The fundamental theory and concepts behind Japanese Candlesticks were invented over three hundred years ago by a Japanese rice trader named Sokyu.
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In the December edition of Futures magazine Steve Nison, who was a technical analyst at Merrill Lynch in New York, produced a paper that showed a series of candlestick reversal patterns and explained their predictive powers. Since then candlesticks have gained in popularity by the year, and these days they seem to be the standard template that most analysts work from.
Candlesticks are important to your trading analysis because, it is considered as a visual representation of what is going on in the market. By looking at a candlestick, we can get valuable information about the open, high, low and the close of price, which will give us an idea about the price movement.
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Candlesticks are flexible, they can be used alone or in combination with technical analysis tools such as the moving averages, and momentum oscillators, they can be used also with methods such the Dow Theory or the Eliot wave theory. Candlesticks are used by most professional traders, banks, and hedge funds, these guys trade millions of dollars every day, they can move the market whenever they want. Using candlestick patterns will help you understand what the big boys are doing, and will show you when to enter, when to exit, and when to stay away from the market.
Candlesticks are a way of communicating information about how price is moving.
Below is a sample of a candlestick chart. This chart shows price on the right vertical axis, and time on the bottom horizontal axis. Moreover, the chart is made of bars that have little lines stemming from the top and the bottom; these are known as candles.
The candle conveys four pieces of information:. Above chart is OHLC chart on daily time frame where each candle represents one single day. And thus, each candle constitutes the open, high, low and close price for that given day. The horizontal axis at the bottom of the chart can be used to understand which day corresponds to which candle. Below is an image that illustrates how those four pieces of information the open, high, low and close for a given period of time are visualized in the context of a candle:.
The wicks, or shadows, are the thin lines that go outside the rectangular body of the candle. They represent the high and the low price during that time period. The color of the candle is also significant in understanding whether the open price was higher or lower than the close price. If the candle is red, or denoted as bearish in some other manner, this means that the open price is lower than the close; and the opposite is true if the candle is green, or denoted as bearish.
Price action traders rely on candlesticks because they convey a great deal of information about each trading period in a visual format that is easy to interpret, allowing traders to compare the behavior of price in different time periods with a quick glance at a price action chart. The ability to read candlesticks allows the price action trader to become a meta-strategist, taking into account the behaviors of other traders and large-scale market-movers.
In other words, candlestick patterns help traders. The analysis of candlestick patterns among traders gained popularity after the publication in of the book Japanese Candles. Graphical Analysis of Financial Markets. This publication made a real boom, and its author Steve Nison became so popular that he even opened his own consulting firm, Nison Research International.
Following the first, Nison published his second work, Beyond Candlesticks. These two books are the most popular, but they include only a few of the patterns that emerge from candlestick technical analysis. One can also note the book by Gregory L. Morris Candlestick Charting Explained: Timeless Techniques for Trading Stocks and Futures, although some experts and practitioners had a number of complaints about it.
All of them are devoted to the intricacies of using this type of graphical analysis, and are also adapted for the forex market. Japanese candlesticks have received huge sympathy among traders due to their high information content compared to line charts. A candlestick consists of the following elements: body and shadows one or two. The upper shadow denotes the maximum that the price approached during this time, the lower one - the minimum. The former are formed as a result of activation of buyers in the slang of traders "bulls" , they always have the closing price above the opening price Fig.
In the classical literature, which we have listed above, they are denoted in white. However, in modern trading platforms, such as MetaTrader 4, a trader can paint a candle on their own, and often green bullish candles are used. In textbooks, they are indicated in black.
The Magic of Japanese Candlestick
If we are talking about the MT4 terminal, preference is given to red. All candlestick elements play a vital role in informing the trader. Separately, we would like to draw your attention to the fact that you can find Japanese candlesticks on the chart, in which the opening price is equal to the closing price. They usually appear during a period of decreasing liquidity or uncertainty inactive trading session, holidays, weekends, absence of a major player, waiting for the release of important macroeconomic data.
Candlesticks are the most important source of information that allows you to see the upcoming developments in advance. The fact is that their combinations and special forms form patterns that are repeated many times from year to year. The analysis of Japanese candlesticks in trading is based on finding these patterns and their correct interpretation.
This at a time when the Japanese culture, as well as many other cultures, thought it common that the eldest son should inherit the family business. The trading firm was moved from their city, Sakata, to Edo Tokyo.
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Homna's research into historic price moves and weather conditions established more concrete interpretations into what became known as Candlesticks. His research and findings, known as "Sakata Rules" became the framework for Japanese investment philosophy. After dominating the Osaka rice markets, Homna eventually went on to amass greater fortunes in the Tokyo exchanges. It was said that he had over one hundred winning trades in a row. His abilities became legendary and were the basis of Candlestick analysis.
Japanese Candlestick analysis was never a hidden or secretive trading system. In was successfully used in Japan for hundreds of years. It has been only recently, about 25 years ago, that it first made its way into the U. Until then, there just wasn't any interest from Western cultures to investigate the Candlestick Technique.
Japanese candlestick trading guide
Even then, it was not noticed all that much. The perception has been that it was difficult to learn and very time consuming. That may have been true until recently. The first books introducing it into the U. Then the chart graphs could be better viewed. Fortunately, the advent of computers and computer programming has taken Candlestick analysis ahead by leaps and bounds. Until recently, the investment community knew about Candlesticks, they just didn't know how to use them effectively.
Interest has been increasing dramatically now that the roaring markets have collapsed. Investors, new and old, are now trying to investigate methods that protect them from the severe losses that occurred from March until now. Hundreds of years of analysis and interpretation can be much more easily extracted through computer programming. Huge fortunes were amassed with simple charting techniques. The same will be true with all the benefits that computer software provides the investor today.
The interest in candlestick signal analysis in the United States has to be credited to Steve Nison. Over three years of extensive research produced Steve Nison's initial publication "Japanese Candlestick Charting Techniques", published in Much of the background and historical information about candlesticks, found in this site and many other sites, was probably the results of Steve Nison's excellent research.
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