Jack be nimble,
Jack be quick,
Jack jump over
It’s not often that nursery rhymes can provide us with insight into investing, but this 19th century stanza actually can help traders make money. When the rhyme was written, jumping candlesticks was a practice used for both sport, and as a form of fortunetelling. If the jumper managed to clear the candle without extinguishing the flame, it was a sign of impending good luck. Of course, there’s not much actual candlestick jumping going on these days, but on Wall Street we have our own version of the sport—and we call it candlestick watching.
Of course, I am talking here about analyzing candlestick chart patterns. Now I must admit that I was a bit intimidated when I first confronted these odd looking bar-like markers on a chart. I thought to myself—how does anyone makes sense out of all of those white and black bars? But with just a little tutorial on what these marking mean, I was able to garner a really good sense of what was actually going on in the price of that security.
Now certainly, one can write an entire book (and many have) on the subject of technical analysis using candlesticks, so I won’t presume to try to provide a comprehensive discussion here. Rather, what I want you to come away with is that these chart patterns—called candlesticks because of their visual resemblance to a candle (including the wick)—are not only easy to understand, they are a much better tool for assessing the market than the relatively pedestrian, line-style charts that are most commonly presented in investing articles.
The first thing to understand about candlesticks is they are bar charts that display the high, low, open and close for a security each day. The way the candlestick chart is drawn not only gives the direction of price, but also the momentum behind the move. Because a candlestick chart shows the movement of a security during a given trading day, traders are able to visually access the psychology of the market in that specific security.
As you can see here, candlestick charts graphically illustrate the relationship behind the open, high, low, and close by drawing what’s called the “real body” of the candlestick, which is the wide part shown here. This real body represents the range between the open and close of that day’s trading.
If the real body is filled in black, it means the closing price of the security was lower than the opening price. If the real body is white (a.k.a. empty), it means the closing price was higher than the open.
Above and below the real body we see what are called “shadows.” These as the wicks of the candle, and that’s how candlestick charts got their name. It’s the shadows that actually show the high and the low of the day’s trading. If the upper shadow on the filled-in body is short, it indicates that the open that day was closer to the high of the day. Conversely, a short upper shadow on a white body shows the close was near the high.
Next week we’ll take a closer look at some of the various candlestick chart patterns, and we’ll see how professional traders use these patterns to make big profits. But for now, understand that there is nothing to be intimidated by with candlestick charts, as they are simple, extremely effective, tools by which a trader can assess market direction.