Candlestick charts were first developed in the 18th Century by successful Japanese rice trader Munehisa Homma. It took a long while for candlestick charts to gain popularity in the Western world. It wasn’t until Steve Nison’s 1991 book Japanese Candlestick Charting Techniques that the charting style gained any real traction with western traders. Throughout the 90’s candlestick charting grew in popularity and is now used by the majority of currency traders.
Candlestick charts are best explained with the aid of several diagrams. Candlesticks can be used in conjunction with any time frame, with the Candlestick providing the trader with a visual description of price action during the specified time frame.
Candlesticks are created using the open, high, low and close of the selected time period. The area between the close and open is known as the real body, price extensions above and below the real body are called shadows. With the wick (thin line) illustrating the high and low prices of the instrument in the given time period. If the instrument closed higher than it opened the real body will typically be unfilled or white. But if the instrument closes lower than it opened the real body will be filled or black, as it is the above diagram.
You should now understand that Candlestick charts display significantly more information about price action than standard line charts.
If you open up a candlestick chart you will notice that the size of the real body will often vary significantly. Longer bodies suggest either strong buying or selling action, while shorter bodies suggest little selling or buying action, with the currency pairing trading in a narrow range.
You should have now worked out that a long white candle suggests that there is strong buying pressure. The longer the candlestick the further the close is above the open pricing. Typically long white (unfilled) candlesticks suggest that lots of buyers were entering into the market forcing prices up.
Long black (filled) candlesticks suggest that there is strong selling pressure. The longer the candlestick the further the close is below the open. Typically long filled candlesticks suggest that lots of buyers were selling forcing prices down.
The upper and lower shadows also impart important information about price action. The upper shadow signifies the high of the time period, while the low shadow signifies the low of the time period. Candlesticks with long shadows show that trading occurred well below and above the close and open, this pattern suggests that there was significant amount of volatility during the selected time period. Candlesticks with short shadows show that the trading was confined to a relatively restricted price range with the market displaying little volatility.
If a candlestick has a long upper shadow but little or no lower shadow, this shows that there was a lot of upward buying pressure. But for some reason or other a number of sellers came in to force prices back down.
Candlesticks with a long lower shadow and no or little upper shadow show that there was significant selling pressure, but for some reason a number of buyers came in provided support to ensure that the close remained close to the open.
Candlestick charts impart traders with significantly more information about price action than standard line charts do. Traders can use the information displayed in candlesticks to get a feel for price action. Many traders keep an eye out for certain candlestick patterns which can be taken as being bullish or bearish. Getting to grips with candlesticks is certainly worth the time, as Japanese candlesticks provide traders with greater insight into price action.