Using candlesticks correctly in trading

Candlesticks are one of the traders’ most popular tools for analysing price action and making forex trading decisions. When used correctly, candlesticks can provide a wealth of information about market sentiment, price momentum, and potential reversals. However, many traders do not understand how to read or use candlesticks effectively. As a result, they often miss out on essential signals or misinterpret the data that candlesticks provide.

To trade effectively with candlesticks, you must understand how to read them correctly, which means knowing what each candlestick pattern represents and what information it can provide about the market. It also means being aware of the potential pitfalls that can occur when using candlesticks. This is why it is important to consult with reliable brokers such as Saxo Bank to make sure candlesticks are read correctly.

Let’s look at some of the most important things you need to know about using candlesticks in your trading strategy.

What is a candlestick?

A candlestick in trading is a graphical representation of price action over a given period. Each candlestick consists of a “body” and two “shadows.” The body represents the area between the open and close price, while the shadows represent the highs and lows of the period. Candlesticks are typically used on bar charts, but they can also be applied to other charts, such as line and point-and-figure charts.

There are three main components to every candlestick:

The body

The body is the area between the open and close price. It is typically coloured white or green if the closing price is higher than the opening price, or black or red if the closing price is lower than the opening price.

The upper shadow

This shadow represents the highest price reached during the period.

The lower shadow

This shadow represents the lowest price reached during the period.

What do candlesticks represent?

Candlesticks provide information about four key elements of price action:

Open and close price

The body of the candlestick represents the open and close prices. Candlesticks with small bodies indicate that the open and close prices are close, while candlesticks with large bodies indicate a significant difference between the open and close prices.

High and low price

The upper and lower shadow represents the high and low prices for the period. Candlesticks with long shadows show that prices fluctuated significantly during the period, while candlesticks with short shadows indicate that prices remained relatively stable.

Market sentiment

The market sentiment is reflected in the open and close price relationship; if the close price is higher than the open price, buyers are in control, and prices move higher. But, if the close price is lower than the open price, sellers are in control, and prices move lower.

Price momentum

The momentum is reflected in the relationship between the shadows and bodies of candlesticks. Candlesticks with long shadows and small bodies show that prices moved significantly but closed near where they started, which indicates strong momentum in either direction. Candlesticks with small shadows and large bodies show that prices moved only slightly during the period, indicating weak momentum.

How to read candlesticks?

Now that you know what candlesticks represent let’s look at how to read them. The first step is to identify the trend, which can be done by looking at the direction of the candlesticks. If the candlesticks are predominantly moving up, the trend is up. If the candlesticks are predominantly moving down, the trend is down. If the candlesticks are mostly sideways, the trend is sideways.

Once you have identified the trend, you can look for reversal or continuation patterns. Reversal patterns occur when the price reverses course and starts moving in the opposite direction. Continuation patterns occur when the price continues moving in the same direction.

The bottom line

Candlesticks are a valuable tool that traders can use to identify market trends, reversals, and continuations so they can make advantageous forex trading decisions. However, it is essential to remember that you should not use them in isolation. Traders should use candlesticks with other technical indicators, such as support and resistance levels, moving averages, and Fibonacci retracements. New traders in Hong Kong are advised to use a reliable and experienced online broker from Saxo Bank to help with their trading strategy.