Getting to Know Candlestick Charts

In This Chapter

^ Considering the advantages of candlestick charting ^ Examining a few potential candlestick problems

^ Checking out the competition: Line, bar, and point and figure charts versus candlesticks

£ver wonder why a trader or investor would choose candlestick charts over other types of charts when analyzing price action of investments or markets? Well, this chapter provides some answers.

Trading and investing aren't easy undertakings, and they're certainly not easy professions. Most traders — professional and amateur alike — and investors struggle just to keep up with the market's performance as measured by the Standard & Poor's 500 Index (S&P 500). The S&P 500 is an index comprised of 500 of the largest stocks traded in the United States (U.S.) and is considered representative of the stock market as a whole.

In order to be one of the successful few who beats the market and other market participants, you should strive to develop a competitive advantage or some unique insight, commonly referred to as your "edge," that you believe most market participants aren't using or considering. I can't say that using candlestick charting provides an edge by itself — and it does come with a couple of potential problems. But when combined with recurring patterns and other technical indicators, you can find your edge!

In this chapter, I cover candlestick charts — the good and the bad — and I review a handful of alternative charting methods. But in the end, you understand why candlestick charting is the way to go!

Brief history of candlestick charting

The history of candlestick charting stretches back to Japanese rice traders in the 17th or 18th century. This fact is why candlestick charts are frequently referred to as Japanese candlestick charts. A very smart man named Munehisa Homma developed the methodology of monitoring the price of daily rice trading, and his methods eventually evolved into what traders and other market watchers call candlestick charting.

Homma found that having a visual representation of daily rice trading allowed him to make more informed buy-and-sell decisions during the hectic trading day. It's said that Homma once had a streak of over 100 winning trades!

Fast forward to the early 1990s, when Steve Nison published a book and magazine article on candlestick charting. Until then, candlestick charting wasn't widely used. Nison's first book, Japanese Candlestick Charting Techniques (Prentice Hall Press), served as an introduction to candlestick charting methods for many traders and investors in the United States. Over the next 15 years, the acceptance and use of candlestick charting became widespread, and the use of computer software for analyzing recurring patterns proved profitable for many traders.

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