WHAT ARE CANDLESTICKS IN FOREX?
- Forex candlesticks provide a range of information about currency price movements, helping to inform trading strategies
- Trading forex using candlestick charts is a useful skill to have and can be applied to all markets
What could possibly be more important to a technical forex trader than price charts? Forex charts are defaulted with candlesticks which differ greatly from the more traditional bar chart and the more exotic renko charts. These forex candlestick charts help to inform an FX trader’s perception of price movements – and therefore shape opinions of trends, determine entries, and more.
All currency traders should be knowledgeable of forex candlesticks and what they indicate. After learning how to analyze forex candlesticks, traders often find they can identify many different types of price action far more efficiently, compared to using other charts. The added advantage of forex candlestick analysis is that the same method applies to candlestick charts for all financial markets.
Individual candlesticks often combine to form recognizable patterns. Test your knowledge with our forex trading patterns quiz!
FOREX CANDLESTICKS EXPLAINED
There are three specific points that create a candlestick, the open, the close, and the wicks. The candle will turn green/blue (the color depends on the chart settings) if the close price is above the open. The candle will turn red if the close price is below the open.
If you have the chart on a daily setting each candle represents one day, with the open price being the first price traded for the day and the close price being the last price traded for the day.
- Open price: The open price depicts the first traded price during the formation of a new candle.
- High price: The top of the upper wick. If there is no upper wick, then the high price is the open price of a bearish candle or the closing price of a bullish candle.
- Low price: The bottom of the lower wick. If there is no lower wick, then the low price is the open price of a bullish candle or the closing price of a bearish candle.
- Close price: The close price is the last price traded during the formation of the candle.
The image below shows a blue candle with a close price above the open and a red candle with the close below the open.
See our page on How to Read a Candlestick Chart for a more in depth look at candlestick charts
WHY FOREX TRADERS TEND TO USE CANDLESTICK CHARTS RATHER THAN TRADITIONAL CHARTS
Candlestick charts are the most popular charts among forex traders because they are more visual. Candlestick charts highlight the open and the close of different time periods more distinctly than other charts, like the bar chart or line chart.
Candlestick charts have certain advantages:
- Forex price movements are perceived more easily on candlestick charts compared to others.
- It is easier to recognize price patterns and price action on candlestick charts.
- Candlestick charts offer more information in terms of price (open, close, high and low) than line charts.
However, there are some disadvantages of candlestick charts:
- Candles that close green or red may mislead amateur forex traders into thinking that the market will keep moving in the direction of the previous closing candle.
- Candlestick charts may clutter a page because they are not a simple as line charts or bar charts.
HOW TO TRADE FOREX USING CANDLESTICK CHARTS
Candlestick formations and price patterns are used by traders as entry and exit points in the market. Forex candlesticks individually form candle formations, like the hanging man, hammer, shooting star, and more. Forex candlestick charts also form various price patterns like triangles, wedges, and head and shoulders patterns.
While these patterns and candle formations are prevalent throughout forex charts they also work with other markets, like equities (stocks) and cryptocurrencies.
Trading forex using candle formations:
The hanging man:
The hanging man candle, is a candlestick formation that reveals a sharp increase in selling pressure at the height of an uptrend. It is characterized by a long lower wick, a short upper wick, a small body and a close below the open.
It is a bearish signal that the market is going to continue in a downward trend. Learning to recognize the hanging man candle and other candle formations is a good way to learn some of the entry and exit signals that are prominent when using candlestick charts.
The chart below shows the GBP/USD on a weekly timeframe. This means that each candle depicts the open price, closing price, high and low of a single week. The hanging man candle below (circled) is a bearish signal. Traders use bearish signals like this to enter short trades, a bet on the GBP depreciating relative to the USD.
If a trader uses the hanging man to execute a short trade, he/she should then place a stop loss and a take profit with a positive risk-reward ratio.
The Shooting Star
A shooting star candle formation, like the hang man, is a bearish reversal candle that consists of a wick that is at least half of the candle length. The long wick shows that the sellers are outweighing the buyers. A shooting star would be an example of a short entry into the market, or a long exit.
Traders could take advantage of the shooting star candle by executing a short trade after the shooting star candle has closed. Traders could then place a stop loss above the shooting star candle and target a previous support level or a price that ensures a positive risk-reward ratio. A positive risk-reward ratio has been shown to be a trait of successful traders.
The hammer candle formation is essentially the shootings stars opposite. It is a bullish reversal candle that signals that the bulls are starting to outweigh the bears. It is characterized by its long wick and small body. A hammer would be used by traders as a long entry into the market or a short exit.
The image below is an example of how a forex trader would use the hammer candle formation to enter a long trade, while placing a stop-loss below the hammer candle and a take profit at a high enough level to ensure a positive risk-reward ratio.
TAKE YOUR FOREX TRADING TO THE NEXT LEVEL
Supplement your understanding of forex candlesticks with one of our free forex trading guides. Our experts have also put together a range of trading forecasts which cover major currencies, oil, gold and even equities.