Candlestick charts are yet another tool used in technical analysis. The data represented in a candlestick chart is exactly the same as the data presented in a regular line graph of a currency pair’s price rate, but its way of presenting this data can add an important dimension to your analysis of the data. Most professional forex traders today tend to prefer candlestick charts to regular line charts, or at least use the two in combination.
A candlestick chart is visually made up of candles that indicate the movement of a currency pair’s price rate over a specified period of time. These time periods can vary from between 5 minutes to 24 hours, with the decision being made of course according to the time frame you’re trading in.
The typical candlestick is made up of a rectangular body with a line coming out from the top and the bottom of the body.
The bottom line is named the “lower shadow” and the top line is named the “upper shadow”.
It is these lines that give the figure the appearance of a candlestick. Every candlestick is determined by five factors that indicate the following information:
1) The color of the candlestick – indicates whether the price rate of the pair went up or down during the certified period of time. The customarily used colors are red for a downward movement and green for an upward movement.
2) The lowest point of the lower shadow – indicates the lowest price rate the currency pair reached during the specified time increment.
3) The bottom of the candlestick body – in an ascending candle indicates the price rate of the pair at the beginning of the specified time increment; in a descending candle indicates the price rate of the pair at the end of the specified time increment.
4) The top of the candlestick body - in an ascending candle indicates the price rate of the pair at the end of the specified time increment; in a descending candle indicates the price rate of the pair at the beginning of the specified time increment.
5) The highest point of the upper shadow – indicates the highest price rate the currency pair reached during the specified time increment.
If you’re watching a live candlestick chart you will see these candles formed with time according to the movement of your currency pair’s price rate. During the formation time of a candle it’s shadows can lengthen, its body can contract and expand and it can even change colors if the direction of the price movement changes in the middle of the candle. The question then is: what can we as forex traders extract from all these extra bits of information that we don’t get from a regular line chart? The purpose of the candlestick chart is to give a clearer indication of the behavior of the forex buyers and sellers in order to help you spot trends and more importantly, judge carefully how stable the trends are and predict when they are about to reverse. For example, a candle with a long body and with little or no upper and lower shadows indicates that the currency is in a strong trend since the movement of the price rate was virtually one directional. On the other hand, if the candle has long upper or lower shadows it can be a strong sign for a reversal since the price rate went up and down a lot before the candle closed. A candlestick with a thin body indicates a struggle between buyers and sellers and clearly indicates the instability of a trend. These price movements are all indicated on a regular line chart, but the candlestick chart can give you insight into the forex market’s behavior that you wouldn’t have spotted otherwise.