Japanese candlestick charts have provided traders with a unique insight into the future direction of markets since their invention by a Japanese trader in the mid 1700s.
Candlestick charts – unlike conventional open, high, low, and close or OHLC charts – convey all of the same information, in addition to whether the instrument was up or down for the period in question.
Besides plotting the candlesticks which make up the most basic element of this sophisticated charting technique, the Japanese also developed a detailed system for the interpretation of the different chart formations. In the process, they often gave colorful descriptive names to the chart formations.
Candlestick Charts History
The candlestick charting technique was invented in the 1700s by a famous Japanese trader by the name of Homma Munehisa (1724 – 1803), who was also known as Sokyu Homma or Honma.
A trader of Ojima rice from the city of Sakata in Japan, Munehisa attained the stature of being one of the most successful traders the world has ever known. History has it that he managed to rack up the present-day equivalent of over $100 billion in trading profits over his illustrious trading career, even making as much as $10 billion over a year’s time, in some cases.
The formidable candlestick charting technique Munehisa invented was subsequently popularized in the West by Charles Dow in the early 20th century. Charles Dow had a number of business publications which published several indexes, including the Dow-Jones Industrial and the Dow-Jones Transportation average. In addition, Dow was the inventor of the Dow Theory, a popular stock market analytical system.
Since their introduction in the West, candlestick charting techniques have become increasingly popular among technical analysts and they remain in wide use today among forex traders.
Basic Candlestick Chart Theory
Unlike the more common “open, high, low, close” bar charts, candlesticks provide some additional informational elements, starting with a two-color scheme that was originally black and white, although red and green are also commonly used these days.
Black candles represent days or periods in which the market declined, while white candles represent the days or periods that the market closed higher.
Each candle on the chart consists of two parts: the body and the shadows.
The body of the candle consists of the rectangle or “candle” that is drawn between the opening and closing prices. The opening price would be at the bottom of a white candle and the top of a black candle.
If the body of the candle is white, then the price of the instrument or currency has gone up for the time period represented by the entry. The opening price would be at the bottom of the white candlestick body while the closing price would be at the top.
Conversely, if the currency has declined, then the body of the candle would be black with the opening price at the top of the body and the closing price at the bottom.
The shadow or wick of a candlestick extends from both the top and the bottom of the body of the candle, and represents the upper and lower trading ranges outside of the opening and closing prices.
Shadows can be on both the top and bottom of the body. A long shadow represents a wide range of trading activity, while a short shadow represents a narrow trading range.
Common Types of Candlesticks
Candlesticks can be either long or short and this provides different market implications depending on the trading range and opening and closing prices.
Long candlesticks represent a definite commitment to the market direction given the wide trading range. On the other hand, short candlesticks generally signal market indecision and a possible reversal in market direction.
Some of the most common candlestick types include the following:
§ Marubozu – a candlestick without “wicks” or shadows. Because of the lack of upper or lower shadows, this candlestick represents strong buying or selling pressure and is often a long candlestick.
§ Spinning Top – a short body formation with long upper and lower shadows. This candlestick indicates indecision in the market because of the wide trading range and the proximity between the closing and opening prices.
§ Doji – a classic reversal pattern, this candlestick typically has the same closing and opening price which will give it the appearance of a cross or a T. The T shaped candlestick is known as a Dragonfly Doji, while an inverted T is known as a Tombstone Doji.
Interpretation of Candlestick Charts
Candlestick chart interpretation typically analyzes formations of several different candlesticks. These candlestick chart patterns usually make up either reversal formations or continuation formations.
The Japanese traders who developed this technique have given colorful names to the different chart patterns and have incorporated sound trading principles behind the classic interpretation of each particular pattern.
Understanding Candlestick chart patterns can be a powerful trading tool for just about any trader operating in any market.
Nevertheless, since it is beyond the scope of this article to elaborate further, other articles will follow on the subject of the interpretation of specific candlestick chart patterns.