Candlestick analysis is by far the oldest method of speculating if the market price of a currency will move higher or lower in the near future. Developed over 500 years ago by Japanese rice traders, the technique aims to look for specific patterns and formations of ‘candles’ within a price chart. Despite its age, it is widely known as one of the most powerful techniques available to modern forex traders with many of the original patterns being incorporated in trading strategies today. As a predictive tool, candlestick price charts can be used in conjunction with a wide range of forex trading indicators and can even be used as a stand-alone tool for currency trading.
What are candlesticks?
Candlestick charts differ from a regular price chart in the formation of the individual bars representing the time frame of any given chart. Whilst traditional price charts will generally be made up of bars showing the open, close, high and low of a time period, candlesticks attempt to visually enhance this in order for forex traders to easily read the markets and identify high-probability trading opportunities. Their name comes from their shape with the open and close of the price bar representing the candle ‘body’ and usually filled in with a colour to show that the bar closed higher or lower than its open. From this body, it is possible that a ‘wick’ emerging from the top or bottom of this will show traders that price moved in this direction before being pushed back within the body of the candlestick.
Candlesticks are effective in predicting future price movements
The formation of the individual candlestick price bars within the price chart can provide forex traders with a deeper understanding of the underlying strength and sentiment within a market. Those candlesticks, for example, with a long body will demonstrate a powerful market move, whilst those with almost no body at all (often referred to as doji’s) will represent a period of indecision or reflection in a market. A long wick at either end of the candlestick will show that traders tried to push the price higher or lower before being pushed back towards the body of the candlestick. This can mean that there may be a large area of support or resistance causing the rejection of price at these levels or, when this occurs in the opposite direction after a long trend, that price is testing the possibility of a reversal.
Using the most popular candlestick patterns in forex trading
By far the most popular and successful way to trade with candlesticks is to look out for candlestick patterns often formed by more than one individual candle. Not only to these have several hundred years of back testing completed but they are also highly reliable across all time frames and may be applied to all price charts. Some of the most popular can be used in conjunction with identified areas of support and resistance in order to maximise their profitable potential. Of the many recognised patterns, there are a handful of the most popular and therefore most important candlestick patterns. A highly popular example of this is the ‘shooting star’ candlestick pattern which is a single candle with a small body and a wick several times larger in either direction. When this occurs near the end of a trend, it often indicates that a reversal is due within the markets. The long wick represents the failed attempts of traders to push the currency pair higher or lower in order to maintain the trend. Forex traders who spot this candlestick can therefore begin to prepare for price to move in the opposite direction and to enter the market as early as possible.
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