Candlestick chart. Beginner's Guide

Introduction

For those who are just beginning to explore trading and investments, chart analysis can be quite challenging. Some individuals may rely on their intuition to make investment decisions. While this approach may work in a bull market, it is not suitable for long-term strategic planning. Trading and investments involve probabilities and risk management. The ability to critically analyze information is crucial in almost any form of investing. In this article, we will delve into what Japanese candlestick charts are and how to extract information from them.

What Are Candlestick Charts?

A Japanese candlestick chart is a type of financial chart that displays price changes of an asset over specific periods of time. This type of chart consists of candlesticks, each representing a defined time interval. The time interval can vary, ranging from seconds to years. Candlestick charts were first developed in the 17th century and are often associated with a Japanese rice trader named Homma, whose ideas laid the foundation for modern candlestick charts. Over time, they have been refined, including contributions from Charles Dow, one of the founders of modern technical analysis. Candlestick charts can be used to analyze various types of data, but their primary purpose is to facilitate the visualization of price changes in financial markets. When used correctly, this tool allows traders to more accurately assess the probability of future price changes. Traders can also use candlestick charts to develop their own trading strategies based on market analysis.

How Candlesticks Operate:

Each candlestick comprises these fundamental elements, illustrating price shifts of an asset within a specific timeframe:

1. Opening (Open): This indicates the initial recorded asset price at the beginning of the defined time period.

2. High (Peak): The highest point the asset's price reached during the specified timeframe.

3. Low (Trough): The lowest point the asset's price touched within the set timeframe.

4. Closing (Close): The last recorded price of the asset as the designated period concludes.

These four aspects are often abbreviated as OHLC (Open-high-low-close chart). The visual appearance of a candlestick is shaped by the interplay between these opening, high, low, and closing prices.

The space between the opening and closing prices of a candlestick is termed the "body" of the candle, while the distance from the high or low to the body is recognized as the "wick" or "shadow." The difference between the highest and lowest prices throughout the timeframe defines the candle's overall "range."

How to Interpret Information from Candlestick Charts:

Candlestick charts are often seen as more user-friendly and easier to grasp by many traders when compared to other chart types like histograms or line charts, despite providing similar data. Candlesticks enable a swift assessment of price changes and offer a more visually intuitive representation.

Candlesticks essentially portray the tug of war between bulls (investors anticipating price growth) and bears (investors expecting price drops) within a specific timeframe. A lengthy candle body indicates a significant presence of either buyers or sellers. When the candle's wicks are brief, it implies that the highest or lowest price during that time period closely aligned with the closing price.

The candle's color and configuration may vary depending on the charting tools employed. Nevertheless, in most instances, a green candle signifies that the closing price exceeded the opening price, while a red candle suggests a price decrease during the designated time frame, concluding below the opening price.

Some analysts favor a monochrome presentation style. In such cases, ascending price movements are depicted through light candles, while descending movements are represented by dark ones.

What Candlestick Charts Cannot Reveal:

Candlestick charts provide a generalized overview of price movements, but they do not encompass all the necessary information for comprehensive analysis. For instance, they do not offer details about the specific price changes that occurred between the opening and closing moments of a candle. They merely display the distance between two points (taking into account the highest and lowest prices).

For example, candle wicks inform us about the highest and lowest prices within a period but do not convey how price changes occurred within that period. However, most charts allow traders to customize various timeframes, enabling them to obtain more detailed information about price fluctuations within a specific period.

It's also worth noting that candlestick charts can contain a lot of "market noise," especially on short-term timeframes. Rapid and frequent candle changes can sometimes complicate their analysis and interpretation.

Heikin-Ashi Candlesticks: Smoothing Price Movements

Up to this point, we've discussed traditional candlestick charts, but there is also a method called Heikin-Ashi candlesticks.

Heikin-Ashi, translated from Japanese as "average pace," is created using a modified formula that takes into account the average price. The primary goal is to smooth out price fluctuations and filter market noise. Heikin-Ashi candlesticks simplify the identification of market trends, price patterns, and potential reversal points.

Traders often combine Heikin-Ashi candlesticks with regular candlestick charts to generate more accurate trend signals, eliminating false signals. Green Heikin-Ashi candlesticks without lower wicks typically indicate a strong uptrend, while red candlesticks without upper wicks may signal a strong downtrend.

Heikin-Ashi candlesticks can be a powerful tool in technical analysis, but like any other method, they have their limitations. They form more slowly due to price averaging, do not reflect price gaps, and may hide some price information.

Conclusion

It is worth emphasizing that candlestick charts are a key tool for traders and investors. They not only visually represent price changes in assets but also provide the capability to analyze data across various timeframes.

A deep understanding of charts and price patterns, combined with analytical thinking and practical experience, can give a trader an advantage in financial markets. However, many also believe that for more reliable analysis, it is worthwhile to turn to other methods, including fundamental analysis.