Candle Charting Basics
Editor’s Note:
For this week’s guest commentary I am pleased to present Steve Nison, CMT, of
Candlecharts.com.
Brice
Candle Charting Basics
“A
good beginning is the most important of things.â€
–Japanese proverb
This article discusses only a few of
the scores of candle chart patterns. There are many important candle patterns
and trading tactics not discussed in this basic introduction. As such, do not
trade based on the limited information. The goal of this section is to
illustrate how candles can open new and unique analytical doors, not to provide
a trading methodology. For example, there are many times candle signals should
be ignored. This is where experience with candle charts comes in.
What Are Candlesticks?
Japanese candle chart analysis, so called because
the lines resemble candles, have been refined by generations of use in the Far
East. These charts are now used internationally by traders, investors and
premier financial institutions. Candle charts:
- Are easy to understand: Anyone, from the
first-time chartist to the seasoned professional can easily harness the power
of candle charts. This is because, as will be shown later, the same data
required to draw a bar chart (high, low, open and close) is used for a candle
chart.
- Provide earlier indications of market turns:
Candle charts can send out reversal signals in a few sessions, rather than the
weeks often needed for a bar chart reversal signal. Thus, market turns with
candle charts will frequently be in advance of traditional indicators. This
will help you to enter and exit the market with better timing.
- Furnish unique market insights: Candle charts
not only show the trend of the move, as does a bar chart, but, unlike bar
charts, candle charts also show the force underpinning the move.
- Enhance Western charting analysis: Any Western
technical tool you now use can also be used on a candle chart. Candle charts,
however, will give you timing and trading benefits not available with bar
charts. This merging of Eastern and Western analysis will give you a jump on
those who use only traditional Western charting techniques.
Constructing The Candlestick
Line
| The broadest part of the candlestick line is the real body. It represents the range between the session’s open and close. If the close is lower than the open the real body is black. The real body is The thin
The color and length of the real body reveals
At Candlecharts.com, we have found the
|
 |
Using Individual Candle Lines
 |
A critical and powerful advantage of candle charts is that the size and color of the real body can send out volumes of information. |
For example:
- a long white real body visually displays the
bulls are in charge - a long black real body signifies the bears are
in control. - a small real body (white or black) indicates a
period in which the bulls and bears are in a “tug of war” and warns the
market’s trend may be losing momentum.
While the real body is often considered the most
important segment of the candle, there is also substantial information from the
length and position of the shadows. For instance, a tall upper shadow shows the
market rejected higher prices while a long lower shadow typifies a market that
has tested and rejected lower prices.
The slogan of our firm is “Helping Clients Spot Market Turns Before the
Competition.” This is based on the powerful fact that candle charts
will often provide reversal signals earlier, or not even available with
traditional bar charting techniques.
Even more valuably, candle charts are an
excellent method to help you preserve your trading capital. This benefit alone
is incredibly important in today’s volatile environment.
Let’s look at an example of how a candle chart
can help you avoid a potentially losing trade.
Exhibit 1 (below) is a bar chart. In the circled
area of Exhibit 1, the stock looks strong since it is making consecutively
higher closes. Based on this aspect, it looks like a stock to buy.
Exhibit 1
The candle chart, uses the same data as Exhibit 1 (above), (remember, a candle
chart uses the same data as a bar chart; open, high, low and close.) Let’s now
look at the circled area on the candle chart in Exhibit 2
(below). Note the different perspective we get with the candle chart than with
the bar chart. On the candle chart, in the same circled area, there are a series
of small real bodies which the Japanese nickname spinning tops. Small real
bodies hint that the prior trend (i.e. the rally) could be losing its breath.
Exhibit 2
As such, while the bar chart makes it look attractive to buy, the candle chart
proves there is indeed a reason for caution about going long. The small real
bodies illustrate the bulls are losing force. Thus, by using the candle chart, a
trader or investor would likely not buy in the circled area. The result —
avoiding a losing trade.
This is but one example of how candles will help
you preserve capital.
When investing his own money, Warren Buffet has
two simple rules that he follows:
| RULE #1 | Don’t lose money. |
| RULE #2 | Don’t forget Rule #1. |
Candles truly shine at helping you preserve
capital!
Let’s now look at a specific type of candle line
that has a very long lower shadow called a hammer (shown in
Exhibit 3 below). So called because the Japanese
will say the market is trying to hammer out a base. The criteria for the hammer
are:
1. The real body is at the upper end of the
trading range.
2. The color of the real body can be black or white.
3. A bullish long lower shadow that is at least twice the height of the real
body.
4. It should have no, or a very short, upper shadow.
Exhibit 3
The hammer reflects the visual insights obtained from a candle
chart—