Understanding Candlestick Charting Potential Risks!

Published: 23rd February 2010
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Candlestick charting is getting more and more popular with the passage of time. A few decades back, these charts were unknown in the Western World. Japanese rice traders have been using these charts for many centuries profitably. In the last two decades these charts have caught the imagination of many traders accross the globe. These charts give a quick visual representation of the battle that takes place constantly between the bears and the bulls for the market control. When you take a look at candles on these charts, you an quickly see who is winning the day. However, when you use these charts, you need to know its limitations too. On very short time frames that are used by day traders for scalping, these charts may nor give valid signals.

In the last decade electronic trading has become highly popular. What this means is that significant volume of the trading takes place outside of the regular market hours. This trading can cause patterns that don't reflect the full picture to appear on a candlestick chart.

Let's make this clear with a practical example. Let's talk of a stock ABC that is being traded on the floor of New York Stock Exchange (NYSE). Regular trading on NYSE starts at 9:30 AM EST each business day. It closes at 4:30 PM EST. After that these stocks keep on trading electronically. Now, suppose the stock ABC had been trading at $59 15 minutes before the official open of NYSE. When the NYSE opens, the stock ABC open price is $60 per share. This $60 per share open price may not be an accurate reflection of the stock open price as the stock ABC has been trading as low as $59 in the pre market hours!

What this means is that the open recorded on the candlestick chart is not accurate. Now, suppose the stock ABC never trades down to $59 during the day. So, the low on the candlestick chart may not be an accurate depiction of the day's price action.

So, electronic trading makes candlestick charts somewhat inaccurate. Couple this with the fact that on short timeframes, candlestick charts are not very accuarate. Candlestick charts are good for timeframes of 1 hour and above. Just keep these two limitations of candlestick charts.

But these two limitations don't make candlestick charts useless. They are still a very powerful tool in the trading arsenal of any trader. Just knowning thse limitation will make your trading more accurate. Combinining candlestick patterns with technical indicators can be a powerful tool in the hands of an experienced trader.

There are many candlestick patterns that can be used to produce buy and sell signals. Some of these candlestick patterns are simple while others are complex. Single stick candlestick patterns can be easily spotted while double stick and three stick candlestick patterns can take two to three days to develop. Mastering these candlestick patterns is what you need to do as a serious trader.

If you are new to trading and don't have access to a good trading platform, you can use, Yahoo Finance that is a FREE resource to create a candlestick chart of any security. Just enter the ticker symbol of the stock and you will create a candlestick charts. You can play around with it to become familiar with these highly powerful charts!


Mr. Ahmad Hassam has done Masters from Harvard. Master these Candlestick Patterns. Get this 1 Minute Forex Trading System that makes money anytime FREE!

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