Japanese Candlesticks – The Norm?

As a technical trader, you need to dig deeper into charts to know future price movements. There are different types of charts you can use for this purpose.

However, the one that stands out is the Japanese candlestick chart.

Japanese candles are a graphical representation of what the asset has done during a specified period.

According to the market, the Japanese candlesticks were used around the year 1700 by rice sellers who were trying to get the best return on their products.

The creator of the candlesticks was a Japanese named Homma. In the western world, it became known in 1991 when Steve Nison published his book “Japanese Candlestick Charting Techniques“.

Candlestick charts have aided traders in forecasting market sentiments since their creation. Traders can improve their trading methods by combining candlestick patterns with other technical indicators.

Let’s dive in deeper on candlestick charts.

Candlestick Structure

Japanese candles are made up of the body, the wicks, and the colours. These three elements provide valuable information.

The Body

The body indicates the price variation during the period studied through its height. Its height is defined by the opening and closing values. Thus, by looking at the candle's body, we can know at what price the period started and with what price it ended.

The wicks

The wicks indicate the maximum and minimum values reached during the period. The upper wick indicates the high, and the lower wick the low.

The colour

This is probably the greatest contribution of Japanese candles to technical analysis in the Western world. Before the Japanese candles, the bar chart was already being used.

The bar chart is very similar to the Japanese candles and gives the same information. However, the Japanese candles greatly simplify observing if the price fell or rose. While the bars can be coloured visually, the coloured body of the Japanese candlesticks is much better.

Why are Japanese candlesticks so popular?

Graphically analysing market trends allows us to understand its behaviour. The Japanese candlestick chart helps us understand how the bullish and bearish forces have interacted in the period studied to have the necessary information to make our investments.

Some common candlesticks patterns

We must understand that when viewing a chart, we are always looking back. Therefore, using charts to support our trading strategies is an exercise in looking to the past to predict the future.

We do this by identifying patterns. We expect that once we identify a pattern, the price movement will be similar to what that pattern has shown previously.

Some of the most effective types of candlestick patterns in trading are:

Hammer

It's the pattern where the lower wick is twice or more the height of the candle's body, and the upper wick is very short, almost non-existent.

So if the hammer comes after a downtrend, this pattern tells us that the market has rejected the minimum values, and the bulls have gained the pulse, with which they have started an uptrend.

Inverted Hammer

As the name implies, it is the opposite of the hammer pattern. Here the upper wick is long, and the lower wick is almost non-existent. This pattern, framed within a downtrend, means that although the highs for the period have been rejected, the market is pushing up, and an uptrend is about to start.

Hanging man

It is a type of hammer candle, but it appears in bullish trends. This candle indicates the end of the uptrend support and a trend-reversal that will initiate the downtrend.

Doji

It's the only trend that does not have a body, or its body is very small. There is almost no difference between the opening price and the closing price.

However, its shadows are prolonged compared to its body. The Doji indicates indecision, so we need to look for other patterns to predict where the market will move.

How to use Candlestick patterns?

Because there are so many distinct candlestick patterns, traders should trade each one separately.

Some of the candlestick patterns are bullish while others are bearish, and some have both qualities.

The engulfing pattern, for example, can form in an uptrend or downturn and signal a reversal to traders.

In a downturn, the bullish engulfing pattern appears, whereas in an upswing, the bearish engulfing pattern appears. After the creation of the engulfing patterns, a trader might enter the trade.

Traders should be extra cautious when dealing with a single candlestick pattern, since they are prone to misleading signals, as in the case of a doji. When the pattern appears in an upswing or decline, it alerts traders of market volatility.

This is only a basic demonstration of how to trade candlestick patterns. Traders should be cautious when a single candlestick pattern appears, since it might generate misleading indications, as in the case of a shooting star.

The pattern appears in an upswing and appears to be reversing. The candlestick can be bullish or bearish, but the issue arises when the price continues to fall despite the formation of the shooting star.

To confirm the trend's direction in a circumstance like this, a trade should combine candlestick patterns with momentum oscillators or technical indicators.

Advantages

• They show a lot of information about market behaviour simply.
• There are many strategies and patterns developed around the chart that facilitate decision-making.

Disadvantages

• In volatile markets, they may send false leads.
• Japanese candles do not allow price target calculation.

Why are they so popular?

The Japanese candlestick chart is by far the preferred price chart in trading and investing in general.

Although there are many alternatives to this chart, the amount of data that a simple drawing produces and the ease in understanding the information visually put this chart as a favourite among investors.

Most successful price patterns have developed around the Japanese candlesticks, but using these patterns in isolation diminishes their effectiveness.

Ideally, you want to confirm the patterns identified on the Japanese candlestick chart with other technical analysis tools to ensure that the market entry successfully generates the desired profits.