Being an expert or a beginner forex trader it is very common for you to learn a few tools and techniques that can help you a long way in entering into such trade positions that are beneficial and profitable. While trading forex commodities or stocks, one of the most common things used by analysts, brokers, and traders are charts. These price charts are widely used in the world of traders and trading to see the price movement in the markets. Where there are many charting techniques, one of the most exquisite techniques introduced only 25 years ago in the U.S. trading community is the Candlestick Technique commonly known as the Japanese Candlesticks.
Technical analysis has been used in Japan since the 17th century to trade rice. This includes the world famous Candlestick methodology that initially had an extensive amount of military terminology used for its explanations because of the then military environment that persisted in Japan back then. As time passed, the exchange of rice through Candlestick technique became an institutionalized market and The Dojima Rice Exchange was established, which was only recently, about 25 years ago, was discovered by Westerner named Steve Nison who learned it from a fellow Japanese broker.
In 1991, he then published his first publication Japanese Candlestick Charting Techniques’ after almost three years of extensive research in this subject. This technique finally grew in popularity in the 90’s and since then has been among the top techniques used by traders.
Japanese Candlesticks basically present the price action over a set period of time. They have their own specific way of providing useful information, such as possible market reversals or the current market sentiment that is the basis of buying and selling in the market.
This Japanese candlestick technique can be used for any time frame, be it a day, an hour, or 15-minutes. It is formed for a specific time period using its high, low, open, and close. Some of the important points regarding its formation are as follows.
- A white candlestick, called the hollow candlestick, is drawn when the close is above the open
- A black candlestick, called the filled candlestick, is drawn when the close is below the open.
- The white (hollow) or black (filled) part of the candlestick is called the ‘real body’
- Lines above and below the real body are called shadows and display the high and low range of the selected time period.
- The top of the upper shadow is the maximum high of the period and the bottom of the lower shadow is lowest of the period.
For more clarity and to understand how these candlesticks look like we have a picture below for you to have a look at.
Anatomy of Japanese Candlesticks
Types of Bodies
Because of the formation of a body or a real body due to the fluctuation of the price in a specific time period, there are different sizes of candlestick bodies that are formed. Either there can be a long body or a short body of a white or a black candlestick.
If the body is long then it signals a strong and more intense buying and selling pressure. This pressure could be either from sellers whose sentiments took control of the market as they were stronger or from buyers. However, if the body is very short then it indicates less buying and selling activity from either of the parties.
To understand this more as per forex lingo, you need to remember that bulls mean buyers and bears mean sellers.
If the candlestick is white and has a long real body that has been formed then it means that there is strong buying pressure. It also means that both the shadows are far separated from each other and further the close is from above the open. This shows that the buyers were aggressive because of which the prices increased considerably.
If the candlestick is black and has an elongated body then this indicates a strong selling pressure and the further the close is below the open. This shows that the sellers were aggressive this time and slammed the market as the prices fell a great deal from its opening price.
Types of Shadows
The two shadows, upper and lower, that we have previously discussed gives us useful information regarding each trading session under consideration.
The upper shadow implies the session high and lower shadows imply the session low.
If these shadows are longer on a candlestick then it means the trading action took place far from the open and close, whereas, if short shadows are formed on candlesticks then it means the trading action occurred near to the open and close.
These shadows also have two different combinations. If the candlestick has a long upper shadow and a short lower shadow then this means the buyers bid prices higher which was then driven back down by the sellers back to the open price by the end of the session. And if the candlestick has a short upper shadow and a long lower shadow then this means sellers forced the price to drop lower which was then brought back up by buyers near it open price, again, by the end of the session.
Basic Japanese Candlestick Patterns
The bodies of Doji candlesticks are very short and appear to be as thin as a line. This is because there has been a struggle between buyers and sellers for having the turf position which resulted in a draw by the end of the session causing the formation of same opening and closing price on the candlestick.
The formation of a Doji on your chart should grab your attention. If after a series of long hollow candlesticks a Doji is formed it means the market might reverse because the buyers have started to exhaust, but if it is formed after a series of long filled bodies then it signals that the sellers have become exhaustive and buyers are ready to enter the market by buying at cheap prices.
There are four common doji that can form on your charts.
Spinning tops are formed because of the indecisiveness between the buyers and sellers. They are called spinning tops because they have long upper and lower shadows and small real bodies. These small bodies, whether white or black, are an indication that both the buyers and sellers were fighting to win the turf but none could succeed despite the major movements in price in the meantime.
If a spinning top forms during an uptrend or a downtrend then it means that a possible reversal is underway.
This is a candlestick with a body that has no shadows. A white Marubozu is a bullish candle which shows control of the buyers on the market during the session in which the open price equals the low price and the close price equals the high price. A black Marubozu, on the other hand, is a bearish candle showing the control of the sellers and whose open equals the high and close equals the low.
Advanced Candlestick Patterns
Single Candlestick Patterns
Hammer and Hanging Man
These two candlesticks are exactly alike but have different meanings depending on where they appear on the chart during the price action. They have small black or white bodies with long lower shadows and upper shadows that are short or absent.
If it formed during a downtrend then it means it is a hammer with a bullish reversal pattern. This means it is hammering out the bottom and is signaling that the price will rise again. The long lower shadow shows control of the buyers which is balanced by buyers by the end of the session by bringing the price back near the open.
The recognition criteria for a hammer is that it has small or no upper shadow with a lower shadow that is two to three times the size of the body, and the body is at the upper end of the trading range.
If this candlestick is formed during an uptrend then it is called a hanging man indicating a bearish reversal pattern and the buyers being outnumbered by the sellers. It shows that the sellers pushed prices lower which were brought up by buyers by the end of the session hence forming a long lower shadow.
The recognition criterion for a hanging man is the same as hammer except that the body is at the upper end of the trading range.
Inverted Hammer and Shooting Star
These two also look identical except for the fact that they are formed in an uptrend or a downtrend.
An inverted hammer occurs in a downtrend and signals the prices to climb up, hence called a bullish reversal pattern. It shows that the buyers tried to bid higher, which resulted in a long upper shadow, which was then pushed back down by the sellers to close the session near the open.
A shooting star forms in an uptrend and is referred to as a bearish reversal pattern where the buyers attempted to push the price up but sellers pulled it back to the bottom.
Dual Candlestick Patterns
These are called engulfing candlesticks because they are formed by the formation of two opposite candlesticks in arrow with the latter one engulfing the initial one.
A bullish engulfing pattern is indicated when a bearish candlestick is followed by a larger bullish candlestick which signals a major up movement in the price in the market. On the contrary, a bearish engulfing pattern is the opposite of the previous one where a bearish candle engulfs its previous bullish candle in the pattern which shows that the buyers were overpowered by the sellers.
Tweezer Bottoms and Tops
These are called tweezers because of the way they are formed in a chart pattern.
They are formed after the extension of a specific trend that indicates a reversal is soon to happen. To recognize if it is an effective tweezer you need to look for signs like the first candlestick is the same as the trend that is followed whereas the second one is opposite to the first one, the shadows of both these candlesticks are of equal length and the tops have the same highs and bottoms have same lows.
Triple Candlestick Patterns
Evening and Morning Stars
Just like dual candlestick patterns, triple candlestick patterns are recognized through three real bodies in a row formed at the end of the trend.
The characteristics to recognize an evening start pattern as per the diagram above includes the presence of a bullish candle in the first which is in actual a part of the trend followed by candle that has a small body which signals that both the buyers and sellers are fighting for the turf and thus indicates a reversal of pattern. This indecisiveness between the two parties then results in a third candle which shows that a reversal is in place as the candle closes beyond the midpoint of the first candle.
Three White Soldiers and Black Crows
This pattern is a clear indication that a reversal has taken place. The first candle in the three white soldiers’ pattern is termed as the reversal candle as it ends the downtrend. For this candle and the pattern to be proved as valid, it should be followed by a second white candle which is slightly larger than the previous one and has a small or no upper shadow. This second candlestick is then followed by a third white body candlestick that is larger than the previous two white soldiers and has small or no shadow.
The three black crows are just the opposite of three white soldiers and are formed after an uptrend in the price chart.
Source of Diagrams, Graphs, and Charts