Candlestick chart

A candlestick chart (also called Japanese candlestick chart or K-line[1]) is a style of financial chart used to describe price movements of a security, derivative, or currency.

It is similar to a bar chart in that each candlestick represents all four important pieces of information for that day: open and close in the thick body; high and low in the “candle wick”. Being densely packed with information, it tends to represent trading patterns over short periods of time, often a few days or a few trading sessions.[2]

Candlestick chart of EUR/USD currency pair on daily timeframe in MetaTrader 5 trading platform.

Candlestick charts are most often used in technical analysis of equity and currency price patterns. They are used by traders to determine possible price movement based on past patterns, and who use the opening price, closing price, high and low of that time period.[3] They are visually similar to box plots, though box plots show different information.[4]

History

Candlestick charts are thought to have been developed in the 18th century by Munehisa Homma, a Japanese rice trader.[5] They were introduced to the Western world by Steve Nison in his book Japanese Candlestick Charting Techniques, first published in 1991. They are often used today in stock analysis along with other analytical tools such as Fibonacci analysis.[6]

In Beyond Candlesticks,[7] Nison says:

However, based on my research, it is unlikely that Homma used candle charts. As will be seen later, when I discuss the evolution of the candle charts, it was more likely that candle charts were developed in the early part of the Meiji period in Japan (in the late 1800s).

Description

The area between the open and the close is called the real body, price excursions above and below the real body are shadows (also called wicks). Wicks illustrate the highest and lowest traded prices of an asset during the time interval represented. The body illustrates the opening and closing trades.

The price range is the distance between the top of the upper shadow and the bottom of the lower shadow moved through during the time frame of the candlestick. The range is calculated by subtracting the low price from the high price.

If the asset closed higher than it opened, the body is hollow or unfilled, with the opening price at the bottom of the body and the closing price at the top. If the asset closed lower than it opened, the body is solid or filled, with the opening price at the top and the closing price at the bottom. Thus, the color of the candle represents the price movement relative to the prior period's close and the "fill" (solid or hollow) of the candle represents the price direction of the period in isolation (solid for a higher open and lower close; hollow for a lower open and a higher close). A black (or red) candle represents a price action with a lower closing price than the prior candle's close. A white (or green) candle represents a higher closing price than the prior candle's close. In practice, any color can be assigned to rising or falling price candles. A candlestick need not have either a body or a wick. Generally, the longer the body of the candle, the more intense the trading.[6]

In trading, the trend of the candlestick chart is critical and often shown with colors.

Candlesticks can also show the current price as they're forming, whether the price moved up or down over the time phrase and the price range of the asset covered in that time.

Rather than using the open, high, low, and close values for a given time interval, candlesticks can also be constructed using the open, high, low, and close of a specified volume range (for example, 1,000; 100,000; 1 million shares per candlestick). In modern charting software, volume can be incorporated into candlestick charts by increasing or decreasing candlesticks width according to the relative volume for a given time period.[8]

Usage

Candlestick charts are a visual aid for decision making in stock, foreign exchange, commodity, and option trading. By looking at a candlestick, one can identify an asset's opening and closing prices, highs and lows, and overall range for a specific time frame.[9] Candlestick charts serve as a cornerstone of technical analysis. For example, when the bar is white and high relative to other time periods, it means buyers are very bullish. The opposite is true when there is a black bar.

A candlestick pattern is a particular sequence of candlesticks on a candlestick chart, which is mainly used to identify trends.

Heikin-Ashi candlesticks

Heikin-Ashi (平均足, Japanese for 'average bar') candlesticks are a weighted version of candlesticks calculated in the following way: [10]

• Close = (real open + real high + real low + real close) / 4

• Open = (previous Heikin-Ashi open + previous Heikin-Ashi close) / 2

• High = max(real high, Heikin-Ashi open, Heikin-Ashi close)

• Low = min(real low, Heikin-Ashi open, Heikin-Ashi close)

The body of a Heikin-Ashi candle does not always represent the actual open/close. Unlike with regular candlesticks, a long wick shows more strength, whereas the same period on a standard chart might show a long body with little or no wick.[11]

Relationship to box plots

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Candlestick chart are similar to box plots. Both show maximum and minimum values. The difference between them is in the information conveyed by the box in between the max and min values.

Head and shoulders (chart pattern)

On the technical analysis chart, the head and shoulders formation occurs when a market trend is in the process of reversal either from a bullish or bearish trend; a characteristic pattern takes shape and is recognized as reversal formation.[1]

Head and shoulders top[edit]

Head and Shoulders Top

Head and shoulders formations consist of a left shoulder, a head, and a right shoulder and a line drawn as the neckline. The left shoulder is formed at the end of an extensive move during which volume is noticeably high. After the peak of the left shoulder is formed, there is a subsequent reaction and prices slide down somewhat, generally occurring on low volume. The prices rally up to form the head with normal or heavy volume and subsequent reaction downward is accompanied with lesser volume. The right shoulder is formed when prices move up again but remain below the central peak called the head and fall down nearly equal to the first valley between the left shoulder and the head or at least below the peak of the left shoulder. Volume is lesser in the right shoulder formation compared to the left shoulder and the head formation. A neckline can be drawn across the bottoms of the left shoulder, the head and the right shoulder. When prices break through this neckline and keep on falling after forming the right shoulder, it is the ultimate confirmation of the completion of the head and shoulders top formation. It is quite possible that prices pull back to touch the neckline before continuing their declining trend.[2]

Head and shoulders bottom[edit]

Head and Shoulders Bottom

This formation is simply the inverse of a head and shoulders top and often indicates a change in the trend and market sentiment.[3] The formation is upside down and the volume pattern is different from a head and shoulder top. Prices move up from first low with increase volume up to a level to complete the left shoulder formation and then fall down to a new low. A recovery move follows that is marked by somewhat more volume than seen before to complete the head formation. A corrective reaction on low volume occurs to start formation of the right shoulder and then a sharp move up due to heavier volume again breaks though the neckline.

Another difference between the head and shoulders top and bottom is that the top formations are completed in a few weeks, whereas a major bottom (left, right shoulder or the head) usually takes longer, and as observed, may be prolonged for a period of several months or sometimes even more than a year.[citation needed]

Importance of neckline[edit]

The neckline drawn on the pattern represents a support level, it cannot be assumed that a head and shoulder formation is complete unless the support level is broken. Such breakthrough may happen to be on greater volume or may not. Breakthroughs should be observed with great care. Serious drops can occur if a breakthrough is more than three to four percent.[clarification needed]

When a stock drifts through the neckline on small volume, there may also be a wave up in some cases, although it has been observed that such a rally normally will not cross the general level of the neckline before selling pressure increases and a steep decline occurs, after which prices may due to greater volume.

Characteristics[edit]

• Most of the time, head and shoulders are not perfectly shaped. This formation is slightly tilted upward or downward.

• One shoulder may appear to droop.

• On many chart patterns, any one of the two shoulders may appear broader than the other which is caused by the time involved in the formation of the valleys.

• The neckline may not be perfectly horizontal; it may be ascending or descending.

• If the neckline is ascending, then to qualify as a head and shoulders formation, the lowest point of the right shoulder must be noticeably lower than the peak of the left shoulder.

Usage as a tool[edit]

Head and shoulders is a useful tool after its confirmation to estimate and measure the minimum probable extent of the subsequent move from the neckline. To find the distance of subsequent move, measure the vertical distance from the peak of the head to the neckline. Then measure this same distance down from the neckline beginning at the point where prices penetrate the neckline after the completion of the right shoulder. This gives the minimum objective of how far prices can decline after the completion of this top formation.[citation needed]

If the price advance preceding the head and shoulders top is not long, the subsequent price fall after its completion may be small as well.

Complex head and shoulders[edit]

Further information: Double top and double bottom and Triple top and triple bottom

This type of head and shoulders pattern has more than one left or right shoulders or head. It is also known as multiple head and shoulders pattern.[citation needed]

One particular type is known as a Wyckoff distribution, which usually consists of a head with two left shoulders and a weaker right shoulder