Updated: Nov 1, 2022
In this article, we will explore Candlestick charting. Candlesticks and technical analysis typically go hand in hand. In this article we will explore why, as well as investigate other forms of viewing price data other than just traditional Japanese Candlestick Charts. This will help us determine the most advantageous methods of viewing price data for our specific trading strategies or personalities. As you read this article, take note of whatever resonates with you the most and try the out!
Candlesticks are awesome. Their use in financial markets made it even more accessible for the average person to participate in trading and investing. With enough time, anyone can understand them.
The most common form of candlestick charting is the traditional Japanese candlestick chart. The Japanese used this to keep track of a number of things before it was ported over into the world of finance.
...it was more likely that candle charts were developed in the early part of the Meiji period in Japan (in the late 1800s). - Beyond Candlesticks, Steve Nison
This form of charting has endured the passing of time due to its accuracy and efficiency. Each candlestick clearly presents four data points over a given timeframe.
The price level at the creation of that bar
How high price got within that time frame
How low price got within that time frame
The price level at the end of that bar or time frame.
Any type of chart that displays these four data points are referred to as "OHLC" charts. They represent the Open, High, Low, and Close price data.
Candlestick charting is flexible once price data is available.
Opens and Closes
The first bar, on the left represents a "bullish" bar. This means that price closed higher than it opened. Whatever is being graphed has gone up in value.
On the second bar, on the right, price has depreciated. It is a "bearish" bar. Whatever is being graphed has gone down in value. It has depreciated.
Highs and Lows
The high represents the highest price that the security being traded has gotten to within that timeframe.
The low represents the lowest price that the security has gotten to within that timeframe.
Typically, on any charting software, the colors would be interchangeable, but usually red represents depreciation while green represents appreciation in price.
Bodies and Shadows
The body of a candle is the thick part of the candle between the open and the close price.
The shadow of a candle is just another name for the wick of a candle. It is the length of either the open or the close from the low or the high.
Candlestick charts serve many functions and are advantageous in a number of ways. They are the most popular and often default form of charting for a good reason.
They are infinitely customizable. - One candlestick can represent any time period of any asset. The only limitation is the data feed.
Lots of information. - Because these candlesticks display the high's, low's, open's and closes' of a given timeframe, they are one of the most accurate, pure forms of charting simply displaying the data in an attractive easy to understand way.
Easy to understand. - Candlestick charts are aesthetically pleasing to look at on a screen and with customizable colors and outlines available on most charting platforms, Any user can make candlestick charts look however they please.
Indicators - Most indicators work best with candlestick charts. If indicators are relevant to a particular trading system, often candlestick charts are required.
Sentiment & Market Psychology - Candlestick charts are great for displaying who is in control of a market, or market sentiment over a given time frame. Through various candlestick patterns and formations such as the Doji Patterns etc, a trader can assess what the overall bias may be over a specific time horizon.
Algorithms - Japanese candlesticks are clear, simple and easy to describe. This makes them easy to describe in code for the creation of trading algorithms which use technical analysis.
Too much information - Not all trading strategies are the same. For some strategies, the edge may lie in "Eliminating the noise" of typical trading systems and focusing on just one or two things on the chart. Candlesticks will therefore clutter the charts for such trading systems.
False Confidence - Many are tricked into believing in one dimensional "trading systems" using price data alone because candlestick charting makes understanding price data so easy. This can be seen in the rise of retail traders using pretty price patterns and a few indicators all because of the accessibility of candlestick charts.
Apophenia - It is a cognitive bias to see patterns in things that are random. Our brains want to see patterns and so they do. Our brains also look for meaning, and so we find meaning in things that are meaningless. When combined, with technical analysis, we see patterns in random data and attach meaning where there is none to said data. Candlestick charts are great for this trap.
Falling in love - Charts are infinitely customizable both aesthetically and practically with various indicator combinations. It is easy to fall in love with the charts, staring at them all day while thinking that this time is being spent productively while doing nothing of use at all. It unfortunately takes a long time for a retail trader to even come to the realization that this is what is happening.
Unknown Movements - Unless you are watching a bar form in real time, retrospectively, a trader has no idea what came first, the low, or the high. A trader must go down to lower timeframes to see what happened within that candlestick. One Bullish bar on a higher timeframe may represent an entire trend on lower time frames, or it may represent a single parabolic move. We won't know unless we sit back and watch the candlestick form or zoom into the lower timeframes.
Gaps - Candlestick charts often come with gaps. There may be instances where one candle closes at a particular level and the following candle may open at a different level.
Analysis Paralysis - These charts can show multiple biases. Technical analysis will remain subjective and create conflicting signals. Especially with the addition of indicators
Fortunately, there are many ways to display price change data other than by using Candlestick Charts. Traders can have their pick in how they wish to see this information.
Charting by time
Displays Open, High, Low, Close data over a given time frame per candle.
Advantages: 1. Lots of visual customization options.
2. Displays the most price data.
3. Most indicators are built with these candlesticks in mind.
4. Popular price action patterns, candlestick patterns, chart patterns etc are all visible on this chart.
1. Can be distracting and a bit too enticing
2. Can lead to a false feeling of mastery over the markets.
3. Can be noisy, messy etc.
The Line chart or line graph is great for clarity and for comparison. It simply displays the closing price of each period, with less data being displayed. This is also helpful for determining the underlying trend at a glance or for detecting major points of supply and demand or support and resistance.
For example, in the chart below, the US stock market prices are displayed according to each index. We can see the Nasdaq, the S&P 500, the DOW Jones Industrial Average as well as the Russel 2000 all at once. This is another distinct advantage of the line charts.
Great for comparisons. Lay two line graphs on top of each other and find correlations or anything else between different assets
Great at determining trends quickly at a glance
Great for neatly looking at multiple markets without cluttering the screen.
Too clean. These charts are great filters but they leave out essential information according to most strategies. There is some limitation which may arise from not having full view of price action and volatility.
A line chart with shading, hashing, textures or colors along the X axis. This chart displays only the closing price data of any security. This chart bares all the advantages and disadvantages of the line chart with some added aesthetics and added clarity.
Lay two area charts or an area chart and a line chart on top of each other for easy comparisons
Great for comparisons, especially for seeing the spread between two assets.
Great for finding support and resistance or supply and demand zones
Great for an aesthetically pleasing chart that is clear and displays only closing prices if that's what matters.
Excellent for spotting patterns such as the Head & Shoulder or Double Top etc
Not ideal for price action, volume or momentum
Only the closing price is shown
The bar chart displays the usual open, high, low, and closing price data (OHLC). These bars are very similar to candlesticks. However, as they are thinner, a lot more of them can be placed on the screen or on a single chart at once in a neat way.
This chart can be used by looking at the length of each bar and using that to determine possible trends or momentum.
The bar chart holds all the advantages of the the candlestick chart. A lot of data is visible in a clear and concise manner
The bar chart is great at simplifying OHLC data at a glance while condensing much more data over a given timeframe.
The visuals may become skewed if there is a single bar that contained significantly higher volatility. This will disrupt a strategy that relies on the visual cue of a single bar being larger than the rest.
Heiken Ashi candlesticks are meant to separate the signal from the noise. They display OHLC prices like Japanese candlesticks but they way the open and the close are calculated are based on a formula and not the raw prices themselves.
The formula is below - it is meant to create a smooth chart meant to display trends and price direction easily. The formula is meant to calculate averages and create a smoothing effect.
Open = [(Open price of previous candle) + (Close price of previous candle)] / 2
Close = (Open + High + Low + Close) / 4
High's and lows are regular highs and lows.
Makes for an excellent indicator.
Makes for beautiful, aesthetic charts
Excellent for observing trends
Great for easily identifying support and resistance
The smoothing effect may result in lagged signals.
Popular price action patterns such as Dojis and Hammers won't be visible.
May not be very useful in consolidated environments.
In this image the price data is accompanied by a 50 period moving average.
Each dot represents a closing price over a given timeframe. This type of chart is one of the most minimal. However, this is often because it is used in conjunction with indicators such as moving averages or anything representing standard deviations or bands such as Bollinger bands or Keltner channels.
The cleanest possible chart.
Easy to focus on indicators
Only shows closing price data.
A lot of missing information such as Open, high and low prices.
Momentum is difficult to gauge.
Charting Without Time
There are arguments that posit the idea that time is just another indicator, a distraction from price data. Traders must focus only on price movements and/or price movements relative to volume or volatility and not to time.
Below are examples of charts that facilitate this trading philosophy.
These charts are great indicators of momentum. Each bar is called a "line". A new line is formed if:
a) the new close is higher than the current close
b) the new close is lower than the close of the previous 3 bars.
The user can choose to change this number to any number of bars in the past.
Remember the terminology however, "bars" are simply called "lines" with this charting technique.
Great for identifying key levels because it is based on momentum.
Great at displaying trends and trend strength
Great for filtering out weak pullbacks.
Price action patterns are obviously not visible on this chart
Price would have already reversed significantly before you know that it has reversed.
Reversals, slowdowns and consolidation all look the same.
A fancy line chart with a formula. Every horizontal line represents either a close and a shift over to the next significant price move. Think of it as someone's finger showing you "We got *this* high then *this low*" However, what determines what gets plotted is if price moves by more than a specified percentage from the most recent close.
For e.g. My settings may be to show me moves larger than 3 percent upward from a recent lower close. Now price can rise by 2% and it would not be plotted, but if it rises to 3% it would be plotted.
The line will also continue going upward until turn significant turn around occurs. Then it will draw another horizontal line and draw the downward move.
The color of the lines changes based on recent highs and lows. If the new high is higher than the previous high, the color changes to green. If the new high is lower than the previous high, it would still be plotted, but it would be red, signaling weakness in price.
Momentum is easy to see and track
Customizable. You can decide what you do not want to see by setting the percentage threshold as you see fit.
Clean. Visually appealing
Focused - This chart focuses on price data and movements regardless of time. Perfect for swing and position traders.
Complex. Intimidating to understand at first.
Does not account for time - this is only a disadvantage if you are a short term trader or have time as an important factor in your system.
Candlestick patterns and indicators would not work normally with this charting setup.
Renko blocks are often referred to as one of the prettier ways to display price data. Each block represents a price move covering a user defined amount of pips from the recent close. If the user selects 10 pips, then each block would represent a 10 pip movement in either direction.
New blocks are only formed when price moves by the set amount of pips. However, these can be tricky because a lot more price movement can occur than expected.
For example, if the price of an asset is 75 and we are using 5 pip Renko blocks, and 75 is the recent high, in order to form a new bearish block, the price needs to move more than 5 pips.
Price would need to come down from 75 pips down to 70, then continue down another 5 pips to 65 before you see a bearish Renko block.
An alternative to this scenario would be if the price went up by 4 pips up to 79, before turning around to arrive at 65. In that case, price would have gone down by 14 pips before drawing a single bearish Renko block.
A good way to remember this is that a new block is only formed if price moves 5 pips up from the high of the previous block, or 5 pips down from the low of the previous block. (If your settings are set to 5 pips)
Clean, beautiful charts.
Easy to spot trends
Focused on volatility, so its easy to see the moves you want without noise.
Support and resistance becomes easy to spot as obvious turning points are visible
Volatility settings can be based on ATR
Price action patterns would not be applicable to these charts
A lot of data is hidden in Renko blocks.
Point & Figure
These charts are similar to Renko blocks. The x's represent bullish moves and the o's represent bearish moves by a set amount of pips. All the rules involved in Renko blocks apply here. However these charts simply look different.
A lot of data can be seen without scrolling.
Trends or momentum is easy to spot as it is clearly represented by x's and o's in a straight line.
Can look a bit noisier than other charts which fill a similar function
Some traders do not use charts at all. They get their information elsewhere and simply enter positions through their brokerage platforms. These traders apply various different types of strategies.
These traders would usually have algorithms displaying data in a number of ways visualized differently or through various charts. They often have a dashboard or interface displaying any data they wish to see. They would then apply filters according to their trade ideas and look for statistical edges.
These dashboards are called "Screeners". They can filter securities based on whatever criterion is set by the user. Take a look at one I've built using Tradingview.
As an assignment, try filtering for something like:
If Price >= 2 Standard deviations away from Moving Average & RSI is not greater than or equal to 70 or RSI is not less than or equal to 30 Then Enter limit order in the established direction at nearest pivot level With Stop Loss = 1.5 x ATR.
This is very general, but it should be enough to get you started using screeners to see how effective they can be if you know what you're doing.
Something like that would be a cool way of combining fundamental analysis and research, with technicals which signal that price is ready for the trade idea.
Take a look at one of our amazing fundamental screeners here at Logikfx.
How much faster do you think trading can be with these screeners and filters sorting through data for you once you've built them? This is one of the arguments that chartless traders make.
With our slow human eyes and our minds filled with cognitive biases and our emotions clouding our judgement, maybe looking at pretty charts with nice patterns may not necessarily be the best idea.
Social Sentiment Trading
Some traders pick up on social trend and take positions based on various social factors that they have researched. This could include hashtags, general news and headlines and business trends. Check out "Dumb Money" for a good example of this done successfully. They were featured in Jack Schwager's latest book, Unknown Market Wizards.
Combining analytics for various hashtags on social media and google trends can really provide interesting insights for trade ideas.
Most popular with scalpers and day traders, the price ladder displays the price of an asset followed by its volume of contracts. The ladder also displays the number of pending orders at various prices, making it easier to gauge how much volume is present in a particular market at any given time.
This type of trading is popular with Futures traders. It is referred to as looking at the tape, or looking at the order book, or looking at the price ladder. It is considered one of the closest methods of displaying raw price data for fastest reaction times.
The above image is the Depth of Market feature from Multicharts. Every trading platform has one. Just search for the "Level 2" or the "Price Ladder" or the "Depth of Market" (DoM), or the "Order Book". Its been called a number of things, including "The Tape".
Bare in mind, with Fx trading this feature may not be as effective due to the fact that currencies aren't passed through a single centralized exchange. If used for Fx Trading, you will be seeing the data passing through your broker only.
Check out Jigsaw Trading for more on the price ladder
Pure Fundamental Trading
Sometimes these would be funds that have large amounts of money to get in and out of the market with. They often take weeks and months to get and out, as such, technical analysis and charts often don't even matter because their money alone moves the markets anyway.
These traders often use a variety of excel spreadsheets or dashboards to interface with economic and fundamental drivers. They make all their decisions from those spreadsheets.
The Final Word
It comes down to the details of each trading strategy! Some strategies shun excess information, while other strategies require as much information as possible. Some strategies require specific information displayed in a specific way. All of these charting techniques may add a degree of edge to your overall trading plan.
A trading plan may be based on the idea that the price change data is being viewed differently. A different view is a different perspective.
Some trading strategies are based around the idea that a trader is looking at different data entirely. All of this was demonstrated in the section speaking about chartless trading.
However, all strategies based strictly on technical or time-series analysis will suffer from an erosion of edge over time. Charting is only one piece of the overall puzzle.
None of these charting techniques or chartless trading techniques are right or wrong. None of them are superior to the the other.
To obtain edges that do not wither with time, consider using a Global Macro approach to currency trading. Then apply unique charting techniques to time the entries and exits of your ideas well, or trade around your main positions.