Candlestick charts were developed in Japan over 100 years before other charts were created. In the 1700s, a Japanese man named Homa noticed that while there was a correlation between the price and supply and demand of rice, markets were strongly influenced by the emotions of traders. Based on this, candlestick charts were created. Candlesticks show this sentiment by visually displaying the size of the price movement in different colors. Traders use candlesticks to make trading decisions based on regular patterns that help predict short-term price direction.
Tips on charts and candles
Traders use candlestick charts to determine possible price movement based on past patterns. Candlesticks are helpful when trading because they show four price points (open, close, high, and low) over a period that the trader specifies. Many algorithms are based on the same price information as candlestick charts. Trading is often dictated by sentiment, which can be interpreted on candlestick charts.
Just like a bar chart, a daily candlestick shows the market’s open, high, low, and close for the day. Candlestick has a wide part which is called “Real Object.” Real Object shows the price range between the open and close of that day’s trades. When the Real Object is filled or black, the closed state is lower than the opened state. If the Real Object is empty, the closed state is higher than the open state.
Traders can change these colors in their trading platform. For example, a lower candle is often shaded red instead of black, and upper candles are often shaded green instead of white.
Candlesticks and bar charts
Above and below the Real Object are “shadows” or “wicks.” The shadows show the high and low prices of that day’s trades. For example, if the upper shadow on a lower candlestick is short, it indicates that the open was close to the day’s high. A short upper shadow on a day high indicates that the close was close to the top. The relationship between the open, high, low, and close days determines the appearance of the daily candlestick. Real Objects can be long or short and black or white. Shadows can also be long or short.
Bar charts and candlesticks show the same information in different ways. Candlestick charts are more visual due to the color code of the price bars and the thicker Real Object, better at highlighting the difference between open and close. Some traders prefer to see the thickness of the Real Object, while others prefer the appearance of bar charts without extra lines.
The reliability of the candlestick pattern
Not all candlestick patterns work equally well. Their high popularity has reduced reliability as hedge funds and their algorithms have analyzed them. This makes investors who are professionals and have substantial budgets superior for trading against retail investors and traditional fund managers who implement technical analysis strategies found in the mainstream literature.
In other words, hedge fund managers use software to trap investors looking for high-probability bullish or bearish outcomes. However, reliable patterns continue to emerge and provide short- and long-term profit opportunities.
This analysis is based on the theory of Thomas Bolkowski, who developed a performance rating for candlestick patterns in his 2008 book, The Encyclopedia of Candlestick Charts. He predicted two different types of patterns to examine price action:
Reversal Pattern – Reversal candlestick patterns predict a change in price direction.
Continuity Pattern – Continuity patterns predict a move in the current price direction.
Common patterns in candlestick trading
Candlestick base patterns
In this pattern, candlesticks are created by high and low price movements. While these price movements sometimes seem random, other times, they form patterns that traders use for analysis or trading purposes. As a result, there are many candlestick patterns.
Patterns are divided into ascending and descending. Bullish patterns indicate the possibility of price increases, while bearish patterns indicate the possibility of price decreases. However, no pattern always gives the desired result correctly because candlestick patterns indicate tendencies in the price movement, not a guarantee of its move towards the target price.
Descending pervasive pattern
A bearish pattern is formed in an uptrend with more sellers than buyers. This action is reflected by a long red Real Object that swallows a small green Real Object. This pattern indicates that the sellers are back in control, and the price can continue to decline.
Ascending pervasive pattern
A pervasive pattern occurs on the bullish side of the market when buyers outstrip sellers. This is reflected in the diagram with a green Real Object enclosing a small red Real Object.
A bearish harami is a small Real Object (red) that is entirely inside the previous day’s Real Object. This model does not give reliable results, but it can be considered for better analysis. This pattern shows the lack of decisions on the part of buyers. Things may still be bullish if the price breaks higher, but a candle below the pattern indicates a further slide.
A bullish harami is the opposite of a bearish harami. In this pattern, a bearish trend and a small Real Object (green) occur inside the body of the previous day’s Real Object (red). This movement indicates to the trader that the trend is stopping. If another bullish day follows, more bullish trends may be coming.
A bearish Harami crossover
A bearish harami crossover occurs in an uptrend, where a high candlestick is followed by a Doji, exactly where the candlestick roughly opens and closes. The Doji in Real Object is the previous day. Its general interpretation is like descending Harami.
A bullish Harami crossover
A bullish Harami crossover occurs in a downtrend, where a Doji follows a down candlestick. The Doji in Real Object is the previous day. The concepts of this pattern are also similar to the ascending Harami.
The pattern begins with something called a “long white day.” Then in the second, third, and fourth trading sections, the small Real Object pulls the price lower but remains in the long white day price range (the first day in the pattern). The fifth and final day of the pattern is another long white day. Even if the pattern shows us that the price has been declining for three days, a new low will not be seen, and traders are preparing for the next move. A slight variation of this pattern is when the second day rises slightly after the first long day. Everything else about the template is the same.
This pattern starts with a weak day. It is followed by three small Real Objects that progress upwards but remain within the range of the first day of the fall. The pattern is completed when it makes another downward move on the fifth day. This indicates that the sellers are back in control, and the price can go down.
How accurate are candlestick trades
Candlestick trading can be reliable, but the patterns presented should not be taken as an absolute indicator of movement and trading. This is because time frames are different and aggregate as the time frame of each candle increases, and the candles themselves are only lagging indicators of market conditions. Such a trend means that all the information obtained through candlestick interpretation has already happened, and will be based on trading patterns, investing in hypothetical price movement based on past patterns and other indicators. Many traders trade with tools such as the Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD). Do not forget that combining different patterns and charts provides investors with more accurate information.
How to interpret the candlestick3
Interpretation of candlesticks is quite simple. The height of each candlestick is determined by the open price and the close of the time frame (usually 15 minutes, 30 minutes, one hour, four hours, one day, one week, and one month). The wick of each candle, or the single line that runs above and below the box, represents the lowest price for the candle and the highest price, but not the closing price. It simply means the highest point reached during the candle’s time frame. If the body is black or red, it indicates a lower closing price. Hollow white or green candles mean that the price closed higher than when the candle started.
How many candlestick patterns are there
The answer to this question will vary depending on who is asked. For example, while traders who focus on the more obscure candlestick patterns may say there are over 50 patterns, cautious traders who trade only the most well-known patterns say there are about 25 candlestick patterns.
Charts and candlesticks attract investors’ attention to the market, but many of the reversal and continuation signals emanating from these patterns do not work reliably in the modern electronic environment. Fortunately, Thomas Bolkowski’s statistics show exceptional accuracy for a limited selection of these patterns and provide traders with actionable buy and sell signals.
Putting the insight from observing candlestick patterns and investing in assets based on them requires a brokerage account. As a result, you should be able to find the right broker for your investment needs.
As Japanese rice traders discovered centuries ago, investors’ sentiments about trading an asset have a significant impact on its movement; Candlesticks help traders gauge the sentiment surrounding a stock or other support, giving them better predictions about where that stock might go.
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