Candlesticks Can Shed Light on Market Emotion

Traders use a variety of charting methods to find an edge. Many turn to the candlestick chart, which can help gauge the sentiment of other traders.  This chart shows five pieces of information for a security: the daily price high, the low, the open, the closing and change in price from the open.

Although there are different variations of a candlestick, a typical one would look like this:

The opening and closing prices can either be at the top or bottom of the body, depending on the performance of the security in question. 

If the body is black or red, it means that the particular security closed lower than the open. Meanwhile, if the body is white or green, that indicates that the security closed at a higher price.

Over time, a candlestick chart would begin to look like this:

For instance, if the body of the candles is predominantly white or green, this indicates that traders are bullish on that particular stock. Meanwhile, if the body is predominantly red or black, this indicates that traders are bearish.

History of Candlesticks

The use of candlesticks dates back to the 1700s. The charts are thought to be developed by Munehisa Homma, a Japanese rice trader. He recognized that although there was some correlation between the price of rice and the supply that was available, much of the price was influenced by whether other rice traders were confident about the market as a whole.

Steve Nison, who wrote the 1991 book, “Japanese Candlestick Charting Techniques,” helped popularize candlestick charting in the Western world.

Using Candlesticks in Trading

Candlestick charts can be helpful tools for several reasons:

  • Traders can glean not only the trend but also the particular force that underlies market movement.
  • The charts can be easy to understand for more novice traders, since they tend to focus exclusively on stock prices and don’t require other, more complicated, data.

While this technique may be good for novices and other traders who are content with limiting their research to security prices, more sophisticated trading strategies would include other tactics to complement candlesticks. That might include other technical analysis techniques along with fundamental analysis, which can involve a company’s financial data and business model.  

“Remember, no technical tool, including candlestick charts, is right all the time,” said Brian Bachelier, vice president of active trader strategy at Scottrade. “In using candlesticks, the trader is hoping to increase the odds of setting up a successful trade. It’s generally helpful to use other forms of technical analysis to supplement the information generated by candlestick charts.”

Read Next:8 Tools to Get Your Portfolio on Track.”

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