How candlestick analysis of stock prices works

Anatomy of a stock chart candlestick

Image attribution: Ticmarc, Public Domain

Candlestick charting is a kind of financial analysis used in what is known as technical analysis. Technical analysis of financial securities interprets charted or graphed price movements, patterns and trends of a financial product to help improve the results of financial activities such as stock trading. In candlestick analysis the candlestick chart or graph is the tool for  analysis, but the analysis of that chart is what provides financial utility. Moreover, as a form of technical analysis, candlestick charting reflects financial influences such as market psychology via product price patterns instead of the evaluating the product itself.

In the book 'Trading Applications of Japanese Candlestick Charting' by Gary Wagner and Bradley Matheny, the origins of candlestick charting are said to date back to the seventeenth century creation of an honorary samurai and futures trader named Sokyu Homma. According to Wagner and Matheny, Homma's candlestick patterns indicated commodity price direction when a series of three candlesticks in either an upward or downward pattern occur as 'gaps' in the opposite direction.

Patterns like those developed by Sokyu Homma are determined using candlestick charting through evaluation of key variables in a financial product's price including its opening price, highest price, lowest price and closing price. These price movements are represented as a pattern or series of chronological units such as a single day, with each unit graphed as a single rectangle or line known as a candlestick.

The appearance of candlesticks and wicks provide a lot of information about a financial product's price patterns for the period of time it is measuring. Essential aspects of the candlesticks are their color, length and the length of the 'wicks' or lines at the top and bottom of the candlestick's body. These candlesticks can vary in length and position on a candlestick chart depending on how the price of a particular price such as company price per share moves in a given time period. The top and bottom of the candlestick's body symbolize the opening and closing prices, and the top and bottom of the wicks represent the highest and lowest values reached during a trading period.

When a candlestick is black or red, a product's price has closed lower than its price when it opened at the beginning of trading. If the product's price closes higher than the opening price, the body of the candle is green or white. Long candlesticks and wicks represent a larger range of price movement than shorter candlesticks where the bottom wicks indicate the lowest price of the trading period and the top wick show the highest price. Sometimes no candlestick body is formed at all and this is called a 'doji'. Also per Wagner and Bradley, a Doji represents a trading period in which the opening price and closing price were very similar.

Once the appearance and location of a candlestick is understood, it is then interpreted for price evaluation and forecasting purposes. This is done by analyzing the form of the candles and their relationship to other candlesticks on the chart. For example, a series of black candlesticks each positioned lower than the next indicates a negative price trend such as a 'bearish hook reversal' and may mean confidence in a stock or commodity has been lost. Furthermore, if the majority of candlesticks on a chart are black with a visible downward trend, this can indicate a long term trend such as a market correction. A market correction is when a price moves lower to correct overly optimistic speculation regarding a specific product's value.

There are several candlestick chart patterns which a chartist is ideally familiar with. These patterns also have names such as 'spinning top', and 'marubozu' which help the chartist quickly interpret their meaning based on previous interpretations of the candlestick pattern. To illustrate, according to Minyanville Media Inc, an Emmy Award Winning business information provider, a 'spinning top' can serve as an indicator a price reversal is about to take place. Candlestick charting analysis, like most financial analysis in general is not definitive proof of where a financial product's price is heading. However, candlestick charts can serve as indicators of market indecisiveness, conviction and momentum; all of which in and of themselves influence the price of financial products.

How technical analysis of stock prices works

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Technical analysis in stock trading refers to the evaluation of stock price changes over time. These changes are measured and plotted using formulas, charts and graphs and assessed in terms of patterns, and strength of stock price movement. A number of basic technical tools, and techniques are used to help technical analysts or chartists assess if specific indicators have occurred.

After a technical indicator has occurred, a confirmation of that indicator may follow using another technical analysis metric. Technical analysis is not an exact science, and generally shouldn't be considered as always being reliable. Rather basic technical analysis is sometimes used in stock trading to assist in substantiating or validating other methods of stock analysis.

• Moving averages

Moving averages are measured in days, usually up to 200. When longer-term moving averages have been moved through by stock prices, it sometimes indicates a significant price movement. Sometimes stock price support and resistance are formed near moving averages, and when these price levels are significantly broken it can mean a possible price momentum trend. In other words, moving averages are at times used as pivot points where a stock may have a pattern of rebounding upward or downward.  

• Candlestick charting

Candlestick charting is a form of technical analysis that began in East Asia. In this type of analysis price movements are represented by black or white candlesticks with lines at the top and bottom. Sometimes colors such as green or red replace the black and white in candlesticks. The color, length and positioning of these candles are placed on a chart and scaled in terms of time and stock price . The technical analysis of these charts will then interpret the candles based on past patterns of similar candle positioning.

• Oscillators

Oscillators are used to determine upper and lower limits of price movements. Examples of oscillators are the Relative Strength Index (RSI), and the Rate of Change (ROC) indicators. These basic stock technical analysis tools plot values on a scale between 0-100 using mathematical formulas. When certain value levels are reached, the oscillators are sometimes thought to show an increased probability of a price being close to a high or low.

• Trading levels

Trading levels constitute the amount of stock trading that takes place during a specific period of time and is another widely used basic aspect of technical analysis in stock trading. Trading levels are measured using volume and when it ncreases it can mean a growing momentum in the movement of a trend may be occurring or about to occur. Volume can also indicate overall market participation. For example, during holidays, volume can be quite low due to the absence of investing activity on those days in holiday when the stock market is open.

• Line graphs

Line graphs are also used in basic technical analysis of the stock market. When stock prices are plotted onto line graphs over time, the movement of that price can be analyzed for patterns in a similar way to candlestick charting. For example, a stock price line graph may create a pattern called 'head and shoulders', which literally takes the shape of a left and right shoulder with a head in the middle. If patterns like this become evident, stock prices sometimes follow similar movements to previous occurrences when a similar pattern was observed in that or other financial securities' line graphs.

Understanding Day Trading Charts

Day trading charts are graphical representations of stock price movements and their derivative calculations and statistics. There are many different types of charts a day trader may refer to in any given day to assess, calculate, time and determine when and what to trade in. A few of the more common charts are listed below:

Stock price history and volume chart

The stock price history chart is the most basic of day trading charts and shows the movement of a stocks value over time periods selected by the day trader. These charts are often accompanied by a volume overlay or separate chart just below the stock price chart that indicates how many shares of the stock are traded and to what extent. These charts can be viewed as either lines, candlesticks or bars, each of which highlights a different aspect of the nature and behavior of price movements.

Stock options chart

A stock options chart is used by options traders to determine what price, and expiration date a stock option will be purchased at. These charts are not used by day traders alone, but also investment firms and investors. The stock options chart is divided into two sections puts and calls. The put section is for traders who are attempting to lock into a sell price on or before a certain date. The call section is for traders who are attempting to lock into a buy price on or before a certain date. Both the puts and the calls are divided further into month charts that extend several months into the future.

Technical analysis charts

Technical analysis charts allow day traders to view many different forms of analysis all at once. These tools are called indicators and are either overlayed onto a basic stock price history chart or take the place of the basic stock price history chart. The trader can refer to the price of the stock in his or her analysis. Some examples of commonly used technical indicators and overlays are moving averages, candlesticks, and Bollinger bands. Each of these helps a trader infer patterns in price movement and volume with the intent of predicting future price movement.

The technical analysis charts can become quite complex and include several other indicators such as commodity channel index, on balance volume, and rate of change/momentum. The purpose of these and other indicators is to help signal the following trends to a trader:

• Daily patterns in a stocks price and volume.

• Price floors and ceilings.
• Support and resistance levels in stock prices
• Changes in trends
• Stock price volatility

Stock charts are one of the day traders most important tools as they are the platform from which a technical trader performs a stock analysis. Each chart indicator and overlay presents price and volume related information that may or may not be contradictory. It is the responsibility of the day trader to interpret the signals based on his or her experience and know how.

The charts are useful tools but are not a guarantee of trading success. This is because the information presented in day trading charts is based on a wide variety of variables and not a controlled amount of factors as in scientific analysis. Nevertheless, day trading charts organize a large amount of data and analysis in to well presented graphical representation of what is going on. These representations most commonly take the form of graphs and sometimes numerical charts as in the case of options traders.

Sources:
1. http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis
2. http://www.thebulltrader.com/

What is the Commodity Channel Index?

Finding free financial advice is a useful first step in improving financial decision making. After receiving free and reliable advice, making financial decisions for yourself may be easier and you might be able to better distinguish between good and bad financial advice. Before searching for free and reliable advice it may be a good idea to identify what it is. In light of this, the following information discusses what reliable financial advice is and some of the sources for free financial advise.

Understanding what reliable financial advice is

Since financial advice spans across a number of areas such as taxation, law, accounting, business and personal finance, the information one receives from different advisers may be quite different. Furthermore, it is not required to be certified however many financial planners are either certified through the Certified Financial Planner Board of Standards, Inc or have considerable financial qualification and backgrounds.

A few such backgrounds are chartered life underwriters CLU, licensed stock brokers via series 7, 633, and 66 licensing, and chartered financial accountants CFA. Several areas of financial expertise exist and many individuals experienced in business, finance, taxation, law and accounting may have significant knowledge of the financial world.

In light of the above, the ideal financial advise is informed in many areas of finance, objective and take into account individual situations when assisting with a financial plan. The financial planner and/or adviser should not expose his or her client to unwanted financial risk and provide a breadth and depth of advice that will help that individual achieve their individual financial goals.

When obtaining free financial advice, it may be necessary to consult a number of sources to compare and contrast information and techniques for the one's that are most comfortable individually. A few key points to reflect on when deciding which free financial advise is most appropriate are as follows:

• Compare and Contrast: Financial information may vary and sometimes even contradict.
• Investigate and Research: If you don't understand something, don't make a decision about it.
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Sources of free and reliable financial advice

• Family and Friends

The more sources one obtains financial advice from the greater the chance one has to draw comparative conclusions, cross reference information for validity and gain multiple perspectives. If one's friends and family are trained and/or knowledgeable in financial matters this can provide additional credibility to the financial information being received. As with all information, being aware of personal motives, misinformation and bad advice is always important whether the advice is free or not.

• Banking Service Providers

Many banks offer free financial planning assistance as a complimentary service to holding an account and utilizing other banking services with that financial institution. The financial planning advice may vary from institution to institutions and there may be an element of cross selling involved. Nevertheless, if one is not obligated to purchase any additional products and services, the sessions offered may be both affordable and useful in managing and planning one's financial future.

• Financial and Investment Seminars

Many seminars are held at local hotels by investment gurus, and financial experts in various areas of finance. These seminars are often attended by financially minded people and can afford one the opportunity to learn new financial information, network, and become more engaged in the financial world. These seminars are often complimentary and may also attempt to sell financial and/or investment programs. As with the free financial planning offered by some banks, all one need do is be weary of the selling goals of the information providers and harvest the financial advice without worry.

• The Internet and financial websites

There are many resources on the internet containing free financial advice from trained and experienced professionals. Yahoo finance is one such website that contains the advice of well known financial advisers such as Suze Orman, Robert Kiyosaki, and David Bach all of which are published authors and have significant business and/or financial backgrounds. The advice on financial websites can be plentiful and factual and need only be filtered for one's unique financial situation.

• Helium, Inc. and other personal finance content

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Summary

Individual financial management is a very personal matter to many people and a good financial adviser will be aware of this point and cater his or her advise with this understanding in mind. There are many sources of free financial advise as this article illustrates and thus the task is not so much in finding the advise but knowing how to use it appropriately as not all sources of financial advice are aware of individuals unique situations.

The more personalized a source of free financial advise can be, the more likely it is to apply to one's own financial situation. When the advice is not customized, asking the adviser how to apply the financial advice to one's unique situation may be necessary and recommended. With free financial advice this may not always be possible leaving some of the guess work up to the recipient of the advice.