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What are Japanese Candlestick Charts?

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Japanese Candlestick Charting

Much of what you see here was scrapped up and adapted from a site that I’d encountered sometime back. If you are brand new to the art/science of chart reading, don’t worry, this stuff is really quite simple to learn.

A little background first… Technical analysis is simply the study of prices as reflected on price charts. Technical analysis assumes that current prices should represent all known information about the markets. Prices not only reflect intrinsic facts, they also represent human emotion, mass psychology, and the general mood of the moment. Prices are, in the end, a function of supply and demand. However, on a moment to moment basis human emotions…fear, greed, panic, hysteria, elation, etc., also dramatically effect prices. Markets may move based upon people’s expectations, not necessarily facts. A market "technician" attempts to disregard the emotional component of trading by making his decisions based upon chart formations, assuming that prices reflect both facts and emotion.

Standard bar charts are commonly used to convey price into an easily read chart. Usually four elements make up a bar chart, the Open, High, Low, and Close for the trading session/time period. A price bar can represent any time frame the user wishes, from 1 minute to 1 month. The total vertical length/height of the bar represents the entire trading range for the period. The top of the bar represents the highest price of the period, and the bottom of the bar represents the lowest price of the period. The Open is represented by a small dash to the left of the bar, and the Close for the session is a small dash to the right of the bar. Below is a standard bar chart example. Breaking down the Candlestick Chart…

In my opinion, the Candlestick Charts are more visually appealing, and convey the price information in a quicker, eye-friendlier, manner. Where did Candlestick Charts come from?

Candlestick charts are on record as being the oldest type of charts used for price prediction. They date back to the 1700's, when they were used for predicting rice prices. In fact, during this era in Japan, Munehisa Homma become a legendary rice trader and gained a huge fortune using candlestick analysis. He is said to have executed over 100 consecutive winning trades!

The candlesticks themselves and the formations they shape were given colorful names by the Japanese traders. Due in part to the military environment of the Japanese’ feudal system during this era, candlestick formations developed names such as "counter attack lines" and the "advancing three soldiers". Just as skill, strategy, and psychology are important in battle, so too are they important elements when in the midst of a trading battle. What do Candlesticks Look Like?

Candlestick charts are much more visually appealing than a standard two-dimensional bar chart. As in a standard bar chart, there are four elements necessary to construct a candlestick chart, the OPEN, HIGH, LOW and CLOSING price for a given time period. This link will take you to a Candlestick Chart on the RollingStock100 .

o The body of the candlestick is called the real body, and represents the range between the open and closing prices.

o A black or filled-in body represents that the close during that time period was lower than the open, (normally considered bearish) and when the body is open or white, that means the close was higher than the open (normally bullish).

o The thin vertical line above and/or below the real body is called the upper/lower shadow, representing the high/low price extremes for the period.

Notice how the candlestick chart appears 3-dimensional, as price data almost jumps out at you. Common Candlestick Terminology

The following is a list of some candlestick terms. It’s important to realize that many formations occur within the context of candlesticks. What follows is merely a definition of terms.

o The Black Candlestick -- when the close is lower than the open

o The White Candlestick -- when the close is higher than the open.

o The Shaven Head -- a candlestick with no upper shadow.

o The Shaven Bottom -- a candlestick with no lower shadow.

o Spinning Tops -- candlesticks with small real bodies, and when appearing within a sideways choppy market, they represent equilibrium between the bulls and the bears. They can be either white or black.

o Doji Lines -- have no real body, but instead have a horizontal line. This represents when the Open and Close are the same or very close. The length of the shadow can vary. Candlestick Reversal Patterns

Just as many Traders look to bar charts for double tops and bottoms, head-and-shoulders, and technical indicators for reversal signals, so too can candlestick formations be looked upon for the same purpose. A reversal does not always mean that the current uptrend/downtrend will reverse in direction, but merely that the current direction may end. The market may then decide to drift sideways. Candlestick reversal patterns must be viewed within the context of prior activity to be effective. In fact, identical candlesticks may have different meanings depending on where they occur.

Final Thoughts…

It’s important to realize that this introduction is just that, an introduction to candlestick analysis. After having read this, you will have merely scratched the surface of the many patterns and variables that can go into candlestick analysis. For a more complete overview of candlestick analysis, it is highly recommended that you pick up a good book or run a search of the Internet via you favorite search engine.

A book with good reviews is “Japanese Candlestick Charting Techniques: A Contemporary Guide to the Ancient Investment Techniques of the Far East.” This book completely explains candlesticks and their formations, but more importantly explains how to combine candlestick analysis with traditional technical analysis, which when done properly can put some extra bucks in the old pocket. As traders, we need as many trading tools in our toolbox, and a basic knowledge of candlesticks provides us with many of those needed tools. Also remember that no matter what the trading tool, no matter how advanced or ancient, it is only effective when put into practice properly. This is, of course, your job as a successful Trader.

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