You might want to claim that the Japanese candle provides the exact same information as the bar chart: the opening price, closing price, highest and lowest prices. This is true, nonetheless there are two differences:
- Because of the different colors, in a split second we can identify whether the stock rose or fell. Compare again with the Apple, Inc. ($AAPL) chart and see which makes identifying stock price movement easier.
- The second and more essential difference is that Japanese candles developed over time with additional techniques that add a further dimension to the method.
A third reason exists for using Japanese candles: Because most professionals have shifted to using this method, it is very worthwhile that you look at the market exactly the way they do, so that you can operate in exactly the same way they do. If you operate before them, they will not be buying together with you, and your risks increase. If you buy after them, you will be buying at too high a price.
Without a doubt, Japanese candles light the way for traders who know how to use them effectively. Here is an example:
Japanese Candle Showing Price Rise:
Let’s assume this candle represents one day of trading. On the left you see a simple line chart describing the stock’s behavior over one day. The stock opens trade at a price of $20, drops to a low of $19.5, rises to a day high of $21.2, and ends the day of trading with a close of $21.
To the right of the chart we see a clear candle: that means the price rose. The opening price is the base of the body of the candle, the close is the upper peak of the candle body, and the bottoming and topping tails indicate the day’s high and low. Simple, right?
Japanese Candle Showing Price Drop:
Let’s say that this Japanese candle also represents one day of trading. Notice that it is in a dark color. Looking at the bar chart, you can immediately understand that this chart shows a day of dropping prices. To the left of the candle you see the simple line chart describing the stock’s behavior over the entire day. The stock opens the day trading at $21, peaks with the day’s high of $21.2, drops to the day’s low of $19.5, and closes the day of trade at $20.
To the right of the bar chart you see a dark candle, meaning dropping prices. Because the candle is dark, you immediately understand that the opening price is the top of the candle’s body, the closing price is the bottom of the body, and the two tails, topping and bottoming, show the day’s high and low.
Japanese Candle Showing No Change in Price
When a stock’s open and closing prices are identical, the candle will not be green or red or any other light or dark color, and its “body” will shrink, as you see, to no more than a horizontal line. This candle is called a “doji,” and indicates indecision: a perfect balance of power between buyers and sellers. In the chart above, you see that the opening and closing prices are the same: $20. The stock did move around, from a low of $19.5 to a high of $20.2, but in the end, closed with no change.
Presentation of Candles over Varying Lengths of Time
Traders operate within different timeframes than those used by investors, but nonetheless they check every stock chart over the long term and short term, as I will explain. When I want a total picture of the stock I'm interested in trading, I alter the presentation to show different timeframes and change the candles to show different timeframes, as explained further.
One of the stocks I am currently analyzing for potential purchase is “Altria,” symbol MO. Altria is the number one cigarette manufacturer in the world, known for Marlboro, Parliament, Virginia, and many other brands. The trade opportunity can be identified easily according to a daily chart, where every candle represents one day of trade:
Altria, MO – Daily Japanese Candle Chart for Three Months
As noted, in this chart each candle represents one day of trading. The size of the chart in relation to the size of this book’s page is what prevents me from showing a longer period. However, when I spread the trading platform across my computer screen, the chart is spread across a larger surface and allows me to clearly discern the candles for at least nine months, which is precisely what I would like you to do when you examine a stock. With Altria, I noticed a sharp increase in price lasting for eight days of trading  and several days of consolidation  around this peak area.
This is one of the technical formations that traders love, and is called the “bull flag.” The term derives from the rise in price  that looks like the flagpole, and then the stable holding of this price, the consolidation, which looks like the flag itself. The term “bull” means it will charge forward. When people are “bullish” on a stock, they expect it to go up.
In this case, we will want to buy Altria if it goes higher than the top part of the bull flag: this increase is known as a “breakout.” In other words, we will buy Altria if its price goes over $21.50. The accepted way of presenting this planned trade is as follows:
One of the reasons that Altria’s formation appeals to me is the fact that in yesterday’s trading, the market dropped sharply by 3%, whereas Altria, as you can see by the consolidation around the flag , held up well for its higher range of prices and was not drawn down with most of the market.
Before making my final decision on whether to buy, I want to know a little more of Altria’s history. To do that, I will change the chart display to “weekly.” Each candle will now represent one week of trading, and I will observe the stock’s behavior over a two-year period:
Altria, MO – Weekly Japanese Candle Chart for Two Years
Here, too, if your screen allows it, display an even longer period, preferably of five years. What do we see? Without doubt, Altria has maintained a nice upward trend over the past two years. Yes, I'm still interested!
Now that I like what I see over two timeframes, the daily and the weekly, I want to check its behavior at a closer level. For that, I move to a display of the last ten days of trade and candles showing thirty- minute timeframes:
Altria, MO – Ten-day Japanese Candle Chart at Thirty-Minute Timeframes
When we look closely, we clearly see the consolidation at the top of the flag. Now imagine a situation where the stock breaks out at the flag’s peak and rises higher than $21.50. That could be very interesting!
To complete my inspection, I check Altria’s behavior over the last day of trading with candles offive5 minutes. To get an even clearer view, I always prefer to see the last two days of trading:
Altria, MO – Two-Day Japanese Candle Chart at Intervals of Five Minutes
Had I checked only the last two days of trading, I'm not sure I would want to buy this stock. But, having already looked at the past ten days, the past two days fit better within the broader timeframe. Additionally, I keep in mind that the last day of trading ended with a sharp drop in prices in the overall markets, which also affected Altria a bit. I am now very interested. When taking into account the candles for day, week and longer periods, I see clearly that I really like Altria’s history and can predict that its future looks good, although not until it moves above $21.50.
When making your decision to buy a stock, and also determining the best entry point (professionally known as a “trigger”), it is vital to switch between different timeframes, examine the stock’s behavior using Japanese candles of different intervals, and even elaborate on market activity during the same timeframes. In weekly candles, I see less “noise” than in daily candles, and in daily candles I see less “noise” than in intraday thirty-minute candles, and so on. As an intraday trader, I will make my trade decision within the day’s trading according to candles of five- minute intervals, and occasionally according to candles of two-minute intervals.
Swing traders buy stocks for ranges of several days up to several weeks. They will make their decision based on daily charts. Long-term investors, known as core traders, who hold stocks for months and even years, will base their decisions on weekly charts.
I couldn’t resist. Almost three months have passed since I did the research above, and now, as I make my final editorial adjustment, I decided to complete the picture with the results. Of course, you would not have gotten to see them if I had failed…
Altria, MO – 13% above the Bull Flag
To learn more about the stock market and to begin your own journey toward financial independence, visit Meir Barak's site Tradenet and check out his book "The Market Whisperer."
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