Candlestick Trading – The Language of Japanese Candlesticks
Candlestick Trading – The Language of Japanese Candlesticks
Candlesticks are one of the most important tools we have in the forex and stock market technical analysis. The information that the candlesticks give us are the best and most accurate. If you like to become a good and professional forex trader, it is strongly recommended to the candlesticks’ signals. This is how we trade. We trade the too strong candlesticks patterns along with Bollinger Bands breakouts. To learn our trading system, first you have to learn the candlesticks signals and patterns. We have published several articles on candlesticks. Please read them here.
What Are the Japanese Candlesticks?
Candlesticks are the oldest form of technical analysis in the world. Japanese Candlesticks were invented by a Japanese rice trader, Sakata, in 17th century. He spent about ten years of his life in researching and analysing of the effect of weather, psychology of buyers and sellers, and many different conditions on the rice price. Then he made 100 successful trades and retired a rich man and wrote two books about technical analysis.
Candlesticks are the indicators of the markets’ psychology. This is the first and most important thing you have to know about the candlesticks. Price volatility is the result of nothing but behaviour of buyers (Bulls) and sellers (Bears).
When there is more tendency to buy, the price goes up and visa versa.
Candlesticks are the indicators that reflect the emotions (fear and greed) of buyers sellers. Candlesticks have their own language which is very easy to learn. If you learn their language, you will see that they really talk to you and tell you about the next price movements
Candlesticks are the only real time indicators that we have and when you combine them with other useful indicators like Bollinger Bands, they will become the best trading tools. All other indicators like Stochastic, MACDand RSI are delayed and produce a lot of false signals. Ignoring the candlesticks and trading based on these indicators is like driving with closed eyes and just by listening to the directions that someone else gives you. It is clear that he can not give you the directions “on time”. Your reactions will not be on time too and you will be delayed which can be too dangerous.
Candlestick trading and the related technical analysis were introduced to the western countries in 1985 and became so popular.
Candlestick is basically a rectangle that gives 4 different information in a special time frame. On the daily time frame, one candlestick forms every 24 hours. On the 5min time frame, one candlestick forms every 5 minutes, and so on.
Each candlestick represents 4 numbers:
1. Open price 2. Close price 3. High price 4. Low price
For example, on one hour time frame, the open price is the price of thecurrency pair at the time that each candlestick opens. In this time frame, it takes one hour for each candlestick to mature.
So let’s say when a candlestick is just opened on the one hour chart, the price is 1.9825. This is the open price. The price goes up and down during one hour and finally, when one hour is over, the price is 2.0080. This is the close price.
When the close price is higher than the open price, the candlestick is Bullish. It means the price has gone up during the formation of the candlestick. If the close price is lower than the open price, the formed candlestick is Bearish. It means the price has moved down while the candlestick was forming.
High price is the maximum price and low price is the minimum price during the formation of the candlesticks.
The shape and color of a candlestick may change several times during its formation and you have to wait for the candlestick to be formed completely, and then you read the candlestick signal and make your analysis and decision.
Candlesticks have two main parts: 1. Body and 2. Shadows
Psychology of the Market:
Candlestick trading means knowing the psychology of the market through the candlesticks shapes and colors. Candlesticks are the indicators of the market psychology. They show us if there is more buying than selling or there is more fear than greed in the market and visa versa. Using this information, you will be able to predict the next direction of the price.
Different Shapes of the Candlesticks
Because of the price changes, candlesticks can have several different shapes. For example the open and close prices can be the same. Or the high price can be the same as the close price.
Lets see how many different shapes candlesticks have:
1. Typical Candlesticks:
All of the four prices are different from each other. A typical candlestick can be Bullish or Bearish.
Typical Candlesticks
2. Marubozu:
Marubozu means shaven. Candlesticks that have no shadows are called Marubozu.
What Does Marubozu Mean?
In Bullish Marubozu, the open price is the same as the low price, and the close price is the same as the high price. Bullish Marubozu means that Bulls are so strong and didn’t allow Bears to take the price down while the candlestick was maturing. It means there is a lot of buying activity in the market. The longer the candlestick, the stronger the Bulls.
In Bearish Marubozu, the open price is the same as the high price and the close price is the same as the low price. A Bearish Marubozu means that Bears are strong and there is a lot of sell activity in the market specially when the Bearish Marubozu is longer than the previous candlesticks.
What does it mean in general?
1. When you see a Bullish Marubozu, you should not take a short position because Bulls are strong and price can go higher. 2. When you see a Bearish Marubozu, you should not take a long position. 3. When you see a Bullish Marubozu at end of a downtrend, it is a reversal signal. You can just wait for the next candlestick and if it is Bullish too, you can take a long position. 4. When you see a Bearish Marubozu at end of an uptrend, it is a reversal signal. You can just wait for the next candlestick and if it is Bearish too, you can take a short position. 5. If you already have a long position and you see a Bearish Marubozu at the end of the uptrend, you should close your position and take your profit. 6. If you already have a short position and you see a Bullish Marubozu at the end of the downtrend, you should close your position and take your profit.
Of course we will talk about the candlesticks patterns and you will learn more about taking the right decision when you see different kinds of candlesticks. However, for now just keep in mind that Bullish/Bearish Marubozu means Bulls/Bears are strong.
3. Doji:
Doji means unskillfully. These kinds of candlesticks are called Doji or unskillfully, because they don’t have a body. Why? When the open price and close price are the same we will have a Doji.
Doji candlesticks have no color, and so they are neither Bullish nor Bearish. What does it mean? It means Both Bulls and Bears have the same power and are matched and the price doesn’t know where to go. It doesn’t know if it goes up or down, because Bulls are not able to increase the price and Bears are not able to decrease it. So Doji candlesticks are indecision and uncertainty signals.
All kinds of Doji candlesticks need confirmation. I will tell you what confirmation means.
There are different types of Doji candlesticks. The most important one is called Rickshaw Man. In Rickshaw Man the cross bar is roughly central.
Rickshaw Man is a strong indecision signal. So when you see it at the top of an uptrend, it means the price can go higher, or go down or moves sideways.
Another kind of Doji is called Gravestone:
This kind of Doji also means indecision and when it is seen at the top of an uptrend it means the prices wants to bounce down.
At the bottom of the market sometimes you see the Inverted Gravestone:
Inverted Gravestone is also known as Dragonfly.
Of course it doesn’t mean that inverted gravestone or gravestone can not be seen at the top or bottom of the market. In both cases they signal indecision.
Doji can be seen in some other different shapes too:
Sometimes Doji has a small body:
What should you do when you see a Doji?
As I said, Doji means indecision and uncertainty. When it forms at the top of an uptrend or at the bottom of a downtrend, it means the price is uncertain to go up or down or sideways. When you see a Doji, if you already have a position, you have to take your profit and if you don’t have any positions, you have to wait for the confirmation to choose a direction and enter a trade.
What do I mean by confirmation? One of the next candlesticks can work as a confirmation. For example when you see a Gravestone at the top of an uptrend, you should get ready to go short, but first you have to wait for the next candlestick or even next two candlesticks. If they are Bearish, it means bears (sellers) have taken the control and the price will go down. You can go short after the confirmation candlestick close.
Please note that Doji candlesticks that have longer shadows, are stronger.
As you see the Doji is confirmed by the next candlestick and the price went down:
4. Hammer and Hanging Man:
Hammer is kind of candlestick that can be seen at the bottom of a downtrend. Hammer has no or a very small upper shadow. A Hammer the forms at the top of an uptrend is called Hanging Man.
Hammer and Hanging Man have three identifying features:
1. The body is in the upper third of the price range. 2. The lower shadow is twice of the length of the body at least. 3. They have no or a very short upper shadow.
Like Doji, Hammer and Hanging man indicate indecision and uncertainty and need confirmation.
5. Shooting Star:
Indeed, Shooting Star is an inverted hammer formed at the top of an uptrend. Its color can be Bullish or Bearish. A Shooting Star at the bottom of a downtrend is called Inverted Hammer. Like Doji and Hammer, Shooting Star and inverted Hammer need confirmation.
A gap between the Shooting Star or Inverted Hammer and the next candlestick is one of the confirmations. A big Bearish candlestick after the Shooting Star is another confirmation. Generally, confirmation is something that confirms that the price has changed the direction.
Candlesticks Patterns
Candlesticks are important signals individually. However, combination of candlesticks can also generate very strong reversal signals.
1. High Wave
A group of candlesticks that have small bodies and long shadows are called High Wave. High Wave is a very strong reversal signal at the top of an uptrend or bottom of a downtrend.
Read this: High Wave Candlesticks and Their Reversing Power
2. Engulfing Pattern
This pattern is a very strong reversal signal at the end of a trend. Engulfing pattern is formed by two candlesticks with different colors. The body of the second candlestick should completely engulf the first one. The shadows may also be engulfed but it is not necessary. The first candlestick can also be a Doji.
Engulfing pattern is stronger when the first candlestick has a small and the second candlestick has a big body. Also when the second candlestick engulfs more than one candlestick, the pattern is stronger.
Read these articles:
Analysis Of Strong Piercing Line And Bullish Engulfing Candlestick Patterns
Features of a Strong Bearish Engulfing Candlestick Pattern
3. Dark Cloud Cover
It is a Bearish reversal signal that can be formed at the top of an uptrend by two candlesticks. The first one is Bullish and the second one is Bearish. Dark Cloud Cover is formed when the second candlestick is started above the high price of the first candlestick, but goes down and becomes finished above the open price of the first candlestick.
Dark Cloud Cover can be considered as a stronger reversal signal when:
1. The closing price of the bearish candlestick is close to the opening price of the previous candlestick. 2. Both candlesticks are shaven (they have no shadow) and the bearish candlestick is opened at the close of the bullish candlestick and is closed at the open of the bullish candlestick. 3. When the bearish candlestick is opened above a strong resistance and then goes down.
Read this: Features of a Strong Dark Cloud Cover Candlestick Pattern
3. Piercing Line
A Dark Cloud Cover that happens at the bottom of a downtrend is know is as Piercing Line.
When you see a Dark Cloud Cover at the top of an uptrend or a Piercing Line at the bottom of a downtrend you have to wait for the next candlestick.
If the next candlestick after a Dark Cloud Cover is a Bullish candlestick that keeps on going up and goes higher than the high price of the second candlestick, then you should consider the Dark Cloud Cover as a continuation signal.
But if the next candlestick after a Dark Cloud Cover is a Bearish candlestick that goes down and preferably lower than the close price of the second candlestick, then the Dark Cloud Cover you have is a reversal signal.
The same thing is correct about the Piercing Line:
If the next candlesticks after a Piercing Line is a Bearish candlestick that goes down and goes lower than the close price of the second candlestick, then the Piercing Line you have is a continuation signal.
But if the next candlestick after a Piercing Line is a Bullish candlestick that keeps on going up and preferably goes higher than the high price of the second candlestick in the Piercing Line, then the Piercing Line is a reversal signal.
Read these articles: Analysis Of Strong Piercing Line And Bullish Engulfing Candlestick Patterns
4. Harami
Harami means pregnant in Japanese. Harami pattern is formed by two candlesticks. One big (the mother) and one small (the baby). The bigger one covers the whole or at least the real body of the smaller one. Harami can be seen both at the top of an uptrend or at the bottom of a downtrend. The small candlestick can be formed anywhere along the length of the big candlestick, but the important thing is that it should be covered by the big candlestick.
The more difference between the size of two candlesticks, the more effective and potent the signal is.
Like the Dark Cloud Cover and Piercing Line, a Harami can work as reversal signal too, but it has to be confirmed by the next candlesticks. These patterns can not be known as reliable and strong reversal signals.
If you already have a position and you have some profit in your hands, when you see any of the above patterns, you have to close your trade or at least tighten your stop loss and wait for the market to go ahead.
If it changes the direction, you will be safe because you already collected your profit or your stop loss will protect your profit, and if it keeps on moving to the same direction, you will make more profit.
When the small candlestick in Harami pattern is a Doji, the pattern is called Harami Cross. A long body candlestick followed by a Doji which is covered by the long candlestick should not be ignored at all:
Read this: The “Inside Day” Candlestick As a Reversal Pattern
5. Morning and Evening Star and Abandoned Baby:
Morning Star forms by three candlesticks. This pattern can be seen at the bottom of a downtrend. It is known as a strong reversal signal.
1. The first candlestick should be a Bearish candlestick with a considerable body. 2. The second candlestick is a small candlestick that is formed lower than the first one. This candlestick can be Bearish or Bullish. In fact, Morning star is the second candlestick but we have to have the first and the second candlesticks for a Morning Star signal. 3. The third candlestick is a Bullish candlestick that is formed higher than the second one and its body covers a significant portion of the first candlestick.
This pattern is called Evening Star when formed at the top of an uptrend:
The effectiveness and potency of the Morning Star and Evening Star patterns as reversal signals is dependent on some special factors that have to be considered:
1. The distance (gap) between the morning or evening star with the first and third candlesticks. The bigger gap, the stronger signal. 2. The degree of the coverage of the first candlestick by the third one. The bigger coverage, the stronger signal. 3. The bigger trading volume in the third candlestick than the first one.
Sometimes the Morning or Evening Star is a Doji candlestick. Again in this case, the most important thing is the gap between the first and third candlestick and the Doji.
Sometimes, the Morning or Evening Star is a very small candlestick with small or no shadows. The gap is so big and even none of the candlesticks shadows cover any part of the Morning or Evening Star. This pattern is called Abandoned Baby which is a very strong reversal signal. Because of the high volatility, this pattern is very rare in the forex market and can only be seen in bigger time frames but it can be seen in the stock market in smaller time frames like one hour.
Abandoned baby can be seen both at the top of an uptrend or bottom of a downtrend.
Make sure to read this article too: How to Trade Using Doji Candlestick and Bollinger Bands
6. Tweezers
Tweezers is made up of two candlesticks that are next or so close to each other. They have identical highs at the top of the market or identical lows at the bottom of the market. Tweezers usually forms by the candlesticks shadows, but it can also be made by the bodies of the shaven candlesticks. The two candlesticks that form Tweezers can have small bodies like Doji and Hammer candlesticks.
Tweezers can not be considered as a strong reversal signal, and it needs confirmation, but you have to be careful when you see a Tweezers signal. You know what I mean by “be careful”.
Tweezers that are formed right under resistance lines or above the support lines, and also under or above the Fibonacci levels that act as resistance or support are important especially when they are made up of two Doji candlesticks. The longer the shadows, the more potent the Tweezers signal.
It is also possible that you see a few or even several candlesticks between the two candlesticks that form the Tweezers pattern. Even in this case you should not ignore the Tweezers as a potential reversal signal.
When there are several candlesticks between the two that make the Tweezers pattern, they may form Double Tops or Double Bottoms patterns that show the levels of resistance or support.
You learned about the different kinds of Japanese candlesticks and their patterns. What next?
I think it is so easy to learn the different kinds of candlesticks and the patterns they make. You can learn all of them in a few hours but something that you have to focus on more than learning the names and their meanings is the psychological story that each candlestick tells.
At the introduction of this article, I told you that candlesticks are the psychological indicators of the market. They reflect the emotions of buyers and seller. They tell you if traders are eager to buy or they have stopped buying and are waiting, or they have started selling like crazy.
This is the language of the candlesticks that you have to learn.
For example, let’s see how a Doji candlestick becomes formed. As I already mentioned, Doji candlestick shows that the market is in indecision. It means the price doesn’t know to go up or down. Sometimes Buyers become stronger (they buy more) and the price goes up, and sometimes sellers become stronger (they sell more) and the price goes down.
Finally, the candlestick closes when the price is exactly at the same level as the open price, and a Doji candlestick forms. So none of buyers and sellers could take the control of the market. That’s why they say Doji means indecision and you have to wait for the confirmation, because it is not clear if the price will go up or down.
If the next candlestick closes as a relatively big Bearish (red) candlestick, it means Bears (sellers) succeeded to take the control, and lower the price and if the next candlestick closes as a relatively big Bullish (green) candlestick, it means Bulls succeeded to take the control and increased the price.
So what does it mean if the next candlestick closes as another Doji?
Yes, it means the market is still in the indecision status and none of Bulls and Bears have been able to win yet.
So you have to learn to hear and understand the story that each candlestick tells you
:
1. When you see a candlestick, first you should find the open, high, low and close prices. 2. Check the previous candlesticks and find out if the market has been Bullish (uptrend) or Bearish (downtrend). 3. Try to understand from the shape of the candlestick that if buyers (Bulls) are stronger or sellers (Bears) or none of them (indecision). 4. Then try to guess the color of the next candlestick using the above information. 5. If there is any candlestick pattern, like High Wave, Harami and … try to interpret them and predict the direction of the market.
Do Not decide about a forming candlestick. You have to wait for the candlestick to mature. The shape and color of the candlesticks changes several times during their formation and so they should be analysed only when they are fully formed.
My bottom line advice for you is that if you cannot make any predictionand the market situation looks unknown and unpredictable to you, DO NOT force yourself to make a prediction and take any position. You will be wrong in most cases and you will lose money. It doesn’t matter how long; just wait until you see a clear signal that makes sense to you.
