Candlesticks are a Japanese invention, and it is believed that they were created by a rice trader around 1700. Traders can use them in any market, but they are prevalent in the stock markets, commodities and foreign exchange markets.
Recently, there has been a surge in their use due to an increased interest from UK traders looking for additional tools to add to their arsenal of technical analysis techniques.
Candlesticks identify four key elements of price action: the open, high, low and close prices within a set period. The coloured sections represent the area between the open and close prices, so when they overlap, it shows where buyers have pushed prices up against sellers pushing prices down. When there is no overlap, this shows that there was no fight between the buyers and sellers at a particular point in time.
The open and close prices should be evident as they are the horizontal lines at either end of each candlestick; however, the high and low prices should be more challenging to spot. The high is represented by the top of the upper shadow or wick, while the low is found by taking the bottom of the lower shadow or wick.
Benefits of using candlesticks in the UK
Candlesticks can help UK traders identify market sentiment and traditional trend analysis techniques such as moving averages applications etc. For example, if a stock has been trading between $10 – $20 for weeks/months on end, then this could indicate that there has been little movement from buyers or sellers during this period. A break outside this range may show that market sentiment has suddenly shifted and can indicate a breakout or reversal is imminent – the candlesticks pattern will confirm this.
Other patterns that UK traders should be aware of are dojis which show indecision between buyers/sellers. These spinning tops also show indecision and finally hammer candles, which significantly move lower after an extended period of upwards price action.
However, the UK financial markets are not as familiar with candlestick charts. This is because UK traders trade on very few currency pairs compared to the US and Japan, so there is little trading activity around these currencies to give meaning to candlesticks. However, this may well be changing soon as volatility rises.
Although many investors will still use standard line charts for their investments, more professional money managers will likely start using candlesticks as they offer a great deal of information that cannot be seen elsewhere on an easy-to-read chart (for example, you can’t tell if a price had closed higher or lower than when it opened except by looking at the length of the candle). Traders can also use them to compare the strength of one currency against another.
How to use candlesticks
To read the mood of candlestick charts, it is essential to understand how they are read. The open and close prices are represented at the top and bottom of the chart (or in the middle when using Japanese candlesticks). This line can be short or long, depending on market sentiment.
Long lines indicate bullish momentum during trading hours because buyers were in control, pushing the price higher throughout the session. In contrast, short lines show bearish momentum where sellers kept pushing prices lower. The lines represent the market’s fight between buyers and sellers. If you see a long upper shadow on a candlestick, prices opened higher than they closed, which is bearish because demand was not high enough to buy at higher rates. The candle closes near its opening price but is green, signalling bullish momentum.
The opposite would be true for a long lower shadow candlestick, where bulls could not push prices higher during the session. Prices dropped throughout the trading hours, creating this long lower shadow but finished just above their opening price, showing strong bullish sentiment.
There are many strategies and methods of analysing the markets, and new investors should use the services of a reputable online broker from Saxo Bank before starting their investment journey.