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The
candlesticks themselves and the formations they shape were give
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 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. Below
are examples of candlesticks and a definition for each
candlestick component:
·
The body of the candlestick is called the real body, and
represents the range between the open and closing prices.
·
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).
·
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.
Bar Compared to Candlestick Charts
Below is an example of the
same price data conveyed in a standard bar chart and a candlestick
chart. Notice how the candlestick chart appears 3-dimensional, as price
data almost jumps out at you.
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( 3a ) |
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( 3b ) |
The long, dark, filled-in
real bodies represent a weak (bearish) close ( 3a ), while a long
open, light-colored real body represents a strong (bullish) close
( 3b ). It is important to note that Japanese candlestick analysts
traditionally view the open and closing prices as the most critical of
the day. At a glance, notice how much easier it is with candlesticks to
determine if the closing price was higher or lower than the opening
price.
Common Candlestick Terminology
The following is a list of
some individual candlestick terms. It is important to realize that many
formations occur within the context of prior candlesticks. What follows
is merely a definition of terms, not formations.
·
The Black Candlestick -- when the close is lower than the
open.
·
The White Candlestick -- when the close is higher than the
open.
·
The Shaven Head -- a candlestick with no upper shadow.
·
The Shaven Bottom -- a candlestick with no lower shadow.
·
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.
·
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 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
within the context of prior trends and formations.
·
Hammer -- a candlestick with a long lower shadow and small real
body. The shadow should be at least twice the length of the
real body, and there should be no or very little upper shadow.
The body may be either black or white, but the key
is that this candlestick must occur within the context of a downtrend to
be considered a hammer. The market may be "hammering" out a
bottom.
·
Hanging Man -- identical in appearance to the hammer, but appears
within the context of an uptrend.
·
Engulfing Patterns -- Bullish -- when a white, real body
totally covers, "engulfs" the prior day's real body. The market
should be in a definable trend, not chopping around sideways. The
shadows of the prior candlestick do not need to be engulfed.
·
Bearish -- when a black, real body totally
covers, "engulfs" the prior day's real body. The market should be in a
definable trend, not chopping around sideways. The shadows of the prior
candlestick do not need to be engulfed.
·
Dark-Cloud Cover(bearish) -- a top reversal formation where the first day
of the pattern consists of a strong white, real body. The second
day's price opens above the top of the upper shadow of the prior
candlestick, but the close is at or near the low of the day, and well
into the prior white, real body.
·
Piercing Pattern (bullish) -- opposite of the
dark-cloud cover. Occurs within a downtrend. The first candlestick
having a black, real body, and the second has a long, white, real body.
The white day opens sharply lower, under the low of the prior black day.
Then, prices close above the 50% point of the prior day's black real
body.
Stars
These candlestick
formations consist of a small real body that gaps away from the real
body preceding it. The real body of the star should not overlap the
prior real body. The color of the star is not too important, and they
can occur at either tops or bottoms. Stars are the equivalent of gaps on
standard bar charts.
Stars make up part of four
separate reversal patterns:
Morning Star
Evening Star
Doji Star
Shooting Star
(Inverted Hammer)
-
Morning Star
-- this is a bullish bottom reversal pattern. The formation is
comprised of 3 candlesticks. The first candlestick is a tall black
real body followed by the second, a small real body, which gaps
(opens), lower (a star pattern). The third candlestick is a white
real body that moves well into the first period's black real body.
This is similar to an island pattern on standard bar charts.
-
Evening Star
-- a bearish top reversal pattern and counterpart to the Morning
Star. Three candlesticks compose the evening star, the first being
long and white. The second forms a star, followed by the third,
which has a black real body that moves sharply into the first white
candlestick.
-
Doji Stars
-- When a doji gaps above a real body in an uptrend, or gaps under a
real body in a falling market, that particular doji is called a
doji star. Two popular doji stars are the evening star
and the morning star.
-
Evening Doji Star
-- a doji star in an uptrend followed by a long, black real body
that closed well into the prior white real body. If the candlestick
after the doji star is white and gapped higher, the bearishness of
the doji is invalidated.
-
Morning Doji Star
-- a doji star in a downtrend followed by a long, white real body
that closes well into the prior black real body. If the candlestick
after the doji star is black and gapped lower, the bullishness of
the doji is invalidated.
-
Shooting Star
-- a
small real body near the lower end of the trading range, with a long
upper shadow. The color of the body is not critical. Not usually
considered a major reversal sign, only a warning.
· Inverted Hammer-- not really a star, but does look like
a shooting star. When occurring within a downtrend, may be a turning
signal. Body color is not critical.
Final Thoughts and Credits
It is 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. No attempt was made to provide a thorough analysis of each and
every pattern. In fact, many formations were left out as they cross the
border into more complicated analysis. For a more complete overview of
candlestick analysis, it is highly recommended that you read the book
that is referred to below.
A large portion of the
material in this introduction is taken from an excellent book called
Japanese Candlestick Charting Techniques: A Contemporary Guide to the
Ancient Investment Techniques of the Far East. In some cases, sentences
were taken almost verbatim, as there was no better way to say what Mr.
Steve Nison, the author, already said. In his book, Mr. Nison,
completely explains candlesticks and their formations, but more
importantly explains how to combine candlestick analysis with
traditional technical analysis. It is highly recommended that you
consider purchasing this book.
As traders, we need as
many trading tools in our arsenal, and a basic knowledge of candlesticks
provides a trader much needed ammunition. 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 the trader
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