Candlesticks chart introduction

In this article we’ll uncover an ancient Japanese method used to attempt to forecast future price movements: Japanese candlesticks. Don’t let the word ‘ancient’ fool you. The Japanese candlesticks might have been invented in the 1700s, but many investors believe that it’s just as relevant today as it was then.

In short, the Japanese candlesticks chart is a multi-dimensional price chart and although at first glance it appears to be showing price changes only, it can also indicate the market sentiment that stands behind the price fluctuations, a more insightful indicator than most standard bar charts.

Although candlesticks are primarily a tool for technical analysis traders, it’s the closest you’ll get to fundamental analysis inside a chart.

What is each candle made of?

The upper shadow, or ‘wick’, represents either the opening or closing price depending on the colour of the candle. If the day’s closing price is higher than the opening price, the real body, or ‘stick’, will usually be either white or transparent. If however, the closing price is lower than the opening price, the candle will usually be black.
See the chart below for a more detailed explanation.

Doji types (Long-Legged, Dragon Fly and Gravestone)

There are many candlestick patterns that interest traders. The Doji is a popular example. Dojis are created if the price of a given currency pair opens and closes at nearly identical levels inside the timespan of the chart being read. Although lots of volatility and price fluctuations could have occurred between the opening and closing price of the stick, if the open and the close price is similar, it indicates that the market is indecisive and has been unable to determine the pair’s direction (up or down).

Traders use Doji candle signals as a potential indication of a price direction. Does this mean prices will always change? Of course not, that’s why it’s just an indication.

Hanging Man and Hammer candlestick patterns

The hanging man and hammer candlestick patterns are signals that can potentially reveal a price correction. The hanging man means that the price trend is heading uphill with a bearish correction expected. A hammer pattern means that the trend is going downward and an upward correction is expected. Besides the aforementioned difference, the two patterns are similar in virtually every other aspect. Both patterns involve one candlestick whose body is close to the top of the candle, an extended lower shadow at least twice the length of the real body and virtually no upper shadow. In such cases, the candlestick’s colour is inconsequential.

Morning Star / Evening Star candlestick pattern

When performing technical analysis using a chart like the Japanese candlesticks, the Morning Star candlestick pattern can represent a reversal pattern. This particular pattern boasts three types of Japanese candlesticks developing at the bottom of a downtrend.

1. The first kind consists of a long and ‘bearish’ Japanese candle.
2. The next candle is a miniature sized candle and features an ‘indecisive’ real body.
3. The final candle is one that is elongated and ‘bullish’.

In the chart above, you can see the morning star candlestick pattern.
When the trend starts heading ‘downhill’, it’s usually an indication of negative outlook (bearish) and comes from the massive selling volume of an asset. When that happens, a long, bearish candle develops. Lack of decision between buyers and sellers will often lead to the creation of the following candlestick, which is a Doji. When investors anticipate positive news of a given asset, it could create the third candle which is relatively long and is ‘bullish’ in nature. If the asset price increases, it can indicate a change in trend. The word to note of course is ‘can’ – keep in mind this is just theory, of course.

Bullish Harami / Bearish Harami candlestick pattern

Simply put, a Bullish Harami candlestick is when a big candlestick is followed by a small one and its real body does not exceed the vertical range of the previous one. Although it’s called ‘bullish’, a Bullish Harami is actually a bearish or downtrend candlestick and is often used to indicate a correction of a downward trend. Because the bullish Harami implies a trend reversal, it could potentially indicate an ideal time to go long. However, there is no guarantee of success.

A Bearish Harami, on the other hand, is a trend presented by a small candlestick followed by a far bigger candlestick with a real body that fits inside the vertical range of the bigger candle's real body. This type of pattern could theoretically mean that the last bullish trend is coming to a grinding halt.

Are you getting dizzy with patterns? We get it. Don’t worry – we’re getting close to the end now. Take a deep breath and let’s get through the last stretch.

Remember: Candlestick chart analysis is theory, not fact

We hope we don’t need to tell you that using candlestick charts while trading is not some magical tool that will tell you what to do next. Past price movements are not necessarily an indication of future price movements. Many traders believe that analyzing candlestick charts can help them make trading decisions, but this is just a theory and it certainly doesn’t guarantee results.

Conclusion

Although candlestick charts may appear intimidating at first glance, they are very accessible and useful tools that help you gauge the sentiment guiding the market. They are not oracles to be relied upon with absolute certainty but, rather, historically confirmed indications of future price activity. Since the future doesn't always look like the past, it's not uncommon for candlestick patterns to fall short in their job of predicting what's ahead.

With steady practice, you can integrate candlestick patterns into your trading strategy to great effect. The extent of your reliance on them, and the particular patterns you use, will ultimately be up to you. Traders agree, however, that their predictive power is enhanced by other technical indicators that confirm their signals.