Japanese candlestick charts originated in Japan in the 18th century and most used price charts in trading since then. They’re called “candlestick” charts because the individual price bars resemble candlesticks, with a long wick at the top or bottom and a thicker body in the middle.
You can get more information than other chart types with the Japanese candlestick charts. You can gain insights into the market sentiment and potential future price movements by analyzing the patterns and shapes of candlesticks.
Each candlestick represents a specific time period like 5 min, 1 hour, or one day. The top of the candlestick represents the highest price during that time period, while the bottom represents the lowest price. The body of the candlestick represents the difference between the opening and closing prices.
Formation of Candlestick
You can spot two colors of candlesticks, red and green. The green candlestick represents the bullish trend whereas the Red candlestick represents the bearish trend.
A green candlestick indicates that the closing price at the end of the time period is higher than the opening price,
A red candlestick indicates that the closing price is lower than the opening price.
To illustrate this, let’s consider an example. Suppose you open a 5-minute candlestick chart of stock at 10:30 am when the price is Rs. 228. If the price rises to Rs. 232 by 10:35 am, a green candlestick will be formed.
Candlestick patterns are composed of four main components: open, high, low, and close, each of which represents a specific period of time, such as 5 mins or 1 day.
- Open: Stock opening price at the time of candlestick formation. For example, if you’re looking at a daily candlestick chart of a stock, the open price would be the price at which the stock opened on that particular day.
- High: The highest price that the stock reached during the candlestick formation.
- Low: The lowest price that the stock reached during one candlestick formation.
- Close: The price at which stock closed. For example, for a daily candlestick chart of a stock, the price at which the stock closed at the end of that particular day.
Candlesticks are made up of 2 parts, the Body and the Wick (Tail).
- Body: The body of the candlestick represents the opening and closing price of the stock over a specified time period.
- Wick or Tail: The wick or tail of a candlestick represents the range of prices that the stock traded within during the specified time period. The upper wick or tail represents the highest price the asset reached during the period, while the lower wick represents the lowest price.
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How to Read Japanese Candlestick Patterns
You need practice and patience to start understanding the candlestick patterns. You can start with the basic steps to reading Japanese candlestick patterns:
- Identify the time period represented by the candlestick
- Determine if the candlestick is bullish or bearish
- Analyze the length of the wicks and the size of the body
- Look for patterns or clusters of candlesticks to identify potential trends
Step 1: Identify the Time Period
Each candlestick represents a specific time period, such as one day, one hour, or one minute. You’ll need to determine the time period represented by the candlestick you’re analyzing to make informed trading decisions.
if you want to enter and exit a trade within a few minutes by taking advantage of small fluctuations in prices you can use 5 min or 10 min candles. But if you want to check the overall trend or take long positions then you can 1-day candles chart.
Step 2: Determine if the Candlestick is Bullish or Bearish
You need to analyze a candlestick whether it’s bullish or bearish. A bullish candlestick has a long body and a short wick at the bottom while a bearish candlestick has a long wick at the top and a short body. This information can give you insight into market sentiment and help you predict the next candlestick for future price movements.
Step 3: Analyze the Length of the Wicks and the Size of the Body
The length of the wicks and the size of the body can also provide valuable information about market sentiment. If a bullish candlestick has a long wick at the top, it indicates that the price reached a high point during the time period but then retreated. Similarly, if a bearish candlestick has a long wick at the bottom, it indicates that the price reached a low point but then rebounded.
The size of the body can also provide insight into market sentiment. If a bullish candlestick has a large body, it indicates that buyers were in control during the time period and drove the price up. But if a bearish candlestick has a large body, it indicates that sellers were in control and pushed the price down.
Step 4: Look for Patterns or Clusters of Candlesticks to Identify Potential Trends
You can identify the potential trend reversals or market sentiment shifts by analyzing the patterns and clusters of candlesticks. There are dozens of candlestick patterns, broadly divided into 3 categories. You can read the article All 37 Candlestick Chart Patterns in the Stock Market.
1. Bullish Reversal Candlestick pattern
A Bullish Reversal candlestick pattern indicates a potential reversal in a downtrend. This pattern suggests that sellers (bears) are losing their grip on the market and buyers (bulls) are gaining control. These patterns are observed towards the end of a downtrend, signaling a change in the direction of the trend.
These patterns can be useful in identifying potential entry points for long positions or confirming a bullish outlook. The most popular bullish candlestick patterns are Hammer candlestick, Bullish Engulfing, Piercing Line, and Morning Star.
2. Bearish Candlestick Patterns
A bearish candlestick pattern suggests a potential reversal in an uptrend. These patterns indicate that buyers (bulls) are losing their grip on the market, and sellers (bears) are gaining control. Usually, these patterns are observed towards the end of an uptrend, signifying a change in the direction of the trend.
These patterns can be beneficial in identifying potential entry points for short positions or confirming a bearish outlook. The most popular bearish candlestick patterns are Bearish Engulfing Pattern, Evening Star Pattern, Dark Cloud Cover Pattern, and Shooting Star.
3. Continuation Candlestick Patterns
Continuation candlestick patterns suggest a temporary pause in a trend before it continues in the same direction. These patterns are referred to as continuation patterns because they imply that the market is taking a breather before resuming its prior trend.
Continuation patterns can be observed in both uptrends and downtrends. The most popular continuation candlestick patterns are Doji Pattern, Spinning Top Pattern, Falling Three Methods, and Rising Three Methods. 1
By analyzing patterns and clusters of candlesticks, you can gain insight into potential future price movements and adjust your trading strategies accordingly. I have explained the steps to use the candlestick for day trading.
How Japanese Candlesticks Different from Bar Chart
While Japanese candlestick charts and bar charts both display the same information, there are a few key differences between the two.
1. Visual appearance
Candlestick charts are more visually appealing and easier to read than bar charts. Candlestick charts use red and green color bars to represent price movements, while bar charts use lines or bars that don’t have the same level of detail.
2. Information provided
Candlestick charts provide more information about the price movement within a given time period. The body of the candlestick represents the difference between the opening and closing prices, while the wicks show the highest and lowest prices reached during that time period. Bar charts, on the other hand, only display the opening and closing prices.
Japanese candlestick charts provide more information about market sentiment. You can identify potential trend reversals and market sentiment shifts by analyzing the patterns and shapes of candlesticks.
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Do not blindly enter a trade based solely on a spotted candlestick pattern. It is crucial to wait for confirmation from subsequent candles, especially in the early stages of the pattern.
Consider the current market conditions and formulate a trading strategy accordingly. For example, breaking news like a financial report, dividend declaration, or regulatory changes can cause sudden market sentiment shifts, regardless of prior technical chart indications.
Like any trading strategy, trading based on Japanese candlestick charts carries risks. It’s important to always manage risk by setting stop-loss orders and maintaining discipline in following a trading plan.
No, candlestick patterns are not always accurate in predicting future price movements. They should be used in conjunction with other technical analysis tools and market research to make informed trading decisions.
The time period you choose will depend on your trading strategy and goals. Shorter time periods, such as one minute or five minutes, can provide more detailed information about price movements, but can also be more volatile and subject to noise.
Longer time periods, such as one hour or one day, can provide a broader picture of market trends and can be more reliable for identifying long-term trends.
Yes, Japanese candlestick charts can be used for any market, including stocks, futures, and forex.