Candlestick Charting

IIM Kashipur, PGP ’11 student, Varun Agarwal,  A finance enthusiast shares his insight on Candlestick Charting

In the 17th century, the Japanese developed a method of technical analysis to analyse the price of rice contracts. This technique is called candlestick charting. Steven Nison is credited with popularizing candlestick charting and has become recognized as the leading expert on their interpretation.

Candlestick charts display the open, high, low, and closing prices in a format similar to a modern-day bar-chart, but in a manner that extenuates the relationship between the opening and closing prices. Candlestick charts are simply a new way of looking at prices, they don’t involve any calculations.

Each candlestick represents one period (e.g., day) of data. The figure below displays the elements of a candlestick.

The interpretation of candlestick charts is based primarily on patterns. The patterns are examined in three main groups as “Bullish”, “Bearish”, and “Neutral”. These groups are further subdivided with respect to the type of the patterns as “Reversal”, “Continuation”, and with respect to their reliability as “High Reliability”, “Medium Reliability” and “Low Reliability”

Candlestick charts are flexible, because candlestick charts can be used alone or in combination with other technical analysis techniques. A significant advantage attributed to candlestick charting techniques is that these techniques can be used in addition to, not instead of, other technical tools. In fact this system is superior to other technical tools. Candlestick charting techniques provide an extra dimension of analysis. As with all charting methods, candlestick chart patterns are subject to interpretation by the user.

Examples

BULLISH MORNING STAR

Type: Reversal

Relevance: Bullish

Prior Trend: Bearish

Definition

This is a three-candlestick formation that signals a major bottom. It is composed of a first long black body, a second small real body, white or black, gapping lower to form a star. These two candlesticks define a basic star pattern. The third is a white candlestick that closes well into the first session’s black real body. Third candlestick shows that the market turned bullish now.

Recognition Criteria:

  • Market is characterized by downtrend.
  • We see a long black candlestick in the first day.
  • Then we see a small body on the second day gapping in the direction of the previous downtrend.
  • Finally we see a white candlestick on the third day.

Explanation:

We see the black body in a falling market suggesting that the bears are in command. Then a small real body appears implying the incapacity of sellers to drive the market lower. The strong white body of third day proves that bulls have taken over. An ideal Bullish Morning Star Pattern preferably has a gap before and after the middle candlestick. The second gap is rare, but lack of it does not take away from the power of this formation.

Important Factors:

  • The stars may be more than one, two or even three.
  • The colour of the star and its gaps are not important.
  • The reliability of this pattern is very high, but still a confirmation in the form of a white candlestick with a higher close or a gap-up is suggested.

BULLISH RISING THREE METHODS

Type: Continuation

Relevance: Bullish

Prior Trend: Bullish

Definition:

The pattern is characterized by a long white candlestick followed by three small bodies in three consecutive days. The small bodies represent some resistance to previous uptrend and they may even trace a short downtrend. These three reaction days usually have black candlesticks but the bodies remain within the high and low range of the first day’s white candlestick. The pattern is completed by a white candlestick on the fifth day, opening above the close of the previous day and closing at a new high. The small downtrend between the two long white candlesticks represents a break during the uptrend. The upward trend then resumes and continues.

Recognition Criteria:

  • Market is characterized by uptrend.
  • We see a long white candlestick in the first day.
  • Then we see small real bodies defining a brief downtrend but staying within the range of the first day on the second, third and fourth days.
  • Finally we see a long white candlestick on the fifth day opening above the close of the previous day and also closing at a new high.

Explanation:

The Bullish Rising Three Methods Pattern typically represents a rest in the market action. This may be used to add new positions by longs. The pattern is the reflection of doubts about the ability of the trend to continue. This doubt may increase because of small-range reaction days. However, given the fact that a new low cannot be made, the bullishness is resumed and new highs are set quickly.

Important Factors:

  • The high-low range includes the shadows.
  • The reliability of this pattern is very high, but a confirmation in the form of a white candlestick with a higher close or a gap-up still is suggested.

 

 

 

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