Introduction

Candlestick charting is one of the most popular techniques to plot a stock chart. These kind of charts have a huge advantage over other charting methods, like line charts for example.

Candlestick charts allow you to clearly see the opening, highest, lowest and closing price of any given period. By ploting the price action this way you will be quickly able to have a good assessment about the relationship between buyers and sellers and benefit from the patterns that often emerge on this kind of charts.

History

The Japanese began using technical analysis to trade rice in the 17th century. While this early version of technical analysis was different from the US version initiated by Charles Dow around 1900, many of the guiding principles were very similar:

• The “what” (price action) is more important than the “why” (news, earnings, and so on).
• All known information is reflected in the price.
• Buyers and sellers move markets based on expectations and emotions (fear and greed).
• Markets fluctuate.
• The actual price may not reflect the underlying value.

According to Steve Nison, candlestick charting first appeared sometime after 1850. Much of the credit for candlestick development and charting goes to a legendary rice trader named Homma from the town of Sakata. It is likely that his original ideas were modified and refined over many years of trading eventually resulting in the system of candlestick charting that we use today.

Formation

A candlestick chart is made of, obviously, candlesticks. These candlesticks in turn are formed by a "real body", which indicates the opening and closing price; and two wicks or shadows, which indicate the highest and lowest price of any given period.

A hollow (sometimes white or green) body, indicates an up day, while a filled (sometimes black or red) body indicates a down day. The size of the real body indicates the rise or drop of price; a big hollow body will indicate a big up day, while a small body would indicate a day where the the opening and closing price barely changed at all.

Regarding the shadows, if there is no lower shadow, it means that the price never went below the opening price and, on the other side, if there's no upper shadow, it indicates that the price went down after the opening for the rest of the day.

When there is a long upper shadow, it means that the stock encountered strong selling pressure, driving the closing price away from the highs; on the opposite side, if there is a long lower shadow, it means that many people found the lower price as an opportunity and decided to buy.

With this information we can start to explore the first candlestick patterns, the single candle patterns, which will be detailed on the next blog post: Important Single Candle Formations.

 For more info on candlesticks I highly recommend to check out Steve Nison's Books or head to ChartSchool for much more detailed info on candle charts.