Japanese candlesticks are one of the most popular methods of the technical analysis. Combinations of Japanese candlesticks are used for two purposes: they help to recognize the current trend and determine entry points to open long and short positions as well as identify possible reversals in the market.
Let's make a short historical journey. Who and when did invent the candlesticks? Japanese candlesticks were invented in the seventeenth century. Japanese traders of rice futures were the first who began to use candlesticks as a tool of the technical analysis. Munehisa Homma, a rice merchant from Japan, is considered to be a father of the candlestick chart.
On the West, Japanese candlesticks appeared much later. Steve Nison, the author of “Japanese Candlestick Charting Techniques”, introduced them. He opened to the Western world candle formations and made a significant contribution to the popularization of Japanese candlesticks.
How are Japanese candlesticks formed?
Japanese candlesticks reflect the price change characteristics of a traded instrument over a certain time interval. For example, if we consider the H1 chart, each candle on it reflects fluctuations within one hour. The visibility of the candle allows identifying chart patterns. Japanese candlestick consists of four indicators.
- Open – the price formed in the beginning of the trading period;
- Low – the lowest price of the trading period;
- Close – the price formed at the end of the trading period;
- High – the highest price of the trading period.
Each candlestick has its own unique look. On the chart, you can find short, long candlesticks, candlesticks without shadows, or candlesticks which are consisted only of shadows, the so-called doji.
A candlestick is a filled or a hollow body with upper and lower shadows. The filled (black) candlestick is considered to be “bearish”, the hollow (white) one – “bullish”. If quotes increase, the candlestick is colored in white. If quotes fall, then the candlestick is black.
The vertical lines above and below the candle body are Highs and Lows for the selected period, they are called shadows.
If the close price is higher than the open price, there is the uptrend in the market and the candle is colored in white. If the open price exceeds the close price, there is the downtrend and the candle is colored in black.
Japanese candlesticks bodies
Candlesticks have different sizes. They may be long or short. The size of the candle shows in what range the price was for the selected period. Typically, the long body of candlesticks indicates the power of sellers/buyers. The longer the body is, the more intense the buying or selling pressure is. Short bodies indicate the consolidation formation. It happens when there are no pronounced trends and directions of the price movement in the market.
Long hollow candlesticks signal a strong buying, when long filled ones mean strong selling pressure, respectively.
What the Japanese candlesticks shadows can tell us?
The shadows of the candlesticks are lower and upper and signal the activity of traders of the chosen time period. Shadows can be either on both sides of the candle, or only on one, or candlestick may be without shadows. The length of the shadows indicates how far the price moved and how much it is corrected.
Long shadows mean the trading activity was quite high, while short shadows tell us that there was a low activity in the market. You can observe long bodies with small shadows in a high momentum trend. Small bodies with long shadows tell us about the uncertainty.
The long white body indicates the bullish trend, ie buyers prevail in the market. The longer the body, the more pronounced the signal. The long black body gives a signal that sellers are prevailing at the moment, there is a bearish trend in the market. The candle body should not be longer than the shadow.
Japanese candlesticks interpretation
There are various types of Japanese candlesticks on Forex. Relying on the bodies and shadows of candlesticks, their length, size, one can judge about the possible future behavior of the price. It is important to get acquainted with them, as they can help you to foresee the movements in the market. Let's consider the main types and its interpretation.
- Hammer is the reversal signal. It has a small body located at the top of the price range, a long lower shadow, the upper shadow is practically absent. Hammer is formed on a downward trend and predicts further growth. So if you see “hammer” on the chart the trend will slow and change its direction. The hammer is also known as Pin-bar.
- The variation of the hammer is the "hanging" pattern. The candlestick always appears on the uptrend and gives a signal about its end. However, before interpreting this signal you will have to wait until the next candle is formed.
- A shooting star is opposite to the hammer. It has a small body and a long upper shadow, and it is formed at the resistance level. Shooting star means that the buyers raised the price, but the sellers managed to overcome them.
- The inverted hammer looks identical to the shooting star, the only difference is what a trend precedes their formation. Both candles have a small body, long upper shadows. The inverted hammer is formed on a downtrend and assumes the possibility of a reversal. It has a long upper shadow. This pattern means that the number of sellers decreases, and buyers – increases.
- Doji is a candlestick which open and close prices are equal. Doji stands for the agreement between buyers and sellers, or it points to the testing of the level, or it means that both sellers and buyers are absent in the market. This formation can lead to the trend continuation or its reversal. Doji has various types depending on the length of the shadows: long-legged doji, dragonfly-doji, gravestone doji.
- Marubozu is a candlestick without shadows. There are bearish and bullish Marubozus. These candlesticks indicate that buyers/sellers dominate in the market and the trend will continue. The black Marubozu tells about the downtrend and implies the bearish continuation or the bearish reversal, the white one indicates the uptrend and tells about the bullish continuation or the bullish reversal, respectively.
- Engulfing is a two-candlestick pattern. It consists of two candles of different colors. The body of the second candle engulfs the body of the first one. There is a bullish and a bearish engulfing.
Many Forex traders prefer the Japanese candlestick chart, as candlesticks display four important indicators at once. The chart is more visual that allows a trader to assess the situation quickly and make the right decision.