Now that we have understood what is Technical Analysis and why do they work, let’s us now jump right into the most important basics of Technical Analysis, which is to understand what are candlesticks. To put it simply, candlesticks are basically the individual boxes (can be green-red or black-white) that made up a chart. They represent the open, close, high and low price of a particular instrument within a specific time period. In this post, we are going to learn about the origin of candlesticks, its basic patterns and how to interpret them.
Where it came from
The Japanese candlesticks or what is commonly known as candlesticks have come a long way since it was first used around 1600. It was first used by a rice trader in Japan called Homma. During the period between 16th and 17th Century, many of Japanese areas are engaging in a civil war, which is why many of the candlestick patterns are named after military terms.
It was not until the last 2 decades that candlesticks start to popularize the investment world. After an extensive 3 year long research done by Steve Nison, he finally managed to popularize candlesticks in the West through its initial publication of “Japanese Candlesticks Charting Techniques”, published in 1991.
How to read candlesticks
Candlestick is very simple to read. Generally, there are only 3 features that made up a candlestick.
1) Real Body
A candlestick body represents its opening price and closing price. Top of the body can be either the opening or closing price, so too the bottom. It depends on the color of the candlestick.
Candlestick generally can be either red & green or black & white. A darker color (in this case red or black) means that the stock price closes at lower price than its opening. Whereas a lighter color (green or white) means that the stock price closes higher than its opening.
3) Upper and lower shadow
Some people also call the shadow as candlestick “tail” as it looks like an additional “tail” on top or below the candlestick. For upper shadow, the tip represents the highest high of the stock price for the day, whereas for lower shadow, the tip represents the lowest low of the day.
Common type and candlestick pattern
By using the shape of candlesticks, we can roughly determine the market sentiment. This can be summarized into the followings:
-Single candlestick pattern
Directly translated from Japanese, “Doji” means “blunder or clumsiness”. A Doji candlestick has the following characteristics:
1. Small bodies that appear as a thin line
2. Upper shadow and lower shadow usually have the same length
3. Looks like a cross or plus sign
Interpretation: Doji pattern means that opening price is virtually equal to the closing price hence there is an even balance of strength between the bull and bear. This indecisiveness between buyers and seller means that the market has not yet taken any stand, hence it is two-sided.
I personally would like to avoid trading when Doji appears as it shows how the market is still very indecisive and channel is likely to be formed in the near future (will be explained in the next post). Bottom line is, avoid Doji because it is Dojy (Dodgy).
Directly translated from Japanese, “Marubozu” refers to shaven top or in Singlish we call it “botak”. This botak candlestick has the following characteristics:
1. Long body
2. No upper or lower shadows
Interpretation: To put it simply, Marubozu is almost the exact opposite of Doji. White or green Marubozu means that Bulls controlled the price from open to close whereas black or red Marubozu means that Bears controlled the price from close to open. This shows that there is a very clear sentiment in the market for the day.
I love Marubozu as it forms a very distinct price signal, especially when the price is about to break the channel into a trend. However, we still need to look out for any possible price correction on the following candlestick.