A candlestick chart is used to visualize the price movement of an asset. A candlestick chart can compress all the information of a given time period into one candlestick. This enables you to get all the important information you need quicker than with a regular price chart, and derive even more information, which you then may use for your own candlestick strategy.
This compact, quickly accessible information helps you to apply certain strategies a regular price chart would not allow you to.
Each candlestick represents the price movement of a certain time interval from a few seconds to days, and consists of a body and a wick.
The body represents the opening and closing price of the asset in the given time period. Is the closing price higher than the opening price, the body color is usually white and the candlestick is classified as bullish. Is the closing price lower than the opening price, the body color usually is black and the candlestick is classified as bearish.
The wick is the smaller extension in both directions of the body, and represents the maximum price movement in the given time period.
Sometimes the body colors are replaced by red and green, grey tones, or other colors. Don’t get confused, these color schemes work the same way.
How to apply a candlestick strategy to trading
Candlesticks create patterns and formations. These formations can consist of one single candlestick with a special form or more candlesticks that create a certain pattern. A skilled trader can use these formations to predict future price movements.
There are too many candlestick formations to explain them all in one article. As main categories, there are simple candlestick formations consisting of only one candlestick, and more complex formations that consist of more candlesticks. In the interest of clarity, we will present you with an example for each here and explain the details in specialized articles.
The Big Candle is an example of a formation created by a single candlestick. The Big Candle is characterized by an unusually large body that opens and closes very near the maximum high and low of the time period. If the candlestick is white, in other words in a bullish direction, this likely indicates the beginning of a longer bullish movement. If the candlestick is black, or in a bearish direction, this likely indicates the beginning of a longer bearish movement.
You can use this information to purchase options in the direction of the candle and predict further price movements in this direction. Which option type you should use depends on the timescale of your chart. In a smaller timescale you should use options with a shorter expiration time, for example 30 seconds or 60 seconds options if your timescale is one minute or less. The larger your timescale, the more option types you can use. For example, when you trade a timescale of hours, you can use High or Low and Touch options.
Are there more complex formations for a candlestick strategy?
One example for a more complex candlestick formation is the 3-Method Formation. The 3-Method Formation builds on the Big Candle. Instead of a single Big Candle it consists of a Big Candle followed by a number of smaller candlesticks included within the range of the Big Candle, but in the opposite direction.
The formation is completed by another Big Candle in the end that breaks out of the first Big Candle. This movement is predicting a price movement in the direction of the Big Candles, too.
When you learn to recognize a good amount of candlestick formations, your trading will benefit greatly. They can enable you to avoid bad trades you otherwise would have made and find new opportunities to make good profits.