a given period.
The combination of these designations is often called OHLC (short for Open-high-low-close chart). The relationship between the open, high, low and close determines the type of candle.
The distance between the open and close is called the body, and the distance between the body and the high/low is called the wick or shadow. The distance between the high and low of a candle is called the range of the candle.
How to read information from candlestick charts
Many traders find that candlesticks are easier to read than bar or line charts, although they provide similar information. Candlesticks are readable at a glance, which means they offer us a clearer demonstration of price movements.
Candles project resistance between bulls and bears on a specific time frame. Generally, the longer the body, the greater the buying or selling pressure. If the wicks of a candle are short, this means that the high (or low) of that time frame was close to the closing price.
The color and settings may vary depending on the charting tool, but generally, if the body is green, then the asset's closing price was higher than its opening price. Red color means the price moved down during the time frame and the candle closed below the opening price.
Some analysts prefer a black and white presentation. In this case, instead of using green and red, the chart represents up moves as hollow candles and down moves as completely black candles.
What information candlestick charts cannot convey?
Candlesticks can provide a general idea of price movements, but they won't give you all the information you need for a comprehensive analysis. Thus, candlesticks will not show what happened between the open and close, they will only show the distance between two points (along with the highest and lowest price).
For example, wicks tell us about the maximum and minimum price of the period, but do not describe the sequence of these changes. However, on most charts, time frames can be changed, allowing traders to get more detailed information about price changes within a certain period.
Candlestick charts can also contain a lot of market noise, especially on smaller time frames. Rapid changes in candlesticks can sometimes make them difficult to interpret.
Heikin-Ashi candles
So far in this article we have looked at what is called a candlestick chart, but there are other ways to create them. One of them is the Heikin-Ashi method.
Heikin-Ashi literally translates from Japanese as “middle lane.” These candlestick charts are based on a modified formula that uses average price data. The main goal is to smooth out price movements and filter out market noise. In this way, Heikin-Ashi candlesticks can make it easier to identify market trends, price patterns and possible reversal zones.
Traders often use Heikin-Ashi candlesticks in addition to candlestick charts to more accurately identify market trends, avoiding false signals. Green Heikin-Ashi candles without bottom wicks usually indicate a strong uptrend, while red candles without top wicks can indicate a strong downtrend.
Heikin-Ashi candlesticks can become a powerful tool for technical analysis, but, like any other method, they have their limitations. Since such candles average the price, they take longer to form than usual. In addition, they do not display price gaps and some price data may be hidden.
Summary
The candlestick chart is one of the fundamental tools for any trader or investor. It not only visualizes the price fluctuations of a particular asset, but also provides the necessary flexibility to analyze data over different time periods.
A wide-ranging study of charts and patterns, combined with an analytical mindset and extensive experience, can ultimately give a trader some edge in the market. However, most traders and investors are inclined to believe that for greater reliability it is necessary to turn to other methods, for example, fundamental analysis.
