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Support / Knowledge Emporium / Candlesticks Technique

Candlesticks Technique: A Panacea Or A Big Frog In A Small Pond?

By the Tradecision Development Team

Just like a vast number of mind-boggling and revolutionary inventions, Candlesticks originate from Japan, where they were initially used by rice traders yet in the 17-th century. This gives the technique an air of Oriental charm, invoking associations with precision, technical eminence, and some innate, hidden ancient wisdom, which, of course, can never fail. Candlesticks were first introduced as a technical analysis technique by Steven Nison in his acclaimed book Japanese Candlestick Charting Techniques. Did the guy do the right thing? We think he did, but let's try to answer this question at a greater depth.

To create a candlestick pattern, you need a data set that will contain an open, a high, a low, and a close. A candlestick is formed by a "body" and two "tails" that grow out of this body. The four milestone points, passed by every trade, are located as follows:

In this pattern, the tails represent the whole range of prices, used during the trade, whilst the body represents the opening and closing prices for the selected period. If the closing price is higher than the opening one, the body will be colored blue or green; when the opposite is the case, the body will be colored red.

Basically, the Candlesticks pattern provides exactly the kind of information that you can observe on about any other kind of chart. The thing is definitely a lot more pleasant to look at than most of the other types of charts, but what's the big deal in terms of its usefulness?

The most powerful advantage that this technique can give is, undoubtedly, the easily discernible respective relationship between the four points that make up the pattern. One look is enough to size up the underlying price action in terms of the two key relationships.

But, the most important advantage, offered by Candlesticks, is that there are a number of sure (well, most of the time, you know) signs of a market development occurring that no other technique can offer. So what is this bag of tricks?

For example, if the body of your candlestick is green and rather prolonged, this means that buyers are very active - a definitely bullish sign. Conversely, a long red candlestick body will be a sure bearish sign.

Another useful sign, offered by the Candlesticks technique is Doji - the situation, when the opening and closing prices coincide. The so called Dragonfly variation of Doji, whereby the prices coincide at the top of the trading range, serves as a sign of trend reversal and a forthcoming upward advance.

An equally useful sign is the so called Piercing Line, whereby the closing price point of the green bar is just slightly higher than the middle of the preceding red candlestick. This situation signals a forthcoming reversal of a downward trend.

The technique offers several more eloquently referred to pattern variations, whose names sound like the names of some mortally dangerous jab or a bizarre and potentially lethal posture from an Oriental martial system. But are these tricks really as dependable as the great ancient fighting legacy of the Orient?

Of course, the technique is not infallible and just like any other trading method is a bit on the dodgy side. One of the main drawbacks of the technique is that despite it clearly shows the relationship between the opening and closing prices, it does not allow seeing how volatile the price action actually was during the different stages of the trade. Actually, some significantly different scenarios can be possible.

All told, a great many traders reckon candlesticks to be the primary trading method in technical analysis. Our opinion would be that although Candlesticks are, certainly, a lot more reliable than most of the other technical analysis methods, one shouldn't still rely entirely on this single method.

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