Tuesday, October 5, 2010

What Are Candlestick Patterns?

Candlestick chart patterns offer independent investors and financial institutions a way to look at price fluctuations from a unique perspective. These charts are most commonly used for day trading stocks, commodities, and currency (forex). However, they can actually be used effectively by any investor in any market. A specific set of well-known candlestick patterns reveal overall market sentiment at any given time. They can also indicate the future direction of trading over the short term.   
A daily chart that displays candlesticks can incorporate other traditional indicators such as moving averages and Bollinger bands. Using candlesticks rather than just a daily average or closing price can give you a better feel for the direction or flow of the market. That’s because intraday fluctuations are revealed within a wider range of longer term data. This additional information can make a significant difference in your ability to make smart trading decisions. 
Chart Basics 
The candlestick chart gets its name from the vertical rectangles featured on the diagram. They look like multiple candles in a row. Each “stick” represents a specific time period of trading. Typically, this is a whole day per candle. However, sticks can represent any relevant time span (5 minutes or 1 hour for example) as long as they are consistent throughout the chart and appropriately labeled for the end user.  
White candles represent a day when the closing price was higher than the opening price. Black candles represent the opposite - a day when the price ended lower than when it started trading. The main body of the candlestick shows the range of trading between the opening and closing prices. 
Each candle may or may not have a “shadow”. This is depicted by a vertical line extending above or below the ends of the candle itself and is sometimes referred to as the “wick”. The shadow gives additional information about the extent of trading throughout the day’s session. It represents a price range where the stock traded during the day that was outside the range between the opening and closing prices.  
Although important, the shadow tends to hold less significance than the main body of the candle. You should take both into account to achieve a reliable interpretation of what is actually happening in the market. 
Pattern Basics 
If you are at the point where you are asking "what are candlestick patterns" then a good place to start is with the top 10 candlestick patterns.
Patterns are created by the makeup of individual candles and the differences (or similarity) in multiple sticks in succession. These give you important clues about how the majority of relevant investors feel toward that particular investment vehicle. Prices tend to follow the opinions of the crowd. These sentiments can change drastically over a short period as relevant news is released. Candlestick chart patterns are a graphical indication of investor sentiment and the publicly known information about the investment over a given time frame.  
Of course, not everyone receives news at the same time or digests it at the same rate. As more and more traders incorporate available information into their decision making process, this will be reflected in the chart as they buy or sell. If you can read the patterns in the chart, you will have a good idea of which direction the price is about to go. 
Correct interpretation of candlestick charts depends on: 
·         The size and shape of the individual candles within the relevant time span 
·         The time frame and type of trading involved 
·         The current price trend indicated in the chart 
·         The distinctive pattern created by multiple candles in a row  
·         The historical significance of those patterns in forecasting price movements accurately 
·         The ability to recognize a given pattern within the chart 
Pattern Names  
Fortunately, there aren’t too many candlestick patterns you have to memorize as a beginner to effectively use this type of chart. Start with these 12: 

Evening Star 
Abandoned Baby 
Engulfing Pattern 
The Hammer 
Spinning Top 
Inverted Hammer 
Three Soldiers 
Three Crows 
Piercing the Line 
Dark Cloud Cover 

You can understand most candlestick patterns through building a solid knowledge of trends, support, resistance, and the breaking or holding of those lines through changes in price.  In short, you don’t have to actually memorize the names of these patterns to know what they mean.  
However, knowing them by heart and being able to instantly recognize them by sight will save you from having to figure out the reason for each upcoming tend. It will also help you feel more confident in your predictions and allow you to move swiftly to take advantage of trading opportunities. 

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