—-Resources from T2W forum.
The history of candlesticks begins in Japan in the 17th century with the rice broker Munehisa Homma, who started using price history to predict the future price. Although his version of Technical Analysis may be quite different to what we now use, it was his trading theories and principles that evolved into the charting techniques we use today.
The modern day candlestick guru is Steve Nison who is credited with bringing the Japanese candlestick theory to the west.
The candlestick theory utilises the premise that actual price action is more important than the news, earnings, etc that have caused it. All known information is reflected in the price and buyers and sellers will influence markets based on the main emotions of fear and greed.
Candlestick patterns can be read on their own, but when looked at in conjunction with other forms of Technical Analysis they become a very powerful tool for the trader.
Candlesticks, like bar charts, use the open, close, high and low values of a set period. However with a candlestick a ‘real body’ is drawn which connects the open and the close price. If the close is above the open, then the candlestick body is drawn clear (white) or sometimes green. If the close is below the open, then the candlestick body is shown dark (usually black or red). There are, however, no hard and fast rules about what colour they should be, as long as it is easy to see what is a up and what is a down candle.
The line that extends above or below the ‘real body’ is known as the upper and lower ‘shadows’ (or wicks and tails) these indicate the high and low of the particular period. The high is noted as the top of the upper shadow and the low is noted as the bottom of the lower shadow.
For example – look at the diagram below
In ‘A’ stock XYZ opens at 50, closes at 90 with a high of 100 and a low of 40.
In ‘B’ stock XYZ opens at 90, closes at 50 with a high of 100 and a low of 40.
In ‘C’ stock XYZ opens at 75, closes at 75 with a high of 100 and a low of 40.
Remember that when the candlestick ‘real body’ is clear (as in ‘A’), this means that the stock closed above its opening price. When the candle ’real body is dark (as in ‘B’) it means the stock closed below its opening price. This instantly gives a very clear picture of what is happening with stock XYZ.
In ‘C’, where the stock opens and closes at the same price, there is no real body present and this candlestick is known as a Doji, it is one of the most important types of candlestick.
While candlesticks and their patterns are very powerful, none of them can predict the size of a move only its probable direction. Even a powerful reversal signal like an engulfing candle (bullish or bearish) only shows the current sentiment of the market, not how long that sentiment will last.