Technical Analysis — Mastering the Candlestick, part 1
If you have ever wondered how to read technical charts and draw those seemingly random support and resistance lines, then this primer is a good start. Even if you do not believe in technical analysis, it is still an interesting topic. This article is the first of a series in a straight-forward introduction to technical analysis.
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They were clouds in my coffee. You stare into the tea leaves in the cup until the distinct Fibonacci pattern finally starts to emerge. A quick blink and another pattern transpires that is more wave like. Never mind, it was just a speck of dust in the eye. Is technical analysis, TA for short, really useful for trading, whether its stocks, bonds, commodities, derivatives, and now cryptos, or is it a practice in futility, akin to reading tea leaves?
Well, it depends. There are valid arguments and supporters on both sides which I will touch on briefly. Let’s get started.
What is Technical Analysis?
Technical analysis (TA) is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume.
The price of almost anything is dictated by supply and demand. These trends have momentum and natural oscillations which are the basis for TA. There are other valid trading techniques, such as fundamental analysis which examines data, e.g., price-to-earnings, balance sheets, and other company statistics. TA is concerned only with trading patterns and basically ignores other aspect of the underlying asset. The theory is that trading pattern is the key and understanding the trend should be the basis of your trading decisions.
However, for crypto trading, there are no fundamentals like there are for equities , so TA is favored in the crypto trading community.
A basic chart depicts the price ranges for a given instrument over a period of time. In the chart below, each bar on the graph represents the daily price range. A green bar indicates the bulls won the day. Likewise, a red bar denotes a win for the bears, calculated from the respective day-to-day closing prices. The time periods on the graphs are not restricted to a daily granularity, although that is the most common. I will talk about interval selection in later articles but assume it’s a daily chart unless otherwise indicated.
There is another style of the candlestick chart. Both display identical information, so its simply one’s own preference.
The wider part of the candlestick is called the body and its height represents the variance between the opening and closing prices. The color is calculated on the intraday trade, not with respect to the previous day’s close. For an example a stock could have closed at 50 yesterday, opened at 49 this morning, and then closed at 49.5 giving it a green bar, but still had a loss of 0.5 for the day. Who is the winner of the day? The Bull or the Bear? The winner is the guy who shorted it at 50 yesterday at the close, and then immediately covered the short at the opening this morning at 49.
A single daily bar does not a trend make but there is still a lot of information in a single candlestick. You’ll notice wicks sticking out from both the top and bottom ends of the body. The total height of the candlestick indicates the whole trading range for the day. It’s also possible that one or both of the wicks are not available. They are not defective candles.
In the example above, the green bar on the left indicates that the stock closed higher and never traded below the open while similarly on the right, the stock closed lower and never traded above the opening. Both are indicative of bullish and bearish trends respectively.
Candlesticks with no wicks are possible but they are rare as the whole trading range was encapsulated between the open and close.
For a day trader, the total height of the bar defines the playground of the session as they will buy and sell back and forth throughout the day. The bulls are on one side, the bears on the other. Many participants are on the sideline - bandwagon jumpers waiting for a clear indication on which way to go. As the price moves along the trading range, lower prices will attract more buyers, while higher prices will entice sellers to take their profits increasing the supply. But perceptions change, and the herd can switch sides at any time. The candlestick is a single quantum of a densely. packed indicator. Now that you understand how to read one, in the next article we’ll start analyzing the relativity of the candlesticks to each other in order start recognizing patterns and the underlying trends. They have very colorful names, e.g., the golden cross, head and shoulders, hanging man, etc. But you need to master the reading of the candlestick first. In fact, some traders use candlestick analysis alone, without comparison to neighboring candlesticks.
In upcoming articles we’ll look into volume, dollar volume, drawing support and resistance lines, and other related topics to TA.