In the forex community, Japanese candlesticks are adored, and rightly so. Chart analytics have gone up a notch since their introduction. One of the unique attributes of this means of data representation is recognizable candlestick patterns/formations.
They help traders to possibly predict what price might do next. Depending on the pattern seen, a reversal or a continuation can be expected.
History of Japanese Candlesticks
Believe it or not, candlesticks were first used by a rice trader in Japan. He went by the name Sokyu Honma and lived from 1716- 1803.
Sokyo Honma studied the movements of stocks before developing the underlying principles for candlesticks.
Further down the line, Steve Nison introduced Japanese candlesticks to the western world. Fast forward to today, almost every trader worldwide on every trading platform view data with candlesticks.
Why Bother Using Candlesticks?
Charts of stocks, commodities, currency pairs, etc. can be viewed with a line/ bar chart or candlesticks.
Nevertheless, the former is quite limited and only a fraction of the market’s activities can be analyzed.
A clear idea of the balance between the bulls and bears can be figured out. Also, the opening and closing price of each session is an extra bonus.
While you learn about candlesticks, it is also essential to learn about the major forex chart patterns and master them.
Type of Candlesticks
Majorly, there are two types of candlesticks used to represent data. They are; bullish candlesticks and bearish candlesticks.
Bullish candlesticks represent the magnitude of an increase in value/price. While a bearish candle does the opposite as it used to show a decrease in price.
On very rare occasions, a candle that’s neither bullish nor bearish appears. It is called a Doji and it represents indecisions in the marketplace.
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Candlestick Patterns
Certain types/combinations of candlesticks show a general assessment of the marketplace. They can appear alone, in pairs, or in a set of three!
Single Candlestick Patterns
Single candlestick patterns are very basic and are easier to discover. Most of them signal reversals of trends but they do not hold much weight.
Doji Star
Doji is a Japanese word that translates to “foreign origin” in English. This refers to the fact that this candle opens and closed at the same price which is extremely rare.
Furthermore, the Doji candlestick looks like a cross or plus sign and it usually showcases a reversal.
Hanging Man
The hanging man is a candle that appears at the end of a bullish rally. It has a small body with a long lower wick at least twice the size of it. In the case of the upper wick, it should be as small as possible or non-existent.
So long the criteria above are met; the hanging man candle stick can either be bullish or bearish.
Additionally, the success of the hanging man candlestick depends on the candle that follows it. A strong bearish candle significantly improves the chance of the reversal taking place.
Hammer
The hammer candle also has a lower wick twice the body and a little upper wick. It differs from a hanging man as it appears at the end of a bearish trend as a bearish candlestick only.
It looks just like the hanging man but the candles serve different purposes.
Here, the way the hammer candle closes shows that during the market session, bears couldn’t sustain strength.
Thereby, the candle closed nearly at the price it opened hinting at bulls taking over.
Spinning Top
A spinning top pattern has a small body and two long wicks. It can appear as a bullish or bearish candlestick.
The wicks of a candlestick are where the price visited but was not sustained. In the case of a spinning top, there are upper and lower wicks showing both buyers and sellers could not sustain their strength.
Therefore, this action translates to a stalemate in the market session since neither bulls nor bears dominated.
Dual Candlestick Patterns
Japanese candlesticks patterns that contain two candles are dual candlestick patterns. More candles mean more information so they’re more accurate.
Dark Cloud Cover
Dark Cloud Cover is a candlestick that forms when a bearish candle opens above the close of a previous prior bullish candle while closing below the midpoint of the up candle.
After this formation is completed, a possible bearish reversal might occur, changing the course of the market.
Harami
In Japanese, harami translates to pregnant and this candlestick highlights that.
The candle on the left is usually larger and it is viewed as the mother. It totally encloses the preceding candlestick.
In the image below, the pattern on the left is a bullish harami while the one on the right is a bearish harami.
Engulfing Candlestick
In a situation where a large bullish candle comes after a small bearish one, it is bullish engulfing.
Contrarily, when a large bearish candle comes after a small bullish candle, the formation is known as a bearish engulfing.
Additionally, the candle is referred to as the ‘engulfed candlestick’.
This is my favourite candlestick pattern as it shows the power balance between bulls and bears. The proceeding candle in this formation is known as the engulfed candle while the second candle is the engulfing candle.
Tweezer Tops
Tweezer tops form at the end of a long uptrend. Both candles in this formation have long wicks due to price rejecting a certain level.
This action shows that buyers can not push prices higher any longer indicating a reversal is imminent.
Triple Candlestick Patterns
Triple candlestick formations go a step further than dual candlestick formations. A broader narrative of trend, structure, etc. is taken into account.
Three White Soldiers
Amongst all the candlestick patterns, this is one of the strongest bullish signals. Basically, this formation comprises three consecutive bullish candles.
These candles are reminiscent of how strongly bulls are dominant in that session. So, shorting here is dangerous, only long orders are in line with logic.
Three Black Crows
The three black crows are the opposite of the three white soldiers, this is a strong bear reversal signal. At the end of an uptrend, three bearish candles follow each other causing a reversal/ continuation.
For this pattern to be valid, the candles have to have large bodies and little wicks. The close of the second candle especially has to be above the first candlestick in this formation.
Morning Star
The morning star candlestick pattern that hints a strong bullish move might occur soon. This chart pattern is formed when a bearish candle (black or red) is followed by a candlestick with a small body which is then preceded by a large bullish candlestick (white or green).
Furthermore, it is a candlestick pattern that changes the course of the market from a bearish narrative to a bullish trend. Therefore, it is a bearish to bullish reversal pattern.
Evening Star
The evening star formation has the same rules/ basis as the morning star. The only difference is the former signals a bearish reversal.
In this case, a bullish candle comes first, followed by an indecision candle, and lastly a bearish candle.
How to Identify Candlestick Patterns
Learning to identify candlestick patterns is quite easy with a few considerations in mind. The first thing to do is to learn where certain patterns appear.
Some patterns form at the end of an uptrend while others form at the end of a downtrend. Knowing this improves your thought process and thereby eases the identification of candlestick patterns.
Candlestick formations are conducive when it comes to identifying the general market’s outlook. Knowing as much as possible is necessary for you to elevate your trading.
But the few that really stand out would be the engulfing candlestick, Doji, and, the morning/ evening star.
They do in fact work although a trading strategy cannot be created with candlesticks alone. Instead, have a solid trading plan with the primary strategy involving indicators/ price action.
Candlestick patterns can then be introduced for confirming market behaviour aligns with a proposed trade.
Candlesticks do an amazing job of representing market prices while giving extra information. Traders can see where the price is visited during instances of a session.
Plus, these days trading platforms offer them in different colours which are more aesthetically pleasing.
A price of a commodity either increases or decreases over time, right? The fluctuations in price over any time span can be recorded with candlesticks.
When a price increases it is shown by a bullish candle which is typically green or white. On the other hand, a black or red candlestick represents a decrease in price.
Summary; The Best Candlestick Patterns To Trade
Most traders today view whatever commodity, crypto, or currency pair they trade with Japanese candlesticks.
To fully utilize the strength of Japanese candlesticks, the patterns/ formations you’d likely come across have to be learned.
These patterns are reliable but are more likely to play out when they conform to the overall market direction.
Furthermore, it has to be ensured that other variables are considered because trades cannot be executed on candlestick formations alone.