Japanese candlestick analysis is one of many approaches to analysing the movement of share prices quoted on the global stock exchange. Dating from the 17th century trade of rice the Japanese developed the technique to better predict the movement of prices and thereby maximise profit. The guiding principles are simple:
- Price action is more important than news.
- All known information is included in the price
- Markets move with the emotions of buyers and sellers.
- As emotions fluctuate so too do market prices.
- Price may not be a reflection of value.
The technique was popularized in the 1990's by a trader named Steve Nison who discovered Japanese candlestick analysis from an asian co-worker. Steve Nison's popularization of the method was as much due to his success as to the publication of his book Japanese Candlestick Charting Techniques. In this book he details the technique and reveals the predictive power of the various candlestick formations.
A formation is basically the record of the share price movement during a specific period of time. All that is needed are the open, close , high and low prices for the stock you wish to analyse. A candlestick is formed by the record of these figures; the open and close prices, determined at the start and end of trading on any particular day, form the wax of the candle, and the high and low prices form the wick (technically termed the shadow). If the stock opens higher then it closes then the wax of the candle is black, and if the share price closes higher than the opening price then the candle is white.
The candlestick is therefore a visual representation of the share price activity and is more easily read than previous methods. For instance, a trader can tell at a glance whether there is buying or selling pressure simply by looking at whether the candlestick pattern shows hollow or filled candlesticks. A long candlestick reveals intense market pressure, a bullish market, whereas a short candlestick suggests little buying and selling pressure within the market.
A chart of the candlesticks formed over a period of time can then be read by a trader in order to discern not only the movement at any one time but also the market trends and patterns. A chart of candlestick data can be analysed for well known formations and market decisions based upon the knowledge gained.
There are many types of candlestick pattern but the main types are categorized by the number of bars that go to make up the candlestick. The most readily recognised single bar formations have such names as the marabozu, Doji's, spinning tops, inverted hammer, hanging man and shooting star. The more complex double bar formations include the bullish and bearish engulfing, and tweezer top patterns. Whilst the last category, the triple bar candlesticks, include the morning and evening star, the three black crows and three white soldiers, and the three inside up and down.
A skilled trader will be able to look for a cluster of three candlesticks and determine the best course of action according to the market conditions. Market reversals, uptrends and downturns can all be visualised, and, for example, in the case of the three white soldiers formation a strong bullish signal of market upturn can be predicted following a protracted down turn and consolidation.
Candlestick analysis pays dividends after significant research and should be considered an important part of any Forex strategy.