By Viraj Bhagat
Trading, an ancient noble profession has progressively evolved to the modern age goliath that it is. The practitioners are called as ‘Traders’ who at some point in time started ‘Trading’. Trading isn’t something that one has born skills of. But these skills can be learnt and practised.
Traders did begin someplace in history, catapulting us to this age of Algo Trading. Terms like Candlesticks, Raw Data, Price Information, etc. form Chart Indicators. Chart indicators provide special and concise information and are able to provide data about what a price is doing at what period of time.
Today, we’ll talk about one such indicator: Candlesticks.
For some, starting Trading can seem like confusing and a daunting task at first. Confusing zig-zag lines with strange indicators with red and green blocks on them, a number of lines of monitors and charts, wouldn’t seem to make sense to the layman or put better - to someone who doesn't have an understanding of Candlesticks.
But some might find it intriguing, exciting and challenging. Candlestick Trading Patterns play a key role in quantitative trading strategies owing to the various notable features of the candlesticks and the variety of Candlestick Patterns present today.
This article will help you gain an understanding of Candlesticks and how to use them, to read candlesticks charts, and to interpret candlestick patterns. To gain a complete understanding of Candlesticks, let us begin with the basics.
Commonly Asked Questions About Candlesticks:
- What is a candlestick?
- What are candlestick patterns?
- How to read candlestick chart?
- What are the best trading patterns?
- What are candlestick trading signals? etc.
We cover most of the content and questions related to Candlesticks in this article, which brings us to our next question.
What Are Candlesticks?
Candlesticks (also known as Candlestick charts) are a style of financial chart used to describe high, low, opening and closing price movements of a security, derivative, or currency for a specific period. It resembles the shape of a candlestick and thus the name.
So what makes them so special, won’t there be certain qualities associated with it? But of course!
Qualities Of Japanese Candlesticks
Their qualities can be listed as:
- Packed with information
- Indicate Market Psychology, and the emotions of buyers and sellers
- Represent trading patterns over a short period of time
- Sometimes, few days or few sessions are required
- Can be used in the Technical analysis of currency price patterns and of equities
- Can be used for any Forex time frame
Candlestick charts are also called Japanese Candlestick Charts. Can you guess where it got its name from? This brings us to our next question.
Why Are Japanese Candlesticks Called So?
Why The Name Japanese Candlesticks?
Candlesticks are thought to have been developed in 17th century Japan, and thus they are called Japanese Candlesticks. Are you wondering.
How Did Japanese Candlesticks Originate?
Munehisa Homma, a renowned rice merchant from the Japanese town of Sakata traded in Dojima market in the 1700s. Further study of Candlesticks mentions ‘Sakata’s Methods’ or ‘Sakata’s Rules’, that are based on the name of this particular market.
Homma is said to have developed candlestick charts during in his lifetime by studying years of historical data and comparing them with weather conditions across the years which also helped him understand the role of emotions on the value and pricing on the trade of rice.
He was known for having practised financial instruments at that time. But then, wouldn’t there be some story behind Candlesticks present globally and how word spread about it? So, we ask this:
What Is The History Of Japanese Candlesticks?
How Have Candlesticks Evolved?
Post their invention, 17th century people from Japan started using Candlesticks while trading rice. This idea proliferated through various people and across countries, getting modified, getting refined and evolved into its present form today.
Japanese Candlesticks are thought to have been introduced to the West in the book, ‘Japanese Candlestick Charting Techniques’ by Steve Nison. The West developed the bar point and figure analysis almost a 100 years later.
In ancient Japan, the principles were applicable to Rice and today they are applicable to stocks. This brings us to the topic at hand:
Modern Day Japanese Candlesticks
Modern Day candlesticks have maintained the integrity, anatomy and meaning behind them with the changing times. Their meanings have stayed the same which is reflected in some candlestick patterns today as well, as you'll see in the post below.
Just to give you an idea of how it would look, I’ll use a sample of State Bank of India to show its Candlestick Patterns during a single Day.
Candlesticks have the potential to become the best trading tools when combined with some useful technical indicators like Bollinger Bands. Now, we will talk about the anatomy of candlestick formations, and how Candlesticks are represented, various numerous patterns that flower from it and what these patterns actually imply for trade analysts.
But first, let’s look at:
The Meaning Of The Colours In A Candlestick
- White Candlesticks: Indicate uptrend
- Black Candlesticks: Indicate downtrend
- Green Candlesticks: Upwards movement over the previous position
- Red Candlesticks: Downwards movement over the previous position
Representation Of Japanese Candlesticks
What Are Candlesticks Made Of?
Candlesticks are generally represented in the following manner:
Candlesticks show and define currency in 4 points (open, closed, high and low) over a vertical line. It consists of the following:
- Upper shadow
- Lower shadow
- Top part - High
- Bottom part - Low
- Top Close End
- Bottom Open End
- Real Body
Anatomy Of Japanese Candlesticks
The anatomy of the Candlesticks has stayed almost similar throughout the ages to give us the current shape and meaning. It consists of an open, closed, high and low end. It is like a combination of line-chart and a bar-chart: each bar represents all four important pieces of information for that day.
Body - The hollow or the filled portion of the candlestick
- Long Body - Indicates heavy trading in one direction and strong buying or selling pressure
- Small Body - Indicates lighter trading and little buying or selling activity
Shadow - The long thin lines above and below the body
- Upper Shadow - High is marked by topmost part of the upper shadow
- Lower Shadow - Low is marked by the bottom part of the lower shadow
Hollow Body Candlesticks And Filled Body Candlesticks
Hollow Body Candlestick
- when the stock closes at a price higher than the opening price
- the body is white
- the bottom of the body depicts the open price
- the top of the body shows the closing value of the stock
Filled Body Candlestick
- when the stock closes at a price lower than the opening price
- the body is black
- the bottom of the body depicts the closing price
- the top of the body shows the opening value of the stock
Categories Of Candlestick Patterns
Trade analysts use candlestick patterns to recognize market turning points and they are utilized to reduce one’s exposure to market risks.
- They are divided into the number of Candlesticks: One, Two, Three and Three and more.
- They are also categorised into 2 broad categories: Bullish and Bearish.
Following are the different types of Bullish and Bearish Candles as mentioned above:
Important Candlestick Patterns And Their Meaning
Following are some candlesticks and their meanings.
Important Questions About Type Of Candlesticks
What Is Marubozu?
- Marubozu means "shaven". They are the Candlesticks without any shadow.
What Is Doji?
- Doji means "unskillfully formed". They are the Candlesticks without a body.
What Is Harami?
- Harami means "pregnant". Harami is a Candlestick pattern formed by 2 Candlesticks namely one big (mother) and one small (baby), thus the name.
Different Types Of Japanese Candlesticks
Today there are varieties of Candlesticks prevalent in the market. It is only with practice that one may gain complete knowledge of each of them. I’ve compiled the various types of Candlesticks that are in practice.
The list is pretty exhaustive. The following infographic will be very useful for those who are using candlestick techniques to monitor market movement and also for those who are learning about them.
Why Do Candlesticks Have Different Shapes And Sizes?
Why Do Candlesticks Have Different Colours?
As you can see above, Candlesticks have various sizes, shapes and even colours. The reason for this is that the Candlesticks are based on the prices. Since the prices keep varying, the size and shape of the candlesticks also vary due to their anatomy and that makes them different.
These various shapes and sizes are indicative of the market psychology but are highly effective in helping one predict the future market direction.
Benefits Of Candlestick Patterns
Candlesticks today are used by swing traders, day traders, investors and financial institutions because of the following reasons:
- They are easy to comprehend
- Patterns are easy to identify
- They can be used in conjunction with other Indicators
- Provide a much more detailed description of the occurrences and happenings in the market, and interactions between buyers and sellers as compared to traditional charts which provide minimal information
- They allow us to understand the sentiment of Investors and the values being determined by the market
- The colour and length of candles helps determine if the market is Bearish (weakening) or Bullish (growing) at a glance
- They indicate market turning points early and estimate the direction of the market
- Overall, Candlesticks provide unique insights
- They display reversal patterns which cannot be seen in other types of charts
- They can be used in all kinds of markets
- Candlestick Patterns are highly accurate in predicting market trends
We have talked about momentum-based trading strategy in the article: Candlestick Trading: A Momentum based trading strategy and used pivot points in conjunction with candlestick technique to predict the movement of price in trade markets. Be sure to check it out!
Knowledge of Candlesticks proves to be invaluable in understanding the profit potential. One can learn about Candlesticks and with some effort, one can memorise Candlestick Patterns quickly and apply this knowledge in a short time.
One doesn’t need to invest months or years to master them unlike any other element in Trading. As it is rightfully said, ‘Practise makes perfect’. A mighty technique which has stood for 300 years and counting, Candlesticks continue to change this world.
If someone is planning to take a course on Analysis, of Trading, it is better to have a beforehand knowledge of Candlesticks that will benefit you and make the course much easier to comprehend.
Candlestick patterns are one of the predictive techniques used by traders all over the world. The candlestick charts are used in stock markets and forex markets among others.
If you are just starting your journey in quantitative trading, check out this course on Quantitative Trading Strategies and Models that teaches basic technical trading strategies, modelling and more! Learn to think Quantitatively Now!
Disclaimer: All investments and trading in the stock market involve risk. Any decisions to place trades in the financial markets, including trading in stock or options or other financial instruments is a personal decision that should only be made after thorough research, including a personal risk and financial assessment and the engagement of professional assistance to the extent you believe necessary. The trading strategies or related information mentioned in this article is for informational purposes only.