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 movements in the price of rice and in this way to be able 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 the use of Japanese candlestick charts becomes more relevant for traders who base their strategies on technical analysis as they are very versatile. For this reason, they are used as basic 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 is more appealing to the user at the same time. Candlestick charts indicate the price range from the highest point to the lowest point by means of a vertical line. Likewise, in these graphs, the large block located in the middle (the body of the candle) indicates the range between the opening and closing prices during a given period of time. 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). 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 indicates the closing price and the bottom part the opening price, which means in this case that the price during that period rose.
Candlestick charts are intended to provide a visual aid, as they contain 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
- Good for identifying key points where prices can be returned.
- Ideal for analyzing price action, as they present many formations and combinations that indicate possible changes in trend or continuation of the current movement.
There are multiple candle formations that provide a lot of information about market behavior so that if interpreted correctly it can allow the broker to forecast movements.
How to read and interpret a Japanese candle chart?
1) See the body-color
The color of the body of the candle indicates whether in that period the price has risen (bullish candle) or has fallen (bearish candle). In other words, it tells you the difference between the opening price and the closing price is positive or negative. Most of the 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 and black for bearish candles, and also 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 large, 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 a good 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 profit of the trader is in the movement of the market.
3) The tails of the candle
You always have to consider the tails that occur 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 reached in that same period.
- Upper tail: Maximum price reached in the period
- Lower tail: Minimum price reached in the market
The extreme prices reached by the market in a period can give us a lot of information about the price behavior. For example, a small-bodied candle with its two long tails indicates a period of indecision in the market where neither buyers nor sellers are dominating.
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), this means that each candle will form after a 4 hour period 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 and each candle will show the price behavior (open, close, maximum price, and minimum price) during that period.
But if we go to a 5-minute chart, it will take 6 5-minute Japanese candles to see the price action in the same period of time as the 30-minute candle.
Most common candlestick patterns
There is a huge variety of Japanese candle patterns, many of which are known only to the most experienced technical traders. However, there are a number of widely known and used candlestick formations, which form the basis for multiple trading strategies based on price action. Among these patterns we can highlight the following:
- Spinning Top
- 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 price action in the market and that is why it is very valuable. If 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. We must remember that even the most reliable formations 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 fundamental information about the psychology of the market participants. This information is useful as it helps to interpret what is happening in the markets and what the future behavior of the price could be.
The information provided by the Japanese candles can help to confirm the signals of the indicators in a trading system. In fact, in many systems, the presence of a certain 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 tool for trading the market. In order 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
Throughout this article, we have seen that Japanese candlestick charts are a particularly useful analysis tool for studying price action. Knowing and knowing how to interpret the different candle patterns is a comfortable way to study 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, especially if they are based on the behavior of price action.
Traders who learn to identify Japanese candlestick patterns can have a clear view of 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 are further increased.