Candlesticks And Crossovers

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Cornelius Luca

22 Jun, 2006

in Technical Analysis and 1 more

Candlestick charts are widely used by traders around the world, as superficial demarcations between East and West are thankfully fading away.  While bar charts are still more popular because of sheer inertia, there is little doubt that candles provide much more information, even though both types of charts are based on the same prices.  Let’s take a look at the advantages of using candles when gauging the validity of intersections.

Traders make a big deal about prices breaking support and resistance lines, trendlines, moving averages and retracement or extension levels.  However, intersecting these lines on an intraday basis and closing outside them are two very different ball games. 

Benefits for Using Candlesticks

Let’s quickly review the reasons why traders should use candlestick charts for daily, weekly and hourly charts:

  1. Candles make it easy to separate bullish periods from bearish periods.
    You can easily do that by looking at the different colors of the candles.
  2. They make it easy to separate truly bullish and bearish periods from failed bullish and bearish. Traders achieve that by avoiding bar charts.  The lowest bar in a downtrend may look like a bearish continuation on a regular bar chart, but it may show just the opposite on the candlestick chart under special conditions. 
  3. Candlestick charts provide specific bullish and bearish reversal patterns that are not seen with bar charts. In addition to the standard head-and-shoulders or flag formations, candlestick charts provide one-day or two-day reversals, such as dark cloud cover or hammers.  These are powerful tools that should be used by all traders. 
  4. They also provide “wait-and-see” patterns.

Traders always like clear directions, and currency dealers will be equally happy with both bullish and bearish signals. However, whether we like it or not, there will be many times when the markets will be quite unclear.  Candlestick charts will provide these “wait-and-see” signals, such as harami, to warn you to slow down considerably or even temporarily stop trading because you do not have sufficient information.

Candlestick charts consist of opening, high, low, and closing prices, just like bar charts, but the significance of the closing price, along with the opening price, is clearly emphasized.  There are two important elements to consider in chasing the above benefits:

  1. the distance between the close and the open 
  2. the amount of trading noise

The body of the candlestick is formed by the difference between the opening and closing prices. Traditionally, a red body indicates that the currency closed higher than it opened, and a black body shows that the currency closed lower than it opened. Of course, select the color scheme of your choice, for as long as they are different and you remember which color is up and which one is down. A long body adds strength to that direction, while a small body indicates lack of confidence.   Figure 1 shows a series of mostly bullish daily candles of euro/dollar, which have different body lengths


caption: Figure 1. A series of euro/dollar prices with mostly bullish daily candles, which have different body lengths.

On the one hand, short tails, or shadows, have no bearing on the significance of the candlestick.  On the other hand, long shadows will point to failure in the direction of the shadow.  Figure 2 shows several attempts to extend the euro/dollar rally seen in the first candle.  However, while the third candle hits the highest level of this move,  the attack is very tentative and the euro/dollar pulls back by the close.  More of the same is seen in the next candle.  Eventually it becomes clear that the market doesn’t have what it takes to break any higher and the euro/dollar came down hard. 

 

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kumarpal
dear sir, i found this article very informative. will you be kind to explain in details the importance of long shadows- , the candlesticks to watch for reversals, and continuation patterns. thank you , kumarpal shah

Hi kumarpal,
Welcome to T2W.
If you want to learn more about candlesticks and what they reveal about the fears and greed of traders and investors, then 'Japanese Candlestick Charting Techniques' by Steve Nison is the book for you. It's not cheap; the free option is to do a search on T2W as there will be a goodly amount of useful info here. This will get you started:
http://www.trade2win.com/boards/forumdisplay.php?f=123
If you really want to get your gloves off and dig deeper, then this is the nearest thread to the Holy Grail on T2W - in my view. It's not about candlesticks as such, after all - they don't tell you anything a bar chart doesn't tell you - the thread concerns the story that charts tell the viewer about what traders / investors are thinking, feeling, hoping and fearing. Enjoy!
http://www.trade2win.com/boards/showthread.php?t=11104
Tim.

Jul 02, 2006

(4793 posts)

dear sir, i found this article very informative. will you be kind to explain in details the importance of long shadows- , the candlesticks to watch for reversals, and continuation patterns. thank you , kumarpal shah

Jul 02, 2006

Newbie (1 post)

Good introduction to price action

Jun 24, 2006

Member (4789 posts)

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