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Written by Forexmotion
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Thursday, 15 January 2009 16:21 |
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Index:
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| 1. Introduction. |
| 2. How a candlestick line is constructed . |
| 3. Example. |
| 4. Types. |
| 5. Notes on candlestick trading. |
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1. Introduction.
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Candlestick techniques were developed in Japan several centuries ago and have only recently become known to Western traders. The recent boom is due to
- The simplicity of implementation versus complex techniques such as the Elliott Wave principle.
- The ability to interpret the every day underlying psychology (something that Western technical analysis hardly does).
- Its demonstrated effectiveness when applied properly.
The main difference between the candlestick charts and graphics used by the Western technical analysis is the use of opening and closing prices to form a range (graphically rectangular). The interior of this range is hollow - or white - if the close is above the opening and filled - or black - if the close is below the opening. |
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2. How a candle is constructed.
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A candlestick line has a rectangular section called the real body and two fine lines, above and below this section, called shadows. The real body represents the range between the opening and closing of the candle while the upper shadow (uwakage) represents the session high and the lower shadow (shitakage) represents the low. The interior of the color range varies depending on whether closing is above opening or vice versa.
White is used when closing is higher than opening and black for the opposite in most technical analysis manuals. In any event, as we shall see later, what really matters is not the colour but the meaning. A close above levels of opening is a positive signal while a close lower than the opening is a negative signal.
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3. Example.
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| Consider a case in which Telefónica climbs to close 2% up for the day. What is a priori a positive signal for candlestick analysis could have bearish implications or less bullish if there had been an upside gap of 4% at opening.. In that case, the real body of the candle would be black, as the opening would have been higher than the close. This warns us that the session is oving from more to less and that buying pressure can not maintain its purchasing power after a clearly bullish opening, without detriment to the final price having risen by 2% above the previous day´s closing.
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Figure 1: Candlestick lines |
In Figure 1 we see an example of candlestick mapping during market trading.
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Open |
High |
Low |
Close |
Day 1 |
11.39 |
11.78 |
11.21 |
11.65 |
Day 2 |
11.48 |
12.06 |
11.37 |
11.91 |
Day 3 |
12.39 |
12.39 |
11.54 |
12.15 |
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Figure 2: Candlestick graph |
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4. Types.
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There are several types of candlestick lines to consider:
- Large real bodies: By large real body, as opposed to medium and small, we mean a difference between opening and closing significantly higher than the real bodies of the previous sessions, a day in which either buying or selling pressure was dominant. For example, a large real body can be considered as 20% bigger than the previous real bodies used as a sample.
- A Marubozu session is the term that applies when the opening or closing prices coincide with the high or low for the same session i.e. there are no shadows.
- Small real bodies: There is little difference between opening and closing of the session. This represents a session which, with greater or lesser volatility, closed with a balance between supply and demand.
- A Karakasa sessions consists of a small real body, either white or black. The real body is small compared to the size of the shadow, which is at least double that of the real body. There is no second shadow or it is very small; less in length than the real body.
- Spinning tops: the tops are candlestick lines that occur in sessions of limited movement between the opening and closing, but with some volatility during the session.
- Dojis: The term is used when opening and closing prices are the same or almost. The real body is therefore very small or inexistent. The moderate flexibility in definition, rather than strictly requiring identical opening and closing, is so as not to reject dojis which only differ by a few ticks but with similar implications.
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5. Notes on candlestick trading.
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It is essential to analyse the context in which a candle is formed i.e. what happened before the formation of the same. Candlestick patterns can never be considered in isolation as depending on where they appear and the previous trend, they will have greater or lesser relevance.
The market trend is especially important. The pattern must be consistent with the trend, especially in the medium term.
Due to the objective characteristics of candlestick patterns, stop loss can be reasonably well established and should be used.
Candlestick techniques are entirely compatible with other analytical techniques such as charting, oscillators, etc. and in the coherence of all of them we find the greatest trading strength.
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