Japanese Candlesticks are a technical analysis tool that traders use to chart and analyze the price movement of securities. The concept of candlestick charting was developed by Munehisa Homma, a Japanese rice trader. During routine trading, Homma discovered that the rice market was influenced by the emotions of traders, while still acknowledging the effect of demand and supply on the price of rice. Homma developed candlesticks that graphically displayed the nature of price movements by using different colors to denote the differences. Traders can use the candlesticks to identify patterns of price action and make decisions based on the short-term direction of the prices.
How a Japanese Candlestick Works
The best way to explain is by using a picture:
Japanese candlesticks are formed using the open, high, low, and close of the chosen time period.
- If the close is above the open, then a hollow candlestick (usually displayed as white) is drawn.
- If the close is below the open, then a filled candlestick (usually displayed as black) is drawn.
- The hollow or filled section of the candlestick is called the “real body” or body.
- The thin lines poking above and below the body display the high/low range and are called shadows.
- The top of the upper shadow is the “high“.
- The bottom of the lower shadow is the “low“.
Each candlestick includes a central portion that shows the distance between the open and the close of the security being traded, the area referred to as the body. The upper shadow is the price distance between the top of the body and the high for the trading period. The lower shadow is the price distance between the bottom of the body and the low for the trading period
The closing price of the security being traded determines whether the candlestick is bullish or bearish. The real body is usually white if the candlestick closes at a higher price than it opened. In such a case, the closing price is located at the top of the real body and the opening price is located at the bottom.
If the security being traded closed at a lower price than it opened for the time period, the body is usually filled up or black in color. The closing price is located at the bottom of the body and the opening price is located at the top. Modern candlesticks now replace the white and black colors of the body with more colors, such as red, green, and blue. Traders can choose among the colors when using electronic trading platforms.
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