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Some devices which were useful in olden times can find new lives today. Although the “Japanese Candlestick” system of monetary price recordation was devised by a successful Japanese trader hundreds of years ago specifically adapted for use in the buying and selling rice, the Candlestick method has, over the past twenty years or so, brought to a renewed understanding of its adaptability across every sector in the Western financial world, including foreign exchange, stocks, and commodities.  The reasons for this acceptance are inherently essentially these two: it exposes the fundamental psychology of the participants in the financial markets to a degree which is unparalleled; and it is particularly adept at forecasting trend reversals in their infancy or when they are about to come to fruition.

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The conventional bar chart records the price movement of a stock, for example, during any particular time span, as a straight vertical line, or bar.  The extreme top of the bar depicts the highest price recorded during that particular session; the bottom of the bar is the low price during the session.  The opening price is displayed as a tiny tick on the left side of the bar, while the price at closing is displayed as a small tick on the right side of the bar.  This can be convenient for drawing a chart which connects with a line the closing prices of a multitude of sessions, but it is quite sterile and mechanical.  The viewer’s eye must analyze it closely in order to know what it means.

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The Candlesticks improve upon the bar chart’s display, by showing the price difference between the opening price and the closing price as a cylinder.  The bar line is “fattened out.”  Extremes of price travel above and below the opening and closing prices are displayed as “shadows,” also called “tails” or “wicks.”  In Candlestick lexicon, the critical portion of any session is displayed as the cylinder – the distance, or price spread, between the opening price and the closing price.  If the closing price of a security during any particular session is lower than the opening price, then the cylinder is filled in, or blackened out.  If the closing price is higher than the opening price, then the cylinder is left blank, or “white.”  The the cylinder itself – i.e., the distance between the opening price and the closing price – regardless of whether it is white or black – is named the “real body” or “body.”

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This process produces a diagram, which the eye recognizes instantly and the brain processes.  The picture reveals the psychology of the traders in a way which the bar chart cannot approach, mimic, or replicate.  It isutterly fascinating to be able to watch the movement of a commodity’s price development in real time, using “streaming data,” and thereby see at first hand the ebb and flow of bullish and bearish sentiment as it springs to life on the computer screen.  The bar chart’s exact same information is being shown to you; it is simply presented differently and much more intuitively by the Candlesticks.

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There is a difference in the definition of an “outside day” as between the Candlestick method and the “Western,” or “bar chart,” method: While an “outside day” in Western terminology would mean that the entire price range of one day’s trading session was totally eclipsed by the price range of the following day, in Candle terminology an “outside day” means that the real body of one session is engulfed by the real body of the following session.  An “inside day” is the inverse of an “outside day.”  In both cases, Candlesticks pay no attention to the “shadows,” “wicks,” or “tails.”

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{The Candlestick bars also create formations, whether by themselves or in combinations of two or of three bars, which are recognized as forecasters of trend reversals.  One of the more frequently observed single-bar patterns is the “Shooting Star,” which occurs at the end of a long ascent in prices, quite often having [gapped above] [gapped up to a point above] the most recent price range.  The Shooting Star is identified by a small real body located at the low end of the total price range of that particular session, and by a long upper shadow.  This pattern is bearish.  Another frequently-seen pattern, this one of three waves, involves a tall white candle at the end of a long rise in prices, followed by a candle bar with a small real body (sometimes itself a Shooting Star) situated at or above the price level of the real body of the first bar, which in its turn is followed by a candle bar featuring a tall black real body.  This three-bar formation is known as the “Evening Star,” and has bearish implications.  Its inverse is the Morning Star, which appears at the culmination of a long decline in prices.

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Candlestick analysis recognizes and uses all of the “Western” formations, such as the Head & Shoulders Top, the Triangle, the Double Bottom, the Island Top, and the Gap.

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The Candlesticks, alone, are remarkably accurate forecasters of a change of trend; but it is not claimed that they predict the extent of the price move following the change.  They are very good, but they are not perfect.  They are only one element of a complete tool kit.  Something is still missing. There remains a subconscious longing for completion. The Candlestick technical analysis can be brought closer to perfection and to greater utility by using them as the base of analysis and then adding thereto a selection of Indicators which can help in assisting or negating a “raw” interpretation of the candle patterns from the standpoint of the underlying psychology of the market.  Some teachers rely on the candles alone to tell the story.  Others do not use candles, but do rely upon Indicators.  Still others use the candles as the starting point, and then build upon that base by interpreting the meaning of the Indicators, alone or in combination; and some very few reviewers carry the analysis to its ultimate by observing not only the psychological and predictive content of the candlestick patterns, but also of the waves of the Indicators and particularly of the relationships between the waves of the Indicators as they are depicted on the charts.

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This is the point at which technical analysis comes into its own.  The perceived gap is filled; the longing for completion is satisfied.  The entire aggregation of tools becomes able to help the analyst to forecast the future direction of prices even more accurately than by using Candlesticks alone or Indicators alone, or even than by using the Candlesticks and Indicators together but still without analyzing the relationships between the waves of the Indicators.  It is that last part that makes the difference.  The old adage “two eyes are better than one” is still relevant.  The more tools which are brought to bear upon the interpretation of price charts, the more accurate the result is likely to be.  We work with these tools every day at http://www.candlewave.com

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