Using Candlesticks As A Tool In Trading
The history of the use of ‘candlesticks’ in trading is quite fascinating. First of all, the reason it’s called that, is because the movement of price illustrated this way, (a one day period, for example) resembles a candlestick. It’s good to have a clear understanding of this historical method of ‘tracking data’, since using and knowing how to interpret Forex candlestick patterns can assist your trading success. Getting right down to it, what is a candlestick, in the world of trading?
In a few words, a ‘candlestick’ is a visual representation of price movement, in a given time frame. It shows the opening price, the closing price, and the high & low of price movement within that period, whether it be 5 minutes or 1 week. These 4 pieces of information are key in helping to determine what may be coming next, in terms of price action. Market sentiment is constantly fluctuating, and the candle ‘captures’ all of that movement enabling the trader to ‘read’ it at a glance.
It is similar to a note on a sheet of music, where one note alone communicates something. A note can be sharp or flat, it can be a half, or an eighth note. It has a particular tone. But it’s only when you put a string of notes together that an actual piece of music ’emerges’.
Much like a jigsaw puzzle, the individual pieces offer clues and information, but, complete the puzzle, and you get a ‘whole picture’. In trading, when you become familiar with the patterns that many candlesticks in succession form, a picture also emerges as to what price is likely to do in the future. It’s a thing of beauty, really, due to what the market is revealing, and it very much involves history repeating itself. It’s predictive in nature.
Like something called ‘pin bar reversals’. A pin bar candle has a long wick and small body. You will frequently see this formation, which, not always, but frequently indicates that a price reversal is afoot.
The candles in the diagram at the right, have bottom wicks, or shadows, as they’re also called, as a result of price dropping down several times, pulling back, and closing higher. The ‘bears’ could not hold on to their momentum at this juncture. As you can see, price did indeed reverse to the upside, following the 2 pin bar candles.
Who Invented Candlestick Trading?
Candlestick trading was first conceived of in Japan, 100’s of years ago, where rice traders developed this charting method to track the buying and selling movements of rice, the number one commodity back then. It’s a complicated history as to how candlestick charting evolved, but bottom line, savvy rice vendors drew ‘candlesticks’ on scrolls, to indicate the raw data of price movement, in order to keep records, and ‘predict’ future outcomes based on past circumstances and actions.
Rice merchants realized that human emotion played a large role within trading, and that emotional reactions were predictable, and cyclical. Hence the need to reflect market outcomes within candle stick renderings, based on ‘sentiments’. Traders don’t always act, based upon facts, but rather on fear or greed.
And sure enough, the market patterns we see today, hundreds of years later, still reflects this same emotional factor that drives futures, derivatives and commodities trading, to this very minute. In the chart comparison below, you can see that the upper chart price movement is more erratic, with large ‘gaps’ in price, and a dramatic long red candle where price dropped suddenly. When I see this on a chart, I move on. The whole recent pattern shows indecision, and confusion as to where price is going.
Little has changed since the 1700’s! I know in my own experience, you can clearly see emotions getting played out on a candlestick chart, in live trading. It is often triggered by various news announcements that impact currency, or the stock market. And you can also see when price is moving cleanly, in an ‘orderly’ fashion, such as in the second chart above. And when things are relatively calm, (both you and the market!), that is usually the best time to make trading decisions.
Once Wall Street caught on to candlestick charting, made famous by Steve Nison, back in the mid 80’s, it wasn’t long before its use was integrated into trading platforms everywhere.
It simply made ‘reading’ price action much easier. I would say it’s the difference between looking at an abstract painting of a flower, or, looking at the flower itself.
When I first began my trading education, I often saw what is called a ‘bar chart’, with just lines. Some traders prefer this. I didn’t like the bar chart, I found it ‘hard’ to interpret.
In comparison, candlesticks were infinitely more visually appealing, and made it easier to quickly identify the opening & closing price, and the high and low. Most traders use candlestick charts.
(Below: bars on the left, candlesticks on the right)
Mapping The Movement Of Price To See Where It’s Going Next
Price action can do only 3 things. It either moves up, down, or sideways. Candlesticks map that movement, but allowing you to not only see the pattern of movement, but also what each candle individually, and in formations, is telling you about what’s coming next. The candlesticks within the wedge or flag pattern below, show how price is moving back and forth sideways, with a lot of ‘indecision’ as to direction.
However, something which happens repeatedly in candle formations is, you will see, after a period of consolidation such as above, that you can draw a trend line across the upper candles where there are 2 or more touching points, and the lower trend line…..the same.
These flag shaped patterns are very common, and once price breaks out above or below the trend lines, price either continues an upward trend such as above, or, in this case, breaks the pattern, to the down side. When price breaks out, you will usually have full, longer candles, which confirms price breakout. In the chart above, red candles are bearish, and green candles are bullish. The longer red candles moving below the lower trend line, are showing strength of movement in a new direction.
There are numerous candlestick patterns that you will see over and over again. That’s why it’s good to become familiar with these formations, so you’ll know where price may be going next. Unless you have a photographic memory, it’s helpful to have a reference guide.
The Best Way To Start Getting Ahead, Fast
I would recommend The Candlestick Trading Bible, a comprehensive book on candlestick analysis, which also teaches you about trends, and support/resistance, 2 other vital elements that go hand in hand with candlestick patterns, in determining trades to take.
I like the simplicity of this book, anyone can follow it, and if you are new to trading, you will be able to practice what you learn, on a demo account.
If you really want to ‘speed up your results’, or you just don’t have a lot of time to learn, you might consider getting trend trading software (HERE) that generates multiple weekly trade signals. (You should also learn about risk management).
Learning to trade can be difficult at first, but when you have the right information at your finger tips, like The Candlestick Bible, which teaches you all the basics you need, and if you also get software that provides signals straight to your inbox, you can start making money right away!
Why not learn and earn at the same time? If you have any questions, please tell me what’s on your mind!