Our Book: Charting Wealth, Chapter 5, Candlesticks for Visualizing Price Movement
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Candlesticks offer traders a visual method for charting price movement. This indicator was developed in the 1800s by Japanese rice traders. The reason the method is called “candlesticks” is because the graphical representation of price movement looks like a candlestick. The candlestick can have a wick protruding from its top and/or bottom.
The candlestick principles, patterns and theories are endless and fascinating. First and foremost, candlesticks focus on price action and movement, not on why the price of the underlying asset or equity is changing. Price is always deemed to reflect all known information, as well as the emotions (fear and greed) and expectations of the buyers and sellers in the marketplace.
Although we use a modified form of candlesticks (we will discuss it later), it is necessary to explain the traditional candlestick method. A specific timeframe is reflected by each candlestick with the opening price, highest price of the equity during the period, as well as the lowest and closing price. Wicks (also known as tails) reflect highs or lows outside the opening or closing prices during the specific time period.
Candlesticks offer both visual appeal and ease of interpretation. They are much simpler to follow than bar charts and other plot styles because traders can see information in a flow of price changes. Buying pressure is indicated by hollow candlesticks, particularly green ones. Selling pressure is demonstrated by filled candlesticks, particularly red ones. Long candlestick bodies show greater buying (green) or selling (red) pressure.
Wicks represent highs (on top of the candlestick) and lows (on bottom of the candlestick). When a long wick exists above the candlestick and a short (or no) wick is below the candlestick, we know that buyers dominated the time frame represented by the candlestick. Conversely, we know that sellers dominated the session when a long wick extends at the bottom of the candle and a small (or no) wick sticks out of the top of the candlestick. Short candlesticks with long upper and lower wicks are called spinning tops and indicate uncertainty because both sides were able to drive the price back and forth. A doji is an extreme form of a spinning top where the opening and closing prices are the same. A doji represents significant price indecision in the marketplace.
With traditional candlesticks, you can study and memorize dozens of patterns, but these patterns are not the key to successful charting. We use all the tools in our kit. Candlesticks are just one of several indicators.
Over time we have been very impressed with the simplicity and helpfulness of a specific candlestick technique called Heiken-Ashi. Translated from Japanese, Heiken-Ashi means “average pace.” We use this technique, instead of regular candlesticks, because it helps us better isolate trends and follow price movements. Plus, it’s very easy to learn and requires no memorization of complicated patterns that may or may not predict future price movement. The technique works best when used with the Price Percent Oscillator, Derivative Oscillator, Trend lines and Bollinger Bands.
While standard candlesticks are calculated as a series of open-high-low-close (OHCL) for each time period, Heiken-Ashi candlesticks are calculated much differently: open (opening price of the previous bar, plus the closing price of the previous bar, divided by two), high (maximum price in the period), low (lowest price in the period), closing price (opening price, plus highest price, plus lowest price, plus closing price, divided by four). Do not worry about the mathematical formula. Any good charting platform provides Heiken-Ashi candlesticks as an alternative to standard candlesticks.
Heiken-Ashi candlesticks are interpreted in much the same way as standard candlesticks. Downward price movement during time periods is shown as filled red candles. Upward price movement during time periods is represented by open green boxes. Several primary signals are solved. First, filled candles with no upper wicks demonstrate a strong downtrend. This means the trader should “stay short.” Second, a simple filled candle indicates a downtrend, meaning: add to any down position or get out of any long position. Open box candles with no lower wicks demonstrate a strong uptrend. In other words, the trader should “stay long.” A hollow candle by itself signifies an uptrend, meaning exit a short position or add to a long position. A small body surrounded by upper and lower wicks indicates indecision in the market and a possible trend change. Uncertainty means “watch out!”