Japanese Candlesticks Patterns are a technical tool that forms unique candlesticks based on market high, low, open, and close. Traders analyze the candlesticks to predict the price movement of financial instruments such as forex, commodities, and stocks. Contrary to western technical tools that use mathematical formulas the candlestick analysis is the visual analysis of the markets using candlestick charts. There are several candlestick patterns like Dark Cloud Cover, Bullish and Bearish Engulfing Patterns, Doji, Hammer, Hanging man, and so forth. These patterns are categorized into single line patterns and multiple line patterns. Throughout this course, we will discuss how the candlesticks are formed and learn to analyze the markets using single line and multiple line candlestick patterns. But let’s first start with a brief history of Japanese candlesticks Analysis.
History Of the Japanese Candlesticks
The Japanese Candlesticks Analysis is the oldest form of technical analysis in the world and has a very interesting history. Munehisa Homma, a Japanese rice trader developed this technique in the 17th century. He was born in 1724 in the city of Sakata, his family-owned vast rice plantations, and engaged in rice trading. After his father’s death, Munehisa started managing his family wealth. Around this time a rice exchange was formed in the city of Sakata, the exchange offered rice coupons which were a receipt for the supply of the next harvest. This is considered as the earliest form of future trading.
Munehisa traded on the exchange for several years, during this time he closely analyzed the market from various perspectives including human fear and greed. He soon started to notice that similar market patterns emerge time and again. To use this to his advantage he started to track the opening, closing, low and high of the market and put them on a paper. This graphical representation of the numbers formed candlesticks which marked the beginning of the candlestick and their patterns.
Munehisa became a rich person by using his trading techniques. He also wrote the world’s first two books on technical analysis and his research work became the basis of trading in Japan. Today, candlestick patterns are used worldwide and there are over 62 recognized patterns used by traders.
Introduction to the West
Until the 1980s the western analysts were largely unaware of the Japanese candlesticks. They used various other charts like line charts, bar charts, and so forth. The bar charts are similar to the candlestick and use the same four key prices as the basis of their construction but the information candlestick charts provide is more comprehensive than the bar charts. In the 1980s Steve Nison became the first person to introduce the Japanese candlestick charting and analysis to the west. He was working at Merrill Lynch when he met a Japanese broker who used terms like “Doji” and “Harami” while talking to his clients. Nison was intrigued and started researching on the Japanese Candlestick. He was impressed by the rich history and the information candlesticks provided. As he dug deeper he realized that the candlesticks are a very useful and reliable source of analysis. In his quest to introduce his findings he started to lecture in the universities and wrote three successful books in the coming years. Nison became a pioneer in candlesticks analysis in the west and was the first person to receive the Chartered Market Technician (CMT) designation. His books are translated in 12 languages and he has appeared on numerous television networks including CNBC.
The Candlestick analysis is now more popular than ever before, the analysts believe that candlesticks are more aesthetically pleasing and of course more useful for technical analysis since they give a more clear view of the market than most other types of charts. The fact that the Japanese nation became an economic superpower not once but twice in the 20th century suggests there’s a lot to be learned from the Japanese way of looking at things.
How are Japanese Candlesticks constructed?
Now that we know the history of the candlesticks, let’s see how the candlesticks are actually constructed before we move on to the advanced part of the course which is learning and analyzing the single and multiple candlestick patterns. The candlestick is basically a rectangle with the open price and the close price at either end. The high and low prices are attached to the rectangle with vertical lines. The rectangle is called the candlestick body or sometimes the real body. The vertical lines are known as the shadows, wicks, or hairs. If the closing price is greater than the opening price it means that price has risen over the period and the candlestick has a red or white body. If the closing price is lower than the opening price it tells us that the price has fallen over the period and the candlestick is red or black. The color change in the candlesticks makes charts more immediate and easier to interpret than the traditional western bar charts.
What Information Candlesticks Provide
Basically, a candlestick represents the balance between the supply and the demand for an asset or in other words the struggle between the bulls and the bears who repeatedly attempt to take control. The beauty of Japanese candlesticks is that one single candlestick has the potential to predict future price action for days or even weeks ahead since it represents a set of data for the complete price action during a selected timeframe. For instance, if you’re looking at a chart in a 15-minute time frame a candlestick is placed on the chart every 15 minutes and represents the entire price movement of that asset in the fifteen minutes. Similarly, if you’re looking at a longer-term chart, say a daily chart, every one day a candlestick is placed on the chart. This is how the candlesticks charts are constructed and provide valuable information to analyze the market.
The two most obvious prices in a candlestick are open and the close. This is not accidental, the Japanese candlestick analysis says that these are the two most emotional times of the trading day, the times most governed by fear and greed. If you have an interest in the stock market you’ll have most probably heard of the January barometer, it tells us that how the S&P 500 does in the first few weeks would be a reliable indication about the direction of the market for the entire year. When Japanese candlesticks were being developed Japan had a very martial culture, it was natural for them to see the trading day as a battleground between the forces of buyers and sellers. The opening can be of vital significance likewise the closing is also significant since at the end of the trading day traders may feel the pressure, they might be thinking of their targets that must be met or the possibility of missing opportunities.
All these considerations hold true for the majority of the stock exchanges but of course on Forex we’ve got 24-hour trading. The world spins around, some exchanges start trading and others stop for the day, openings merge into closings which in turn merge into fresh openings. It’s difficult to know where the beginnings and the ends are. The only things we can say for sure on a forex market are that we must take all four key prices, the time of the day, and the currency pair that you are working on into consideration.
The Candlesticks have different shapes and they form a variety of distinctive patterns that can be translated into information. For example, a long green body candlestick represents intense buying pressure and a long red body candlestick represents intense selling pressure. These candlesticks have different names and when they are put on a chart they emerge and re-emerge which forms patterns that are further categorized into a single line and multiple lines patterns.