An Introduction To CANDLESTICKS, PART 3

PART 3

Supply and Demand

A stock's price will adjust to higher or lower prices based strictly on
supply and demand principles.
In Figure 7 is shown a diagram of a green candlestick.

The green color of the candlestick indicates that the closing price of the
stock at the end of the day is higher than the opening price at the
beginning of the day.

Figure 7

As you will see, the candlestick's color and size provide very important
clues regarding the TRADER'S SENTIMENT toward a given stock's
future price.

Notice that 'trader's sentiment' is the key phrase here. In short term
trading, it is critical for the trader to have a clear understanding of
what other traders are thinking. As you will see, the most direct way to
get that understanding is through proper interpretation of the
candlestick.

Let's look at an example. In Figure 8 is shown a candlestick of XYZ
Company, which opened at 25 and closed at 25 3/8.

Figure 8

The candlestick is green in color, which gives us a quick visual signal
that the stock price has rallied higher during this period.

How can we use this information to help us understand what other
traders are thinking? To answer this question, we will follow the
candlestick's changes step by step to understand the mechanism which
is driving the stock price to move higher.

In Figure 8, we see the stock opens at 25, and then quickly rallies to 25
1/8. The reason the price moves to 25 1/8 is because there is a high
demand to buy the stock at 25 1/8, and a short supply of sellers
offering stock at 25 1/8.

Once all of the stock available at 25 1/8 is snatched up, the next group
of sellers steps up to offer their stock at 25 1/4.
All of the 25 1/4 stock is quickly snatched up because there are still a
larger number of traders willing to buy at 25 1/4 than sellers willing to
sell stock at 25 1/4.

Once the 25 1/4 stock is gone, the next group of sellers steps up to
offer their stock at 25 3/8. The 25 3/8 stock is quickly snatched up
too.

This process will repeat itself until the buyers loose interest in buying
the stock resulting in a reduction of demand.

The result of combining these steps is a green candlestick with an
opening price of 25, rallying to a closing price of 25 3/8.

During the rally period; however, the astute candlestick reader will be
able to observe the long green color of the candlestick, and deduce that
buyer demand is high.

Now there is only one reason why traders would increase demand by
stepping up to buy the stock, and that is because they think that the
stock will go up in the
near future. So by observing the candlestick color and size, the astute
candlestick reader is able to deduce exactly what other traders are
thinking, and that is that they think the stock price will go higher in the
future.

In Figures 9 & 10 we show an example of how the same principle in
reverse applies to the analyses of a red candlestick.

Figure 9

The red color of the candlestick indicates that the closing price of the
stock at the end of the day is lower than the opening price at the
beginning of the day.

In Figure 10, we see the stock opens at 25 3/8, and then quickly drops
to 25 1/4.

Figure 10

The reason the price moves to 25 1/4 is because there are many sellers
looking to unload there stock at 25 1/4, and a low number of buyers
willing to buy at 25 1/4.

Once all of the buyers have bought the stock at 25 1/4, the next group
of buyers steps up to bid for stock at the lower price of 25 1/8.

The desperate sellers quickly sell all of the stock at 25 1/8, and then
the next set of buyers step up at the price of 25.

This process will repeat itself until all of the sellers have unloaded all of
the stock that they want to sell, resulting in a reduction of supply.

The result is a red candlestick with an opening price of 25 3/8, falling to
a closing price of 25. During the stock's price fall; however, the astute
candlestick reader will be able to observe the long red color of the
candlestick, and deduce that demand for the stock is low.

Now there is only one reason why traders would increase the supply of
stock to sell, and that is because they think that the stock will go down
in the near future.

So by observing the candlestick color and size, the astute candlestick
reader is able to deduce exactly what other traders are thinking, and
that is that they think the stock price will go lower in the future.