Japanese Candlesticks: Game of Body and Shadows

14 gru 2022

So, in the last post we learned how to build a simple line chart based on the tape. Each point on the chart is defined by coordinates from the time (X scale) and price (Y scale) of a trade. But some stocks are traded at a frequency of hundreds of trades per second, at different prices. The question arises: which trade price to choose from this set?

Interval charts were invented to solve this question. The most popular is the Candlestick Chart. They appeared in Japan three hundred years ago, when the Japanese exchanges were trading rice. They were invented by a trader named Homma. Apparently, being tired of drawing a lot of points on charts, he decided that it would be more convenient to show the price change over the time interval. So, what he came up with.

Let's take a time frame equal to one hour and plot a 1-hour candle on the basis of the following tape:
FB $110 20 lots 12/12/22 12-34-59
FB $115 25 lots 12/12/22 12-56-01
FB $100 10 lots 12/12/22 12-59-12
FB $105 30 lots 12/12/22 12-59-48

A candle consists of a body and upper and lower shadows. Like a float. The body is formed from the open and close prices of a certain time frame. In our case the hour interval is from 12-00-00 till 12-59-59. Only 4 deals were concluded in this time interval. The price of the first deal is $110, which is the opening price of the period or the so-called "open". The price of the last deal was $105, which is the period closing price or "close". These two prices are enough to form the body of the candle.

Now let us move on to the shadows. The upper shadow is drawn at the maximum price of the interval (115$) and is called "high". The lower shadow is drawn at the minimum price of the interval ($100) and is called "low".



The shape of our candle is ready. However, it should also have a content, namely the color. What is it for? Let's take a look at another candle.



Here we can see where is the high and where is the low. But how do we know which is the open or the close? After all, the open is not always at the bottom of the candlestick body, as in the previous example, it can be at the top.

To understand where is the open and where is the close, Homma has invented to paint the body of a candlestick in black, if close is lower than the open, i.e. if the price in the interval is falling (falling candle or bearish candle).

But if close is higher than open, the body of the candle remains white, it will indicate the growth of price during the interval (rising candle or bullish candle).



Sometimes a candlestick has shadows, and the close price is equal to the open price. Then it will look like a cross. This candlestick is called a doji.



White and black are the classic colors for the bodies of Japanese candles. However, you can come up with your own colors. If you want the rising candles, for example, to be blue, and the falling orange - you're welcome. The main thing is to make it convenient and understandable for you.

So, one candlestick allows us to understand where we had the first trade, the last trade, the price maximum and minimum in a given time frame. But it does not allow us to understand how the price changed within the interval: when the maximum or minimum was reached and what was happening within this price range.

But the problem can be easily solved if we switch to a smaller time frame. If we look at the daily candlesticks (this is when the time frame of one candle is equal to one day), and we want to see what was during the day - we switch to the hourly time frame. If we want to see even more details - we switch to 15-minute candles and so on down to the seconds. But you and I will most often use daily timeframes, so as not to be distracted by the fluctuations that occur during the day.

To be continued :)