Plotting Japanese Candlesticks

You can't go on a boat trip without oars.

The differences between bar charts and candlestick charts are easy to spot, even though they both contain the same price information. When using candles, a flat, two-dimensional bar chart becomes three-dimensional: it seems as if the candles are trying to leave the page, creating a stereoscopic picture of the market. Compare Figures 3.1 and 3.2 - the candlestick chart is clearly more impressive.

To build a daily bar chart, you need to know the opening (open) and closing (close) prices, as well as the maximum (high) and minimum (low) prices of trading sessions. The ends of the vertical line of each bar correspond to the daily low and high. On the left side of the vertical line, a horizontal line is placed, reflecting the opening price of trading, and on the right side, another one, reflecting the closing price.

Figure 3.3 shows bar and candlestick charts that are based on the same source data. The wide part of the candlestick is called the real body and covers the price range between the opening and closing prices. If the body of the candle is black (that is, filled), then the closing price was lower than the opening price of trading, if it is white (empty), on the contrary, trading ended at a level higher than the one at which it started. The thin lines above and below the body of the candlestick are called shadows and reflect the price extremes of the day. The highest point of the upper shadow (upper shadow) corresponds to the maximum price, and the lowest point of the lower shadow (lower shadow) corresponds to the minimum. It is not difficult to guess why these charts are called candlestick charts: outwardly, they really look like candles with wicks sticking out of them. If the candle does not have an upper shadow, then they say that it has a cut off top (shaven head), if the lower one, that the bottom is cut off (shaven bottom). The Japanese believe that the body of the candle conveys the most important information about the price movement, while shadows in candle analysis are considered as additional, less significant details. Figures 3.4–3.7 show different types of candlesticks. The long black candlestick in Figure 3.4 corresponds to a bearish period in which trading opens near the highs of the day and closes near the daily lows. In turn, the long white candle, shown in Figure 3.5, is typical for a bull market: in this case, the price also fluctuates in a wide range, but the opening of trading occurs near the minimum price, and the closing is near the maximum. Figure 3.6 shows the so-called tops(spinning tops) - candles with a small body size, indicating that there was a stubborn struggle between bulls and bears. On their own, tops are neutral when they occur within a narrow trading range, but they start to play an important role when adjacent to some other candles (we will talk about this in the sections on candle patterns such as stars and harami). In this case, tops have short shadows, but it doesn't matter: the main distinguishing feature of a top is its small body, which can be either black or white. Finally, in Figure 3.7 you can see variations of the doji type of candlestick . The body of the doji is completely absent - it has turned into a horizontal line, while the length of the shadows can be different. To form a doji, it is necessary that the opening and closing prices of the trading session coincide or almost coincide. Dojis play such an important role in candlestick analysis that we will give them special attention in this book (see Chapter 8, Magical Dojis). Candlestick charts look more colorful when bright contrasting colors are used on them, for example by replacing white candles with red ones, as is customary in Japan. Perhaps some readers are familiar with the expressions "yin line" and "yang line". So called black and white Japanese candles in China. In Japan itself, they say “in-sen” (black line, in-sen) about a black candle, and “yo-sen” (white line, yo-sen) about a white candle. It is no coincidence that special importance is attached to the opening and closing prices in candlestick analysis, because they correspond to the two most emotional periods of the trading session. A Japanese proverb says: "The first hour of the morning rules the whole day." Similarly, the market opening period sets the vector for further price movement: by this moment, all evening news has already been filtered and comprehended, and all emerging market trends seem to converge at a single point in time. The stronger the emotions that have seized the trader, the sooner he will try to make a deal, whether it be buying, selling or opening new positions to hedge old ones. Potential buyers and sellers, after the morning surge in trading activity, have some price benchmarks that can already be used as a starting point when planning further transactions. Trading on the stock exchange is often compared to participating in a battle, and if we continue this analogy, we can say that the beginning of the session allows traders to preliminarily assess the balance of power on the battlefield. Sometimes at this moment, large market participants try to deliberately shift prices in one direction or another by placing large orders to buy or sell. The Japanese call this the morning attack - note that another military analogy arises here. As for the closing price, in some cases, margin calls on open positions depend on it, so the last minutes of trading are also associated with strong emotional stress in the market. The closing price is closely monitored by technical analysts, because, firstly, it can confirm the formation of a particular model on the chart, and secondly, it is used in many technical tools, such as moving averages. If at the close of trading or a little earlier, a large order for sale or purchase is placed on the exchange in order to influence the price, then the Japanese call this a night attack. Figures 3.4–3.7 show how the relationship between open and close, high and low prices affects the appearance of a candlestick. And now let's see how candles and their combinations allow us to predict market movements.