Japanese Candlestick Charts and Candlestick Pattern Techniques

Introduction to Japanese Candlesticks

It’s said that “time is the teller of all truth” and this wise saying has a direct implication for the trading system we are about to discuss. You see, the Japanese Candlestick Trading System was brought into being over 400 years ago by Japanese rice traders. I’m sure you would agree that a system that has been in use for so long certainly must have some credibility. It’s simple, based on fundamental truths of human nature and over the centuries has made countless traders wealthy. It is indeed, the “Zen” of trading. If you are a trader or an aspiring trader, if you don’t learn this venerable system it will be at your own peril. But before we get into specifics, let’s discuss some basic concepts.

Trader vs. Investor

A trader is a short-term investor. Icons like Warren Buffet and Peter Lynch are what would be called investors. They buy shares of companies who have a good story, sound financial's and capable management. They buy shares and then hold them for long periods of time knowing that these companies will prosper overtime. A trader, on the other hand, is an investor who buys for short- term gains and is based more on short term price movements. While an investor might hold a position for years, a trader might hold a position for only days, hours or even minutes. Also, a trader makes many more trades in hopes that smaller profits made many times will maximize returns. Another distinguishing factor that marks a trader is that trading requires active participation. Investors are usually “passive” in their buy and hold strategy. There are other distinctions, but you get the picture. But alas, the main difference is that risk of capital depletion (going bust) is usually more prevalent with trading if not done correctly and with discipline. We’ll discuss what makes a successful trader in another article.

Fundamental vs. Technical Analysis.

Fundamental analysis depends more on macro and micro economic consideration and company financial issues. A company is analyzed from all angles and compared to industry standards to determine if it is a suitable candidate .Technical analysis focuses on price movements and momentum. The main belief is that price, volume and other metrics reflect the collective “judgement” of the universe of investors. The use of stochastic's, charts and statistical measurements give signals to buy or sell. Most traders lean toward the technical analysis persuasion though it’s not uncommon that some fund-amental considerations are in the mix. Both fundamental and technical forms of analysis try to provide a high probability estimate of price movement in the future.The Japanese Candlestick Trading system is a form of technical analysis where decisions to buy or sell are decided by recognizing chart patterns.
But to successfully use this “technical system” is relatively easy and requires little technical knowledge.

Philosophy of the Japanese Candlestick trading system:

Even though tons of sophisticated studies and software are used to conjure up an objective way to predict price movements, the theory of Candlesticks is simple and true. It’s core belief is the following: Changes in price movement are decided by the human emotions of fear and greed and these emotions can be clearly captured and used to create wealth through understanding the patterns of price movement over any certain period of time.

How does a "candlestick chart" work?

Japanese Candlesticks reflect a change in investor sentiment which will soon translate into a change of price direction within a certain time period.
Even when the trend is in one direction, there are always changes within the trend and as a trader is focused on short-term movements, the concept of “don’t go against the trend” is a matter of relative time period.

A trader looks for an equity, option or commodity with movement (volatility). Even though the long term trend might be in one direction, there are many directional changes as price snakes along its path. Traders make money on these mini changes within the trend.

Construction of a “Candle”

First of all, horizontal lines mark the opening and closing prices. A box is made of these end points and the extreme high and low prices are noted as candlestick charts example vertical lines extending from the box. These are known as “Shadows”. If the closing price was higher than the opening price, the box is left blank. If the closing price is lower than the opening price, the box is colored red or black (or filled in).

In the next article, we will introduce the ten most important candle patterns and we will begin to learn how to use their power in generating wealth “the old fashioned way”.