A Japanese Candlestick chart was first used in the 18th century, in Japan obviously, when rice was the currency of exchange. During that time, rice trader Homma Munehisa studied the market to develop his fortune- he sought to understand everything from the basic fundamentals to the psychology behind the market. The trading principals and techniques behind Homma’s fortune caught on and became known as the candlestick methodology. This method was used by analyst in Japan at the beginning of the stock market in the 1870s. Charles Dow adapted the Japanese Candlestick method in the 1900s and is remains to be one of the most used forms of technical analyzing in today’s modern financial markets. So what exactly is it?
——
Why use Candlestick Charts?
Candlestick charts show the same information as bar charts but in a graphical format that provides a more detailed and accurate representation of price action.
Candlestick charts visually display the supply and demand situation by showing who is winning the battle between the bulls and the bears.
Candlestick charts reveal another dimension of the given period’s price action by pictorially displaying the force (or lack of force) behind each price bar’s movement.
Candlestick formations make all single bar and multi-bar patterns significantly easier to spot in real time, thus increasing your chances of catching high probability trade setups. In addition, because candlestick charts use the same data as bar charts (open, high, low, and close), all Western technical signals used on a bar chart can easily be applied to a candlestick chart.
• The Anatomy of a Candle
Candlesticks have a central portion that displays the price distance between the open and the close. This area is known as the real body or simply the body.
The price distance between the open and the high for the period being analyzed is called the upper shadow, sometimes referred to as an “upper wick” as well. The highest price paid for a particular period is the marked by the high of the upper shadow.
The price distance between the close and the low for the period being analyzed is called the lower shadow, sometimes referred to as a “lower wick”.
The real body displays the opening and closing price of the security being traded. Closing prices have added significance because they determine the conviction of the bulls or bears. If the security closed higher than it opened, the real body is white or unfilled, with the opening price at the bottom of the real body and the closing price at the top. If the security closed lower than it opened, the real body is black, with the opening price at the top and the closing price at the bottom. Depending on the price action for the period being analyzed a candlestick might not have a body or a wick.
To better highlight or visualize price movements, modern candlestick charts (especially those displayed digitally) often replace the black or white of the candlestick real body with colors such as red (for a lower closing) and blue or green (for a higher closing).
• Core Candlestick Patterns
There are multiple forms of candlestick patterns; here is a brief overview of the most popular and widely used single and multi-bar patterns commonly used today.
Bullish Candle
Signals uptrend movement, they occur in different lengths; the longer the body, the more significant the price increase
Bearish Candle
Signals downtrend movement, they occur in different lengths; the longer the body, the more significant the price decrease.
Long Lower Shadow
These candles provide a bullish signal, the lower shadow must be at least the size of the real body; the longer the lower shadow the more reliable the signal.
Long upper shadow
These candles provide a bearish signal, the upper shadow must be at least the size of the real body; the longer the upper shadow the more reliable the signal.
Hammer
The hammer is a bullish signal that occurs during a downtrend. The lower shadow should be at least twice the length of the real-body. Hammers have little or no upper shadow. When a hammer occurs during an uptrend it is known as a “hanging man” and is a bearish signal. Because of the bullish long lower shadow however, this pattern needs bearish confirmation by a close under the hanging man’s real body.
Shooting Star
This candle has a long upper shadow with little, or no lower shadow, and a small real body near the lows of the session that develops during or after and uptrend.
Harami
The Harami is a two-candlestick pattern in which a small real body forms within the prior session’s larger real body.
Doji
The Doji is a candlestick in which the session’s open and close are the same, or almost the same. There are a few different varieties of Dojis, depending on where the opening and closing are in relation to the bar’s range.
Dragonfly doji
The Dragonfly Doji has a long lower shadow, the open, high, and close are at or very near the session’s high. This pattern often signals reversal of downtrend.
Gravestone doji
The Gravestone Doji has a long upper shadow, the open, low, and close are at or very near the session’s low. This pattern often signals reversal of an uptrend.
High wave candle / long-legged doji
This candle has a very long upper or lower shadow and a small real body. If the opening and closing price are the same the candle has no real body and is then called a Long-Legged Doji. The first picture is a high wave candle the second is a Long-Legged Doji.
Engulfing candles
The bullish engulfing pattern consists of large white real body that engulfs a small black real body in a downtrend. The bearish engulfing pattern occurs when the bears overwhelm the bulls and is reflected by a long black real body engulfing a small white real body in an uptrend.
Spinning tops
Spinning tops are simply candles with small real bodies.
• How Candlestick patterns translate into Nial Fuller’s Price Action Setups
My favorite price action setups consist of the pin bar, the inside bar, and my proprietary fakey setup. The above candlestick patterns can easily be condensed down to one of my three price action setups or may be applicable to more than one of my price action setups. It can be difficult to keep track of the various forms of candlestick patterns. This is why I feel like my three main price action setups do a great comprehensive job of including all the relative candlestick patterns and make them easier to understand in the context of daily price action. Let’s take a look at some charts with examples of some of the various candlestick patterns converted into my price action setups.
Pin Bars
The pin bar can include the following previously described candlestick patterns; long lower shadow candles and long upper shadow candles, hammers and shooting stars, dragonfly and gravestone dojis.
Inside Bars
Inside bars can technically encompass any candlestick pattern because they are simply a series of at least two candlesticks where the first candlestick completely engulfs the entire range of the subsequent candlestick, however, more often than not inside bars end up being spinning tops or dojis. Note, the inside bar is different from the “engulfing pattern” because it includes the entire range of the bar, from high to low, where as the engulfing pattern only includes engulfment of the real body of the candle. I generally trade inside bars in the context of a strongly trending market as they are often great entry points into trends. However, often times inside bars will occur at major market turning points as well as the previous trend loses momentum, pauses and forms an inside bar, and then changes direction.
The Fakey Setup
My fakey setup is essentially a multi-bar pattern that consists of a false break from an inside bar pattern or a key level. The fakey can consist of a number of different candlestick patterns. Often times the fakey setup will consist of a bullish or bearish engulfing pattern which is completely engulfing the range of a spinning top or doji candle which gives rise to a false break bar that can take the form of any of the candlesticks above that qualify as pin bars.
———–
The Japanese Candlestick patterns are very useful for what they are- there are also many different names and translations of these patterns. Since there are many variations, users may become confused and have a difficult time keeping track of the system.
Overall, there are 12 major candlestick patterns that successful analyst will use. Within the Japanese Candlestick trading is around 40 different reversal and continuation patterns. All of these have their own credible probable outcomes and indication of a correct expected direction of a price movement. In order to produce a series of profitable tables in the Japanese Candlestick system, you must clearly understand the method and how it is applied to charting.
Do you use the Japanese Candlestick methodology? Have you had proven success in predicting profitable trades?
Our Rating: [yasr_overall_rating]