Although traders can use things like bar charts, line charts and Heikin Ashi, candlesticks are the most versatile. A single or a few candles offer powerful information on the psychology of buyers and sellers.
Japanese candlesticks have roots in the 18th century from an unlikely market: rice. Munehisa Homma, a Japanese rice merchant, is regarded as the creator of this charting style.
It wasn’t until 1991, with the release of the Steve Nison book Japanese Candlestick Charting Techniques, that candlesticks became popular. Nowadays, you can find them on all mainstream trading platforms like MT4, cTrader, TradingView, NinjaTrader and many others.
So, let’s look at trading Japanese candlesticks in more detail.
What is Japanese candlestick charting? The anatomy of Japanese candle sticks
Japanese candlesticks are a type of detailed color-based price chart borrowing elements from the bar chart. They come in various body shapes and sizes, which traders use for predicting price movements.
In their basic form, Japanese candlesticks show the open, close, low and high prices:
Traders generally use green (or white) for bullish candles and red (or black) for bearish ones. Of course, you can alter these colours to suit your preferences.
The open represents the candle’s original formation, the price where a particular market has opened in a session. Of course, the close signifies the end price of that trading period. The candle will fluctuate, depending on market activity, to form its lowest and highest points.
We refer to the coloured of a candle stick as the ‘body.’ The upper or lower parts of the candle are called the ‘wick,’ ‘shadow’, or ‘tail.’
Japanese candlesticks are effective because they quickly provide the four most important price points. We can derive several meanings by looking at the size of the body in relation to the wick. For instance,
- A candle with a little wick suggests dominance and the likelihood of it continuing in the next session.
- Candles with long wicks and small bodies are the first clues of a potential reversal.
Most candlestick patterns are derived from this theory.
Of course, another reason for the popularity of candlesticks is aesthetics. Because these charts are easy on the eye, they enhance your overall trading experience and make charting more fun.
Finally, there are many, many interesting candle stick patterns (with quirky names) to learn and exploit.
Popular Japanese candlestick trading formations and patterns
Let’s explore all the various traded candle stick formations and patterns with illustrations.
The Marubozu (Japanese for ‘bald hill’) is a candle frequently appearing in trending and fast-moving markets. It is characterised by a whole body with little to no wicks.
A bullish Marubozu means that few or no sellers pushed the price below the open. The opposite is true for a bearish Marubozu. In either case, this suggests dominance. Therefore, in any trend, you’ll typically find a string of Marubozus.
So, depending on the session, its appearance is a clue that the price will travel in the previous direction. Yet, you should note that the Marubozu is a natural occurrence in Japanese candlestick charting, not a pattern.
So, traders cannot always assume one Marubozu leads to another without looking at the market context.
A doji is a rare occurrence when trading Japanese candlesticks. The term ‘doji’ is Japanese for ‘same thing.’ This is because the open and close prices are near the exact level. Such an event produces a T-shaped or cross-shaped candle where the body is small while the wicks are long.
Dojis represent indecision. When they appear, it implies no dominant force between buyers and sellers. Therefore, the next candle may move in the previous direction or be the trigger for a reversal.
This is why Dojis are neutral patterns. Also, Dojis are more common on lower time frames because of the amount of price action. You’ll see less of these on higher charts. The best way of trading Dojis is using the Doji star formations.
We have four kinds of Dojis: the normal Doji, dragonfly Doji, gravestone Doji, and long-legged Doji. Although these are slightly different in appearance, they serve the same function.
A spinning top is a Japanese candle stick that looks similar to a Doji. The main exception is that it has a slightly bigger (but overall small) body than its counterpart. Also, while some traders consider the spinning top an indecision candle, some traders use it only for reversal signals.
Let’s look at an image of this candlestick before explaining how it works:
The final colour of the spinning top is generally different from when the candle opened. For instance, with a bullish spinning top, the candle is often red at the beginning. This is because buyers and sellers push the price at considerable distances on either end during the session.
That’s what produces the long wick. However, the colour change is a slight but notable indication of a potentially new dominant force. If the colour stays the same, the trend will likely continue in its previous direction.
The pin bar is another intriguing set-up when looking at Japanese candlestick trading. It’s a candle with a small body (usually covering about 15 to 20% of the entire candle) and a long wick on the other side.
The body’s remaining end has a small tail or ‘Pinnochio nose,’ which is why it’s called a pin bar.
Chartists like to regard the pin bar as a ‘rejection’ candlestick with a similar structure to a spinning top. The length of the wicks is more or less the same as its counterpart. Yet, the pin bar’s body is a little bigger.
So, it can offer a more accurate picture of the dominant force going forward based on the colour.
The ‘hammer’ goes by several names like the ‘hanging man’ and ‘shooting star.’ It looks similar to a pin bar; long wick (covering most of the candle) and a small body. The difference is that the body doesn’t have a ‘nose’ or a tiny tail.
There is always confusion between hammers and pin bars as both are rejection candle sticks. It boils down to individual preference. Some traders consider hammers as continuation signals while pin bars as reversal set-ups.
However, both hammers and pin bars can indicate either, depending on where and how they form.
Now we’re looking at double Japanese candlestick formations. An engulfing consists of a bullish/bearish candle with another candle of a noticeably larger size. We say the latter candle is ‘engulfing’ the one next to it, given its superior proportion.
Like other single-candle formations, an engulfing pattern can signal a reversal or continuation.
Think of the harami as a ‘reverse’ engulfing candle stick set-up. It is a two-candle pattern where the first candle is considerably bigger than the second. This is in contrast to an engulfing pattern where the roles are reversed.
The name ‘harami’ is Japanese for pregnant, referencing how the pattern resembles a pregnant stomach. Like the engulfing, traders use the harami in trend and non-direct scenarios./
Evening and morning stars
The evening and morning star candlesticks are three-pronged reversal patterns (check out the Doji version here), combining elements of several formations.
An evening star consists of a bullish candle, a bullish spinning top and a bearish candle that engulfs the previous two.
On the other hand, the morning star has a bearish candle, a bearish spinning top and a bullish candle engulfing the last two candles.
What makes evening and morning stars more compelling is the time they take to form. The extra engulfing candle offers confirmation that the price is more likely to reverse.
Three white soldiers and three black crows
The other popular reversal formations of three candles are white soldiers and black crows.
The former appears after a downtrend, where you get three consecutive bullish candles. On the other, ‘three black crows’ form after an uptrend, where you see three successive bearish candles.
The main drawback of this pattern is that your stop loss will need to be wider, given the distance from the entry to the bottom swing low or top swing high.
Why using Japanese candlestick charts is the best
Japanese candlesticks borrow elements from line and bar charts. While line charts are simplistic, they only consider the open and close prices. Bar charts are slightly better because they consider the open, close, high and low.
Yet, their construction is bland since the bars look the same. Think of Japanese candles as the 3-D version of bar charts. They add variety or spice to the price and tell a story through various unique patterns.
Excellent technical analysis needs the most visual approach, which candle sticks provide.
On the downside, some traders feel Japanese candlesticks offer too much information. This is why some prefer Heikin Ashi, which also uses colours. The main difference is that an average-based formula is applied to the chart, giving them a ‘smoother’ look.
Yet, this calculation leaves out the nuance and detail that candlesticks have.
Drawbacks of Japanese candlestick charts
We’ve just mentioned one disadvantage of these charts. However, the biggest one to keep in mind is a problem with technical analysis generally: predictive ability. Candlesticks are not the be-all and end-all.
Everything in trading is about context. A pin bar or hammer alone is not a powerful signal. Yet, if you’re trading forex and combining it with support/resistance, or patterns like head and shoulders and double bottoms/tops, they become more effective.
Something else worth mentioning about candle stick patterns is the time frame. The higher the time frame, the more reliable they become. This is because of the concept of ‘noise.’ The lower charts show higher volatility, given that they reflect a greater number of candlesticks.
The depth of information makes it challenging to form an idea of the trend and can lead to false signals. Yet, the bigger time frames ‘smooth’ out the movements, making them more reliable.
The type of chart traders use greatly impacts the quality of their trading decisions. While you can use many charts, it’s hard to beat Japanese candlesticks. They are easy to use, visually aesthetic and data-rich.
Remember that context and confluence are crucial if you’re looking to incorporate candle stick patterns.