One of the greatest values of the candlestick chart is the ability to read market sentiment regarding a stock. To illustrate consider the following example of a stock traded from the eyes of a Western chart trader and then from the eyes of a candlestick chart trader.
Western Chart Trader
At the close of the day's session you observe that the stock closed well above your entry price (2), which leaves you very content with your trade.
After the close of day 2, you open the financial section of the paper and check the closing price of the stock and observe that not only is your stock well above your entry price, but also has gained slightly (it is worth mentioning that most western papers only publish closing prices while Japanese papers publish both opening and closing prices).
On day 3 you open and the newspaper to check the close and notice a slight dip in your stocks price but you do not panic, because you are still well in the money.
You convince yourself that the stock has only dipped slightly relative to the entry day close (day 1), and should resume its up trend on the next day.
On day 4, you check the close and notice that the stock has fallen significantly relative to the prior days close.
You are now concerned about protecting the profits that you had previously bragged about just days before.
On the beginning of day 6, you call your broker (or logon to your online trading account) and place a market order to sell at the first opportunity.
At the day 5 markets open, the stock opens sharply lower and continues to fall.
Your order is executed at a price several points below where you entered.
You then shrug off the trade as an unpredictable misfortune, and move on to the next trade.
Figure 5
Candlestick Chart Trader
Now suppose you are a candlestick chart trader trading the same stock using a candlestick chart (Figure 6).
At the beginning of Day 1 you enter the stock based on a candlestick pattern entry signal (we will discuss proper entries in detail latter in this unit).
At the close of the day's session you observe that the stock closed well above your entry price (2) which leaves you very content with your trade, but also moves you into a state of caution for signs of a change in trend or reversal.
After the close of day 2, you observe the candlestick formed for the day and notice that the real body is small indicating that there was a tug of war between the bears and the bulls.
You also observe that the real body is read in color indicating that the stock closed lower than the open indicating that the bulls actually lost the tug of war to the bears.
Based on these observations you conclude that the bullish rally in the stock has ceased, and the bullish sentiment of the market regarding the stock is changing.
You decided to sell your position at the days close, or at the market open on the next day to lock in your profit.
If this were a stock in the midst of an overall downtrend, you may decide to short the stock under the low of the day 2 bearish candlestick.
As you can see the candlestick chart trader has the advantage over the western chart trader in that he can use the signals generated in each candlestick to help foretell the changing sentiments of the market regarding a stock.
The open to close relationship revealed in the candlestick is more effective than the close-to-close relationship commonly used by western traders.
Figure 6
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