A candlestick is a price chart that helps investors or traders identify price direction and movements for a particular period. This chart embodies data for different periods and each period is clearly demarcated by price bars. Included in a candlestick are the high, low, opening and closing prices of securities trading at a specific period.
A Little More on What is a Candlestick in Investing
A candlestick has its origin in the Japanese market, it originated when the Japanese rice traders track the price movement of rice daily. The candlestick is now popularly used in many countries, including the United States.
Here are some important things to know about candlesticks;
- A candlestick is a price chart that reflects the price movements of a security for a specific period.
- The opening, closing, high and low prices of securities are contained in a candlestick.
- Candlestick has its origin in the Japanese rice market before it was adopted by the United States.
- Typically, a candlestick reflects the price trends of a security for a trading day. Traders can use the candlesticks to determine price patterns in the market.
Candlestick chart was developed in Japan in the 1700s, it was used by the Japanese rice traders to track the price of rice everyday. Basically, a candlestick shows the price of a security for a trading day, the high, low, opening and closing prices are shown in the price chart. Hence, if a month has 15 trading days, there would be 15 candlesticks. Generally, investors and market analysts use the candlestick in making decisions as to when it is appropriate to enter or exit the market.
There are different colors of candlestick, the white, green, black, red and few others. White and green candlesticks indicate a bullish trend in price movement while black and red candlesticks indicate a bearish pattern in price movement. Candlestick charting is used for asset trading, security trading and in the foreign exchange markets.
Two-Day Candlestick Trading Patterns
A two-day candlestick trading pattern can occur, it is a candlestick pattern mostly used in short-term trading. In this trading pattern, there is the presence of an engulfing pattern in which the first candlestick is small and submerged by the second candlestick.
When the engulfing pattern occurs at a downtrend, it indicates a bullish pattern and when it occurs uptrend it is a bearish pattern.
Three-Day Candlestick Trading Patterns
In this trading pattern, there are three candlesticks, this can occur in a bearish reversal pattern called an evening star and a morning star which is a bullish reversal pattern. In an evening star for example, the first candlestick moves at an uptrend, the second candlestick outperforms it a little while the third candlestick closes below the middle of the first candlestick.
Reference for “Candlestick”
Academic research on “Candlestick”
Expert system for predicting stock market timing using a candlestick chartLee, K. H., & Jo, G. S. (1999). Expert system for predicting stock market timing using a candlestick chart. Expert systems with applications, 16(4), 357-364. It has been one of the greatest challenges to predict the stock market. Since stock prices vary dramatically, it is important to determine when to buy and sell stocks in order to get high returns from stock investment. In this study, we have developed a candlestick chart analysis expert system, or a chart interpreter, for predicting the best stock market timing. The expert system has patterns and rules which can predict future stock price movements. Defined patterns are classified into five groups with respect to their meanings: falling, rising, neutral, trend-continuation and trend-reversal patterns. The experimental results revealed that the developed knowledge base could provide excellent indicators with an average hit ratio of 72% to help investors get high returns from their stock investment. Through experiments from January 1992 to June 1997, it was proven that the developed knowledge base was time- and field-independent.
Candlestick technical trading strategies: Can they create value for investors? Marshall, B. R., Young, M. R., & Rose, L. C. (2006). Candlestick technical trading strategies: Can they create value for investors?. Journal of Banking & Finance, 30(8), 2303-2323. We conduct the first robust study of the oldest known form of technical analysis, candlestick charting. Candlestick technical analysis is a short-term timing technique that generates signals based on the relationship between open, high, low, and close prices. Using an extension of the bootstrap methodology, which allows for the generation of random open, high, low and close prices, we find that candlestick trading strategies do not have value for Dow Jones Industrial Average (DJIA) stocks. This is further evidence that this market is informationally efficient.
Are candlestick technical trading strategies profitable in the Japanese equity market? Marshall, B. R., Young, M. R., & Cahan, R. (2008). Are candlestick technical trading strategies profitable in the Japanese equity market?. Review of Quantitative Finance and Accounting, 31(2), 191-207. We show that candlestick charting, the oldest known form of technical analysis, is not profitable in the Japanese equity market over the 1975–2004 period. Candlestick technical analysis, which was developed in Japan in the 1600s, is deeply intertwined with Japanese culture and is very popular in Japan. However, there is no evidence candlestick technical trading strategies add value in either the entire 30 year period, in three 10 year sub-periods or in bull or bear markets.
Profitable candlestick trading strategies—The evidence from a new perspective, Lu, T. H., Shiu, Y. M., & Liu, T. C. (2012). Profitable candlestick trading strategies—The evidence from a new perspective. Review of Financial Economics, 21(2), 63-68. This paper aims to investigate the profitability of two‐day candlestick patterns by buying on bullish (bearish) patterns and holding until bearish (bullish) patterns occur. Our data set includes daily opening, high, low, and closing prices of component stocks in the Taiwan Top 50 Tracker Fund for the period from 29 October 2002 through 31 December 2008. We examine three bullish reversal patterns and three bearish reversal patterns. We find that three bullish reversal patterns are profitable in the Taiwan stock market. For robustness checks, we evaluate the applicability of our results to diverse market conditions, conduct an out‐of‐sample test and employ a bootstrap methodology.
The application of Japanese candlestick trading strategies in Taiwan, Goo, Y., Chen, D., & Chang, Y. (2007). The application of Japanese candlestick trading strategies in Taiwan. Investment Management and Financial Innovations, 4(4), 49-79. The Japanese candlestick is one of the most popular technical methods used to predict future price trends based on the relationships among opening, high, low, and closing prices. By using the daily data of 25 component stocks in the Taiwan Top 50 Tracker Fund and Taiwan Mid-Cap 100 Tracker Fund from 1997 to 2006, this study tries to explore which candlesticks can be used by investors and how many holding days will be profitable for each of them. The t-tests are applied to test the profitability of the candlesticks, and ANOVA and Duncan’s multiple range test are then used to examine and compare the profitability of candlesticks and holding days. Furthermore, this study also tries to implement a stop loss strategy to improve the performance of candlesticks. The research findings provide strong evidence that some of the candlestick trading strategies do have value for investors and different candlestick needs different holding days. Meanwhile, the performance of the most candlesticks has been improved with stop loss strategy.
Hybrid approach to the Japanese candlestick method for financial forecasting, Kamo, T., & Dagli, C. (2009). Hybrid approach to the Japanese candlestick method for financial forecasting. Expert Systems with applications, 36(3), 5023-5030. This paper discusses an experimental study of the Japanese candlestick method as used in hybrid stock market forecasting models. Two models are presented in this paper. Model 1 is a committee machine with simple generalized regression neural networks (GRNN) experts. This model also has a simple gating network. Model 2 has a similar committee machine along with a hybrid type gating network that contains fuzzy logic. Model 1 was developed to introduce the candlestick method and examine whether using the candlestick method improves performance. Model 2 is developed to determine whether the application of fuzzy logic could improve the former model. This model uses standard IF-THEN rules based fuzzy logic. In the experiment, a few simple Japanese candlestick patterns are integrated into the models. Both models use the same simple candlestick patterns to provide a basis for comparison. The Japanese candlestick method is implemented in the gating network. Model 1 uses features of candlestick patterns in the gating network. Model 2 uses candlestick patterns for recognizing the strength of market conditions. To investigate the performance of these models, the daily stock quotes of Hewlett-Packard, Bank of America, Ford, DuPont, and Yahoo are used as input data sets. The performance of the models was satisfactory based on the mean squared error.