Candlesticks tell stories to those who are able to read them. Having deep knowledge about what’s behind a candle can help you analyze any financial market.
Candlesticks tell more than traders can imagine. Even if traders usually memorize patterns, understanding what a candlestick tells is a core step to avoid unfruitful learning – no pattern works 100% of the time.
So, understanding the hidden messages that candles communicate can be extremely helpful to make reliable analysis.
BTSE Blog shared with its readers articles related to advanced trading strategies that work — like trend trading and swing trading – but how can we exactly know when it’s time for a trend reversal, or where a swing is about to occur?
Being able to read candlesticks makes it possible for traders to predict changes in the market.
Candlesticks: A Bit of History
Candlesticks have Japanese origins. Their birth traces back to the 1700s when Munehisa Homma started using charting techniques to analyze prices.
Homma, a wealthy Japanese businessman, started analyzing the price of rice to try to understand the psychology of traders and make predictions. He found a way to easily gather all the information he needed in a simple graphical representation: candlesticks.
But the man who shared this charting technique with the Western world is Stevie Nison.
In 1989 he started writing and publishing a series of articles on the topic since he was one of the few Americans who knew the Japanese techniques.
The work of Homma and Nison enabled us to use candlesticks, but they are not the only kind of chart used by traders and investors.
Candlesticks vs. Lines
Even if candlesticks are extremely popular, there are other charting techniques used by technical analysts. One of these techniques is line charting.
You don’t need to use one instead of the other: both candlesticks and lines can be combined with other charting techniques to obtain useful information about markets.
But it is still worth making a comparison between these two technical tools since they are the most widely used by traders and investors around the world.
Line charts have the advantage of avoiding noise. Compared to candlesticks, line charts enclose less information, but they can better show trends.
Let’s compare two charts, a line chart and a candlestick chart, which refer to the same asset and period of time:
BTSE/USD – Line Chart Vs. Candlestick Chart – Source: TradingView
If we analyze this BTSE/USD chart, we soon notice that on June 30, 2021, the price of BTSE token dropped and then fully recovered its positive trend.
Traders and investors, especially if less than advanced, who use line charts maybe did not notice the volatility – and in a case like this, that is not wrong, just that those who use candlestick charts maybe had bad times and reconsidered their positions.
As you can see, a line better spots the trend, avoiding momentary volatility: this is possible because lines are drawn taking into account only closing prices.
On the other hand, a single candle records the low, the opening price, the closing price, and the high over a given time period.
So, while lines help you to have a general overview of the market and to better consider trends, candles are more suitable for predictions: they show what traders are doing, and good analysis can tell you what they are about to do.
What a Candle Can Tell You
In the image below you will find the main terminologies used by traders and investors to indicate the different parts of a candlestick.
Of course, if a candlestick is bearish, the open is above and the close is below.
The anatomy of a candlestick
But let’s see how much useful information a candlestick provides, referring to the image above.
In the first candle, we can see that there is no lower shadow: the opening price corresponds to the low, and the price starts rising. It reaches its high, then it closes at a lower price.
This tells us that traders and investors are trying to push the price down, and the strength is enough to make us predict that the price will continue to move downwards.
The second candle opens at a lower price: bulls still try to push the price up, but the price still closes lower than the first candle.
Now we’re led to believe, given the strength of bears, that the third candle will be bearish. But there is a powerful element that tells us that bears are not so strong yet, and that bulls are still trying to lead the game: volume.
Volume is always a safety net when it comes to technical analysis, and it’s the most objective indicator.
Pro tip: When in doubt, always check volume. Technical analysts always check it, but it is useful especially when price movements can have more than one interpretation.
The positive peak in volume, combined with the strong downward movement, tells us that bulls and bears are fighting, but bulls are a little stronger. This is why bulls manage to drive the price upwards with the third candle, but the body is short, it doesn’t correspond to the strength of volume, and this tells us that bulls are also struggling.
This leads us to think that the next movements can be two: a slight downward movement or a sideways movement.
This happens because the long upper shadow of the second candle tells us that bears want to push the price down, but there is a level at which bulls don’t permit the price to go down. They will defend that level, creating a support level.
At that point, traders can predict that it is a good accumulation point, at least in the short run, as long as volume and candles will confirm that there is a sort of defense against bears. But volume tells us that we are not at the beginning of an uptrend: this is because the price didn’t rise that much – that is, it is not proportional to the peak in volume.
We can expect at least a short-term rise.
Let’s see what happens later:
BTSE/USD Chart – Source: TradingView
Our prediction about the support level and the price rise was correct: bulls are still fighting, but we need to continue observing both candles and volume to know who will win.
As we can see, candlesticks can share with traders and investors a lot of information easily and intuitively.
What many don’t consider is that every single part of a candlestick is important to try to make reliable predictions. Tails – or shadows – are as important as the body of the candlestick.
It is fundamental to understand the psychological process behind each piece of information shared by the candle, so as to avoid learning all candlesticks patterns without really understanding what they represent.
Understanding the logic behind candles helps traders and investors to rely on accurate and professional technical analysis, reducing mistakes. We can decrease mistakes but we can’t eliminate them. No one can predict the future, and for this reason, it is far better to use objective and logical information before investing money.
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Note: BTSE Blog contents are intended solely to provide varying insights and perspectives. Unless otherwise noted, they do not represent the views of BTSE and should in no way be treated as investment advice. Markets are volatile, and trading brings rewards and risks. Trade with caution.