Forex is the global currency exchange market. A decentralized and over the counter money market, it is one of the most volatile yet liquid markets. New traders usually perceive the Forex market to be an easy market to trade in. A volatile FX market is considered to be the best to bet on. The belief is that a high-risk market is always a potentially high gain market. However, on the dilemma about the FX market being lucrative, the answer would be a yes or a no. For an extremely well-versed FX trader or a hedge fund, FX is the market to dabble in. However, for retail traders, Forex trading can be extremely risky.
Yet traders including the retail traders, employ aids to help them trade efficiently in the FX market. The Forex trading community is classified into two primary categories: The technical traders and the fundamental traders.
These two schools of thoughts have diverged principles on which they base their trading styles. Kishore M, Dubai based FX expert says, “Charts are the tools used by technical traders, to understand the price movement in the market, look for entry and exit points, define their stop-loss orders and trace a pattern of price movement with historical back-drop as a reference. Technical traders work on the principle that history repeats itself and hence they lay emphasis on the comparison with history to speculate on the future price movements”.
History of Candlestick chart in brief:
Candlestick chart is one of the most used and informative charts for trading. History traces the origin of the candlestick charts to ancient Japan. According to historical records, back in the 15th century, the Japanese lived a competitively expensive lifestyle. Their primary source of income and livelihood was rice. Hence people would sell off their rice in a bid to afford the extravagant lifestyle. When the cost of living inflated and the present stock of rice was not sufficient to pay for the lifestyle, people started trading rice for future dates in secondary markets. This was the beginning of the futures market. During this time, a rice trader named Homma Munehisa, developed the candlestick way of keeping a tab on rice trading and to speculate on how will the trade do in future. This laid the base for candlestick charts in Japanese technical analysis. Later on, this was worked and refined by the trading community.
Brief on what a candle stick represents:
Reading the candlestick chart:
- A body: The length of a candle’s body is representative of the trading volume in the market. A long body is representative of a market which is trading in a particular direction. A shorter and smaller body is indicative of a light day of trading. The colors of the candlesticks also change according to the trading trend of the day.
- If the market closes at a higher level than the preceding day, the candles will turn either green or white. This is indicative of a bullish market, where a strong buying sense prevails.
- If the market closes lower than the previous day, the candlesticks will turn red or black. This will be the bearish market where the inclination would be towards selling.
- Two wicks at each end: The wicks at the ends of the candle are called the shadows. The varying extent of a wick or shadow represents the market’s trading pattern for that day. On the other hand, the length of the shadow, on either side of the candle showcase the highest or the lowest price of the day.
The close and the open of the wick refer to the closing prices of the day. A longer wick would mean that the market traded away from both the open and the close levels for that day. On the contrary, a smaller candle signifies that the market remained proximate to the close and open levels.
Kishore M, FX trader and expert says, “The unique trait of a candlestick chart is that one candlestick signifies one day of trading on the chart. However, traders may customize the appearance of the candles on the chart using the customization settings to suit their requirement”. Hence the candles can be customized to appear as and when desired, in any time-frame as needed.
Candlestick patterns on charts:
Hammer and the Hanging Man: The hammer is the reversal pattern of a bullish market. Being a bullish pattern, here the buying price moves lower than the open level. The price, however, rallies back to the high for a close. The reversal of the Hammer is the Hanging man pattern. Here the selling price moves closer higher than the open level and then falls through. This is, therefore, a bearish pattern
While trading in the hammer pattern, look for the pullbacks. When patterns of this kind form, the market eventually rallies, post the pullback.
The reverse phenomenon of this is the hanging man pattern. Here a trader is advised to wait for the trade to peak and place the stop loss -order a little higher, maybe 2 pips high above the “high” of the wick and sell before the downtrend starts.
Two-day reversal candlestick patterns: These patterns form over a period of two days. They are :
- Harami; &
This is a short-term pattern where the first candlestick has a small body. The second stick that is formed completely overshadows the first candle. This is a bullish pattern. The reversal of this pattern where the first candle engulf the second one is a bearish pattern. This is one is called the Harami pattern.
What if the charts showcase a pattern where the bigger candlestick completely overshadows the second candle, called the Doji. In case this happens, the traders have a Harami cross pattern on the chart. In this pattern, the smaller candlestick is within the first candlestick. A Harami cross pattern could be bullish or bearish.
Conclusion: Technical analysis is one of the ways traders speculate in the FX market. This is usually a short-term trading technique. However with candlestick charts, the details sought by the traders to make better informed decisions, becomes more convenient.