A Beginner's Guide to Candlestick Charts
Introduction
As a new investor or trader, it can be quite daunting to learn to read charts as they can appear to be complex. Some people rely on intuition to make their investment decisions, and others rely on their gut feelings. In a bullish market environment, this strategy may temporarily work, however in the longer run, it is extremely unlikely to be effective.
A trader or an investor is fundamentally just a game of probabilities and risk management. Being able to read candlestick charts is, therefore, one of the most important aspects of almost any investment style. Let us take a look at exactly what candlestick charts are as well as how to understand them.
What is a candlestick chart?
The candlestick chart is a type of financial chart in which the price movements of an asset are shown in a chronological order for a particular time period. The candlesticks represent the different periods of time, as the name implies. Each candlestick can be used to represent a period of time from seconds to years.
The candlestick chart dates back to around the 17th century, but it is a very ancient trend. The Japanese rice trader Homma is often credited with the invention of these tools as a charting tool. He is likely responsible for laying the foundation for the modern candlestick chart. Many people have refined Homma's findings, but one of the most influential of these was Charles Dow, one of the fathers of modern technical analysis.
The candlestick charts can be utilized to analyze any other type of data, but these charts are most commonly used as a means of facilitating the analysis of financial markets. By using them correctly, they provide a tool that can help traders gauge the probability that a particular outcome will occur in a particular price movement. Traders and investors can make use of them as they are able to formulate their own ideas based on their analyses of the market, and thereby formulate their own ideas.
How do candlestick charts work?
To create each candlestick, the following price points must be met:
Open
- The first recorded trading price of the asset within that particular timeframe.
High
- The highest recorded trading price of the asset within that particular timeframe.
Low
- The lowest recorded trading price of the asset within that particular timeframe.
Close
- The last recorded trading price of the asset within that particular timeframe.
It is commonly referred to collectively as the OHLC values. How a candlestick appears depends upon the relationship between the open, high, low, and close. Distance between the open and close is referred to as the body, while distance between the body and the high and low is referred to as the wick or shadow. A candlestick's range is defined as the distance between its high and low points.
How to read candlestick charts
Candlestick charts are considered to be easier to read by many traders than the more conventional bar charts, even though they provide similar information. It is easy to read candlestick charts at a glance, placing a simple representation of price action. A candlestick, in practice, reflects both bulls and bears fighting for control of the price market for a specific period of time.
Generally speaking, the longer the body is, the greater the intensity of the buying or selling pressure during the time period measured. When the candle's wicks are short, it indicates that the high (or low) for the measured timeframe was closer to what the closing price of the candle was.
If the body is green, it generally indicates the asset closed higher than it opened. The color and settings may vary with different charting tools, but it generally means the asset closed higher than it opened. In the case of the color red, it indicates that the price moved downward during the period, so the close was lower than the open of the period.
Black and white representations are preferred by some chartists. So instead of using green and red, the charts represent upward movements with hollow candles while downward movements are marked by black candles.
What candlestick charts don’t tell you
The candlestick chart is useful for giving you an overall picture of price action, however, they may not be enough to give you the full price movement. As an example, candlesticks do not indicate in detail what happened during the interval between the opening and closing of the trade, only the distance between the two points (along with the highest and the lowest prices). For instance, while the wicks of a candlestick can inform us of the highs and lows of a period, they cannot tell us which occurred first.
In most charting tools, however, there is the option to change the timeframe, which gives traders the opportunity to zoom into lower timeframes in order to see more details. Candlestick charts, especially those charting on lower timeframes, can also contain a lot of noise resulting from the market. It can be challenging to interpret candlestick charts due to the fact that candles fluctuate so quickly.
Heikin-Ashi candlesticks
So far, we have learned about what is sometimes referred to as a Japanese candlestick chart. The calculation of candlesticks can also be done in different ways. One of these is to use Heikin-Ashi's method.
In Japanese, the word 'Heikin-Ashi' means "average bar".There are several ways to create candlestick charts using a modified formula that incorporates average price information. By using this method, the aim is to eliminate market noise and smooth out the price action. So the Heikin-Ashi candle can provide you with useful insights into price patterns, market trends, and possible reversals.
The Heikin-Ashi candlestick is often used in conjunction with the Japanese candlestick so that traders can avoid false signals and increase the chances of spotting market trends. A green Heikin-Ashi candle with no lower wick points to a strong upward trend, whereas a red candle with no upper wick generally points to a strong downward trend.
Although Heikin-Ashi candlesticks, like any other technical analysis technique, can be an effective tool, they do come with their own limitations. The candles are using averaged price data, which means that patterns may take longer to develop since they use averaged price data. Furthermore, they do not show price gaps, which may cause other price data to be obscured.