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Japanese Candlestick Patterns
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Japanese Candlestick Patterns

What is the Japanese Candlestick Chart?

This type of graph began to be used in Japan in the middle of the seventeenth century as a means to predict the price of rice and, in this way, to establish Futures contracts based on this grain that was profitable for the trader. Initially, in Japan, receipts were issued for these rice futures contracts, and these receipts were traded through a secondary market. Because it was rice that did not belong to anyone, it was known as empty rice.

Every day, Japanese candlestick charts become more relevant for traders who base their strategies on technical analysis as they are very versatile. For this reason, they are used as essential analysis tools in multiple systems of technical analysis of financial markets.

In general, Japanese candlestick charts display the same information as bar charts but use a format that is easier to interpret and more appealing to the user at the same time. Candlestick charts employ a vertical line to indicate the price range from the highest point to the lowest point. Likewise, in these graphs, the large block in the middle (the candle’s body) indicates the range between the opening and closing prices during a given period. In case the block or body of the candle has a dark color, such as red or black, it means that the asset closed at a lower price with which it opened (bearish candle). On the other hand, if the color of the body of the candle is light, such as green or white, this indicates that the price of the asset closed at a higher price than it opened (bullish candle).

In the following image, you can see two candles, one with a green body (the asset closed with a higher price than it opened) and another with a dark red body. The upper part of the red block indicates the opening price, while the lower part indicates the closing price. For the green body candle, the top part shows the closing price and the bottom part the opening price, which means, in this case, that the price during that period rose.

Japanese Candlestick

Candlestick charts provide a visual aid containing the same information as a bar chart. The advantages of the candle chart over other types of charts are as follows:

  • Easy to interpret, ideal for beginners starting their chart analysis
  • Easy to use
  • Easy to remember
  • Suitable for identifying critical points where prices can be returned.
  • They are ideal for analyzing price action, as they present many formations and combinations that indicate possible changes in trend or continuation of the current movement.
Example of Japanese candlestick charts
Example of Japanese candlestick charts

Multiple candle formations provide much information about market behavior so that, if interpreted correctly, the broker can forecast movements.

How to read and interpret a Japanese candle chart?

1) See the body-color

The color of the candle’s body indicates whether, in that period, the price has risen (bullish candle) or fallen (bearish candle). In other words, it tells you whether the difference between the opening and closing prices is positive or negative. Most trading platforms allow you to configure the colors of the bodies of the candles to your liking. The most popular colors are white for bullish candles, black for bearish candles, green for positive ones, and red for negative ones. Therefore, if in a 5-minute chart, a candle is green, it means that in that period, the closing price is higher than the opening price. Therefore, the price has risen.

2) Real Body length

The length of the candle tells us how much difference there was between the closing and opening prices. If the difference was significant, it indicates a strong market (in that period), bullish (if the candle is green or another light color), or bearish (if the candle is red or another dark color). This helps us determine if the market is moving or calm. If, when opening a chart, we see large candles, it is an excellent time to trade. If instead, they are all small body candles, it means that the market is stagnant (showing no activity), and we must think twice before trading. Remember that the trader’s profit is in the market’s movement.

3) The tails of the candle

You must always consider the tails in the candle, both above and below the body. The tails represent the most extreme prices of the period. The top tail represents the highest price the market reached in that period, while the bottom tail represents the lowest price the market got in that same period.

  • Upper tail: Maximum price reached in the period
  • Lower tail: Minimum price achieved in the market

The extreme prices the market reaches in a period can give us much information about price behavior. For example, a small-bodied candle with two long tails indicates a period of indecision in the market where neither buyers nor sellers dominate.

Time frames on Japanese candlestick charts

Japanese candles can be used in any time frame. Technically speaking, if we use a candlestick chart on a 4-hour time frame (H4), each candle will form after 4 hours of trading in the market has elapsed. Similarly, if a candle chart is used in a 30-minute time frame, each candle on the chart will take 30 minutes to form.

Therefore, in a 30-minute time frame, the time between the opening and closing of a candle is 30 minutes. Thus, each candle will show the price behavior (open, close, maximum, and minimum) during that period.

But if we go to a 5-minute chart, it will take six 5-minute Japanese candles to see the price action in the same period as the 30-minute candle.

Most common Japanese Candlestick Patterns

There is a vast variety of Japanese candle patterns, many known only to the most experienced technical traders. However, several widely known and used candlestick formations form the basis for multiple trading strategies based on price action. Among these patterns, we can highlight the following:

  • Doji
  • Spinning Top
  • Hammer
  • Inverted hammer
  • Bullish engulfing pattern
  • Bearish engulfing pattern
  • Morning Star
  • Evening Star
  • Shooting Star
  • Three Black Crow
  • Piercing Line
  • Dark cloud cover
  • Hanging man
  • Three white soldiers

Studying the patterns of Japanese candlesticks allows you to analyze the market’s price action, which is why it is precious. Combined with other technical analysis tools, it can lead to powerful trading signals and highly reliable strategies, as they are based on pure price behavior and not only on price-derived indicators that often present false signals.

When operating with candle patterns it is recommended to incorporate them into complete trading methodologies that allow verifying the signals of these price formations to increase their reliability. However, remember that even the most reliable figures are not infallible and can sometimes present false signals.

Why incorporate Japanese candlestick formations into trading strategies?

As we already indicated, the Japanese candles on the charts offer basic information about the psychology of the market participants. This information is helpful as it helps to interpret what is happening in the markets and the future price behavior.

The information provided by the Japanese candles can help to confirm the signals of the indicators in a trading system. In fact, in many designs, the presence of a particular candle pattern is used to generate the market entry or exit signal. The combination of price action signals (candle formations) and signals from different technical indicators can be used to create profitable strategies.

No technical analysis indicator is foolproof and sufficient to be used as a single market trading tool. Therefore, to minimize false signals and increase the reliability of our trades, it is necessary to collect price action information of various types. For example, a trader can create a trading strategy that involves price action (Japanese candles), trend indicators (moving averages), and volatility indicators (Bollinger Bands).

Conclusions on Japanese candles as an analysis tool

This article shows that Japanese candlestick charts are a handy analysis tool for studying price action. Knowing and knowing how to interpret the different candle patterns is a comfortable way to learn the behavior of prices, which does not require any special knowledge.

Traders who learn to identify and trade Japanese candlestick patterns gain a clearer view of price swings and the direction of trends in the market. Therefore, they can be used as the basis for many trading strategies, mainly if they are based on the behavior of price action.

Traders who learn to identify Japanese candlestick patterns can clearly see the fluctuations, direction, and power of the financial market trend. In reality, Japanese candles are almost self-sufficient if interpreted the right way.

The goal of every trader is simple: determine whether buyers or sellers dominate the price action in a given period. Whoever can get this information before others through price action analysis will be able to get ahead and improve their chances.

If candle trading is combined with proper risk management, the chances of developing a profitable strategy increase.

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  • August 2, 2021

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