Markets

Quickly Spot Patterns With This Popular Charting Style

Candlestick charts were first used by rice traders in Japanese futures markets in the 1700s. They were introduced to traders outside of Japan in 1991, when "Japanese Candlestick Charting Techniques" was published by Steve Nison. This charting technique immediately gained widespread acceptance among traders.

Candlestick charts are available on many websites and this chart style is an option in every major trading software package. Candlesticks offer more information at a glance than traditional bar charts. Experienced traders can quickly spot patterns in the candlesticks and many patterns are formed with only one to three bars. They can be applied to any market and over any time frame.

To draw a candlestick, the opening and closing prices are used to draw a rectangle that forms the body of the candlestick and lines above and below the body are the wicks, which incorporate the high and the low prices. The body is usually filled in when the close is lower than the open signifying that price action in that time period was heavy and the price was pulled down by the weight of the selling. The white body of an up close can be thought of as prices floating higher and the lighter candlestick symbolizes that. These visual cues help the trader quickly assess the market condition.

Other visual cues are gained from the size of the body and the wicks. High volatility periods show larger candles. Strong trends will have a number of candlesticks with large bodies on the chart and small-bodied candlesticks often highlight market turning points. This is seen in the chart below.

How Traders Use It
Traders can spot a number of patterns using candlestick charts to identify times when the trend of the market is likely to change. One of the simplest patterns is the doji, which forms when the body is very small, indicating the open and close were very close to each other and price was almost unchanged. Traders believe that dojis represent a period of indecision in the market and the battle between the bulls and bears has resulted in a draw without a clear winner. These times when buying and selling pressures are relatively balanced usually don't last long and the doji often signals a large price move is coming.

There are dozens of other candlestick patterns that have been identified by traders. Many software programs and websites can scan for patterns and help traders find possible buys and sells.

Why It Matters To Traders
A number of traders use candlesticks in deciding when to buy and sell. This requires either a great deal of study in order to identify the patterns or software to highlight them. Candlesticks are also often combined with traditional indicators and a pattern such as oversold momentum with a doji near a four-week low in price would signal a buy. Other traders use them as a signal that a large move is possible. Traders spotting a series of candles with small bodies could expect a trend reversal and the candlestick chart would help them to be prepared for that.

More complex patterns consisting of three to five bars are also commonly used as trading signals. Candlestick patterns form very quickly, unlike traditional bar chart patterns, which can take weeks to unfold. This makes candlesticks the preferred tool of short-term traders.

(This article originally appeared on ProfitableTrading.com.)

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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