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Investing Tools - What's All the Fuss About Candlesticks?

Posted April 22, 2010

Topics: Finance & Investing

Investors and traders are very visual, and if you’re like most people, you can clearly spot a trend from a chart much faster than you can running a column of numbers and percentages. The candlestick chart is the perfect analytical tool because it shows you everything you need to know about a day’s price movement, in a single glance.

Candlesticks contain several features other kinds of charts lack:

1. The “real body” is a rectangle that appears white (for days that move up in price) or black (for days that move down in price. The top and bottom of the rectangle are the opening and closing prices.

2. The “shadows” appear above and below the real body. Also called “wicks,” these show you the day’s complete trading range above and below the opening and closing prices.

3. Day-to-day changes are very important in the patterns that candlesticks form over two or three trading sessions. These various patterns are excellent for predicting reversals or for confirming a current trend.

With any system, candlesticks included, you need to confirm anything that appears to be about to happen. Candlestick formations are great confirmation tools for other, traditional patterns, and can strengthen what you conclude from observing chart patterns. So combining candlestick formations with patterns involving resistance and support, price gaps, relative strength, money flow, volume spikes, and moving averages, makes technical analysis more accurate and helps improve entry and exit timing.

No system works 100% of the time. Candlesticks do not substitute for analytical methods, but they do provide one more strong confirmation tool that is valuable for short-term trading. For the pure speculator, day or swing trader, and even for the long-term value investor, using candlestick charts just makes sense.

Many sites offer free candlestick charting. One of the most flexible is www.stockcharts.com, which lets you design your chart to include as many accompanying technical indicators as you want; trading session duration; and even colors. For example, you can vary analysis between daily charts, hourly, or even shorter durations; or you can look at weekly summaries for a full year.  Since everyone has their own systems and preferences, the free online charting services are exceptionally valuable. Coupled with the ability to interpret candlesticks and what they mean in a series of sessions, any trader’s analytical skills can be improved greatly.

In my upcoming book “Trading with Candlesticks” (FT Press) I document how each kind of candlestick works and what it tells you. I also tie candlesticks in to the traditional technical indicators most chartists and technicians use. That’s the real key: Developing a system that makes sense and improves your ability to time entry and exit decisions.