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A Complete Guide to Japanese Candlesticks

A Japanese candlestick is a technical tool used by traders to pack price information into a single candle. They are considered an extremely useful tool, since the traders are able to easily see and analyze a large amount of data.

Origins of the Japanese Candlesticks

Japanese candlesticks go back to as far as the 18th century. A Japanese trader Munehisa Homma traded rice in the local markets. He also served as an adviser to Japanese government. 

Homma started recording prices of rice on a daily basis, including opening price, high, low, and close. After some time, he started noticing patterns that were repetitive.

In 1755, he wrote a book titled The Fountain of Gold — The Three Monkey Record of Mone, discussing the psychological aspects of the trading process. 

He is believed to be the first person to realize that the behaviour of other participants in the market is a crucial element in trading. The emotions of traders play a huge part in their decisions. Homma realized this and took advantage while trading the rice. 

Homma is also known for introducing the Sakata Rules, a set of five rules that outline patterns developed by local traders. It is exactly this set of rules that created the basis for the birth of Japanese candlesticks. 

It was not until the end of the previous century that Steve Nison introduced the concept of Japanese candlesticks to the wider public in a classic investing book titled Japanese Candlestick Charting Techniques.

The essence of this concept is the psychology of a trader, which we will discuss in detail below.

The key elements of Japanese Candlesticks

A Japanese candlestick consists of four main elements: 

  • Opening price 

  • Highest point reached by the asset’s price

  • Lowest point reached by the asset’s price

  • Closing price of the candle

 

structure of a Japanese candlestick

 

As seen in the photo above, the four elements create two parts of the candle: the wick (extending up and down) and the body that consists of the opening and closing prices. The wick can be long or short, depending on the price movements.

As such, candlesticks differ from the simple bar charts by displaying more information, but in such a way that they are still easy to read. 

 

narrow- and wide-spread candlestick

 

Traders usually use either green (bullish) or red (bearish) colour to paint the candlestick, although some also use white (bullish) and black (bearish) as well.

 

green (bullish) and red (bearish) colors

 

As seen in the photo below, the bullish candle is formed when the open is higher than the close, and the opposite for the bearish candle. There is a wide range of different shapes, from those with long wicks to either side to those with almost no body. 

The top of the upper wick shows the session’s high and vice versa. The longer the distance between the high and the low, the wider the price range of the given session is. 

You can test how different Japanese candlestick patterns work by trading without risking your  capital first, by opening a demo trading account

What the Japanese candlesticks tell you

As noted earlier, the Japanese candlesticks are important as they display data to traders that reflect the state of the market. Based on the key elements, traders can better understand the prevailing trend in the market and which side has the upper hand. 

Looking at the image above, we see the EUR/USD daily chart. At the right end of the chart we see a series of long and green candles. This type of candle is very strong as the body is long and the close is usually near the top of the candle. It means that the bulls are in control of the price action as they could facilitate a series of wins that brought them huge gains. 

A clean uptrend, which is characterized by a series of higher highs and higher lows, sends a message that there is a continuous interest from the side of buyers to push the price higher. On the other hand, the long and red candles are a sign of strong selling pressure. 

It is exactly the relationship between individual candlesticks that creates patterns that help traders predict future price changes. 

The most popular candlestick patterns 

There are two major groups of candlestick patterns: bullish vs bearish, and then there are reversal, transitional and continuation patterns. Patterns also differ based on the number of candles, starting from a single-candle formation to those consisting of two and three candles. 

Bullish patterns are those that predict that the price of an asset is likely to rise while the latter indicate the price is likely to fall. A reversal pattern signals a potential change in direction, while the continuation, as the name itself says, signals an extension of the current trend. 

In the section below, we will discuss the five most powerful candlestick patterns used by traders to predict price movements and make profits. All of these patterns generate a sign or message only, and you should consult other technical indicators before you engage in a trade.

For this purpose, we have prepared detailed guides to explain the best candlestick patterns with examples and how to use them in your trading strategy. See a short summary for the most popular ones below or just follow the links here to the detailed guides gain deeper understanding:

Hammer pattern

A hammer candlestick is a single-candle formation that is classified as a bullish reversal candlestick pattern. It always takes place at the bottom of the downtrend and it signals that there might be a change in the direction of the trend as the bulls are showing signs of life.

The image below shows two hammer candles on the EUR/USD daily chart. It's clear that both candles occurred at the bottom of the downtrend and that they sparked a rebound in the price.

 

Hammer candlestick pattern

 

The hammer candle is characterized by a long wick that extends lower with a short body in the upper part of the candle. The open, close and high are approximately the same price, and the wick should be twice as long as the body of the candle.

This formation occurs after the price action had created a new short-term low, but the bears were not able to secure a close near the lows. As a result, the bulls pushed the price higher and got a positive (green) close.

Hence, the message that the hammer pattern sends is that the bear run is almost done as the bulls won the last round. Moreover, the reason the hammer is such a popular pattern amongst traders lies in its effectiveness and reliability.

Shooting star pattern

The shooting star candlestick formation is actually the hammer turned upside down. Instead to the downside, the long wick aims higher and it signals that the bulls were unable to secure a strong close. 

Due to this, a shooting star is considered to be a bearish reversal pattern. It materializes at the end of an uptrend when the bulls start losing bullish momentum, which is likely to result in a rotation lower. 

In order to test the reliability and effectiveness of a shooting star pattern, as well as to learn the difference between a hammer and shooting star first hand, you may want to consider opening a demo account. A demo account is a necessity for the modern trader. 

The image below shows USD/JPY in an uptrend, which resulted in a shooting star at the top of the uptrend. This formation is particularly effective when the price travels north of the resistance (the horizontal line), but the bulls are unable to force a close above the resistance level and the price action returns back below.

 

shooting star candlestick pattern

 

What usually happens is a reversal initiated by the shooting star. Similar to a hammer, a shooting star signals the end of the current uptrend and a potential reversal lower.

Engulfing patterns

Engulfing patterns (bullish and bearish) are reversal patterns. Unlike a hammer and shooting star, these two patterns consist of two candles. It is important to note that the longer the preceding trend is, the stronger the pattern is. Engulfing patterns with three or fewer trending candles are not considered.

It is important to note that they only warn the trader about the potential reversal, hence they dont generate direct trading signals. There are two types of engulfing patterns: bullish and bearish.

Bullish engulfing pattern

The bullish engulfing pattern occurs at the end of the downtrend and it consists of two candles - the first bearish (red) candle and second bullish (green) candle. The first candle has a smaller body and wick and it is engulfed by the second candle.

For this scenario to be classified as a bullish engulfing pattern, the second candle has to completely engulf the first candle i.e.: The low of the second candle has to print lower levels, while the high has to travel further higher than the high of the prior candle.

 

bullish engulfing candlestick pattern

 

In the chart above, we see USD/JPY moving in a downtrend. The price action prints a new low and closes negatively, while the next candle opens at the low but extends higher to have a marginal new high (compared to the prior candle), while the body is much bigger.

The bullish engulfing pattern sends a message that the bears have run out of gas and the bulls are now growing in the game. Again, it's not a direct signal but a sign of the impending reversal.

Bearish engulfing pattern

Contrary to a bullish version, the bearish engulfing pattern can be found at the end of the uptrend and it signals a nearing end of the bulls’ run. Again, the second candle should engulf the first candle to send a message that the bears have the upper hand, hence indicating that lower prices are likely to follow.

 

bearish engulfing pattern

 

As seen in the sample above, the price action has moved higher in the EUR/USD daily chart before the bearish engulfing pattern sparked a correction lower. The second candle clearly engulfs the first candle, the low is lower, the high is higher, while the body is almost triple the size of the prior candle’s body.

 

What follows after is a convincing pullback as the bulls lost control over the price action.

Summary

The Japanese candlestick chart is a basic technical tool used by traders to analyze the markets behaviour and predict future price movements. Here are some important takeaways for you:

  • The Japanese candlesticks go back to as far as the 18th century, although they became widely popular only in the 1990s after an american trader introduced this concept to a wider public.

  • They are widely used by all kinds of traders today, mainly due to the fact that they display data to traders that reflect the psychological state of the market. Their key elements are: open, close, high and low.

  • There are two major groups of candles: bullish and bearish. Within these, there are also reversal, transitional and continuation patterns.

  • While there are numerous different trading formations based on the Japanese candlesticks, we introduced three popular patterns for you to get a better feel of how these patterns work.

  • Finally, its important to note that you should always consult other technical indicators as these formations generate a message only, rather than a directly applicable trading signal.

 

 

 

 

 

 

 

 

 

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