Every stock or currency pair has a corresponding price chart that details every price movement within a given time-frame. It is common for beginners to read line charts, but the information on a line chart is insufficient as it only takes into account closing prices of each period. Hence, I would like to introduce a more comprehensive charting type; candlesticks chart.
Candlestick charting was developed by the Japanese rice traders in the early 17th century to indicate price changes in rice contracts. This charting method was later introduced to the Western world by Steve Nison. Today, traders all around the world use candlesticks chart. A candlestick chart is made up of many candles that represent price movements of its corresponding time-frame (minute, hour, day, week). A candle is made up of a body and a wick. The body of the candle tells us the opening and closing prices, while the shadow (wicks) represent the high and low of that time-frame. Below is the anatomy of a candlestick
Anatomy of candlestick
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A close above a high will be denoted by a green body (bullish), while a close below the low will be denoted by a red body (bearish). If the opening price and closing price is the same, the candle will usually be black and this is called a “doji” candle. Below are examples of dojis.
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Candlesticks can be used to determine a reversal or continuation in trend. Today, let’s learn to two common reversal patterns; hammer (shooting star) & engulfing.
Hammer & Shooting Star Candles
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A hammer / shooting star signals an exhaustion of the prevailing trend. It is usually characterized by a long wick and a small narrow body, similar to a pin bar. A hammer tells traders that sellers made an attempt to push prices lower but buyers came in to push prices back up for a close way above the low. The same is true in a bearish scenario represented by the shooting star.
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In both cases, we can see that the engulfing candle is long bodied, completely engulfing the preceding candle, signalling a possible change of trend. Traders usually will wait for the next candle after the engulfing to make a trade entry.
Let’s take a look at how these candles can be used as trade setups.
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So you have learnt 4 basic candlesticks patterns and their significance to traders in this article. Hopefully we have sparked your interest in learning more about candlesticks. For further reading, you might want to check a comprehensive book on candlesticks “Japanese Candlestick Charting Techniques” by Steve Nison.
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Till next week, have a good weekend!