Japanese Candlestick Patterns
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Candlestick trading has become popular among technical traders due to the rapid growth of the candlestick trend. In addition, Japanese Candlestick Patterns are incredibly versatile, and many consider these patterns reliable indicators of future positive or negative price swings.
Can these chart patterns be trusted to give reliable and accurate results, and do they work in all market conditions?
Candlestick patterns are unreliable in every case, but some are, and you can use them as part of a trading strategy. Many factors related to your overall trading strategy affect the reliability of the candlestick pattern, including the market, your trade-in, the timeframe, and other related factors.
This article will tell you all you need to know about Japanese candlesticks charts, how they work, and whether they are reliable and accurate for trading decisions.
What is a Japanese candlestick?
The Japanese candlestick pattern is a technical analysis tool traders use to chart and analyze price movements. A Japanese rice trader named Munehisa Homma developed candlestick charts. When Homma was routinely trading, he found that market forces such as supply and demand affected rice prices.
Homma’s candlesticks portray price movements graphically using different colours to denote the changes. Traders can use such patterns to identify price action patterns and decide on short-term price movement.
Famous for developing the method of candlestick charting, Homma dominated rice markets and became an expert trader of financial instruments. Technical analysts in Japan incorporated Homma’s candlestick methodology into the trading process shortly after Japan’s stock market began in the 1870s.
By publishing his book “Japanese Candlestick Charting Technique,” the American technical analyst Steve Nison debuted the technique in the West. As a result, financial trading markets using Japanese Candlestick charts have widely used technical indicators.
How does candlestick trading work?
The candlestick chart consolidates the data from a selected time frame into a single chart bar. A candlestick provides information about the price movement of a security over a specified period, such as a minute, hour, day, or month.
Thus, a candlestick indicates opens, closes, highs, and lows within the chosen timeframe.
The colour codes make it easy to determine whether a price has increased or decreased. For example, red or black candles indicate negative (bearish) candlesticks, while white or green stick indicates positive (bullish patterns).
A bullish candlestick will generally show a higher close than the open. On the other hand, a bearish one will show a lower close than the open one.
To identify a candlestick, look at its body, wicks, and colour. Patterns can take many forms, and while individual candlesticks’ shape, colour, and direction may seem random, sometimes several candlesticks join together to tell a story.
By examining candlestick patterns, traders can determine bullish or bearish market sentiment and confirm their predictions about the market’s future direction.
Bearish candlestick patterns
Bearish patterns signal an impending downward movement.
Like their bullish counterparts, they can be classified as reversal or continuation patterns. Reversals usually signal a rally’s end and a downtrend’s beginning. On the other hand, continuation patterns can indicate that a bear run is not over yet.
When trading bearish patterns, be sure to wait for confirmation. You can confirm a bear move by looking for a red candle right after the pattern or waiting until a key support area has been broken.
Bullish candlestick patterns
Candlestick patterns with bullish candles indicate that a market is about to move upwards. Patterns can be reversal patterns or continuation patterns.
Markets in a downtrend might be about to bounce back into an uptrend if they show a reversal pattern. Continuation patterns, on the other hand, occur during uptrends and may indicate that momentum isn’t waning.
It’s always a good idea to wait for confirmation before opening a position when trading candlestick patterns. A pattern does not guarantee future behaviour, so waiting for confirmation can reduce the risk of losing out in case of a trend or continuation does not materialize.
It is possible to confirm before trading in several different ways. Before jumping in, you might want to wait for the trend or continuation to begin. To take a closer look at current price movements, you could also look at a shorter-term chart.
Does Japanese candlestick Patterns trading work?
Some traders who have had marginal success using candlestick patterns fail because they erroneously believe all patterns follow a similar path. Instead, these patterns form when traders take a single action, such as selling when they see bearish pin bars.
However, the reason a market pattern forms have nothing to do with this, so traders don’t carry out an analysis to determine the reason.
Simply put, candlestick traders believe the price moves according to the candlestick pattern after a pattern. Therefore, they assume the pattern caused the market to behave the way it did and that new patterns will behave similarly in the future.
Candlestick patterns have consistently been 50% successful in studies examining their effectiveness. To do this, traders need to learn how to differentiate between patterns that are likely to turn profitable and those that are likely to lose money. When used correctly, trading Japanese candlestick patterns is effective.
Market analysis can benefit from it.
Candlestick patterns and shapes provide valuable data regarding what transpires in the market and can be used to predict what will happen in the future. Some patterns could indicate reversals in the market, indicating a continuation pattern.
This makes chart patterns an essential tool for analyzing the market, which explains why some price action traders work with chart patterns when doing technical analysis.
Candlesticks make it easier to read price action.
Even beginners can interpret candlesticks efficiently and accurately. By simply looking at the colour-coded candlesticks, you can determine the direction of price movements, making it much easier to analyze the market. Furthermore, you can use the information you get from your chart to make your analysis.
How to read Japanese candlestick patterns?
The three elements of Japanese candlesticks you need to become familiar with are their colour, body, and wicks. This chart’s colour indicates movement within the period, its body indicates the opening and closing levels, and its wick indicates highs and lows.
As a rule of thumb, green candlesticks indicate upward movement, and red ones suggest downward. However, some people may prefer white (up) or black (down) candles.
For a green stick, the top of the body represents the close, and the bottom represents the open. On a red candle, it’s the opposite.
Both the red and green sticks have wicks (sometimes called shadows) at the top and bottom, indicating how high and low the market got in the period.
An example of a green and red candlestick
These three elements can significantly influence the movement of a market within a certain period. For example, a green candlestick with a long body indicates significant bullish price action.
It is a sign of high volatility within the period when the wick is taller than the elongated body. Bulls and bears were battling for control, with the bulls ultimately winning.
Short red candlesticks with high upper wicks indicate the price was driven higher by bulls before bears subdued it. A candlestick without any wick means the open or closing price was also high or low.
Technical traders use specific patterns as indicators of possible future movements. These patterns indicate specific behaviours that have led to particular outcomes.
Candlestick patterns come in three variations: single, double, and triple. A candlestick pattern consists of a certain number of sticks.
These patterns can be helpful for spotting opportunities despite past performance not guaranteeing future price movement. There are several examples below.
Single Japanese candlestick patterns
The following patterns consist of only one trading period and are some of the simplest. These preferred Japanese candlestick patterns often serve as building blocks for more complex ones.
The design of inverted hammers is the same as that of hammers, except they are placed upside down. This means that the body has a relatively short range beneath the wick, which has a high upper end.
It is also common for them to appear at the end of downtrends, and they can signal the end of the trend. Inverted hammers, however, behave differently in terms of price action.
It can be seen from the upper wick that buyers controlled the market within the session, but sellers resisted. Despite this, sellers could not drive its price further down, suggesting that bearish sentiment may be waning.
Whenever there is a hammer, the best way to open a buy position is to wait for confirmation immediately following it, usually through a bullish candlestick.
Meanwhile, a shooting star is an inverted hammer’s doppelgänger. Unlike the hanging man, a shooting star appears at the top of an uptrend instead of the bottom of a downtrend.
Shooting stars begin with the bulls still in control. Bears then take over, pulling the asset’s price down once again.
- Green shooting stars have been pushed back to just above the open area
- The red shooting star has been pulled down below the open area
- It appears that both indicators point to a reversal imminent.
To trade forex in a bear market, you’ll often need to wait for signs of a new one, just as you would with the hammer, inverted hammer, and hanging man.
In appearance, a hanging man and a hammer are identical, but where they appear differs.
After a bear market, a hammer appears, while after an uptrend, a hanging man appears. The indicators show that the significant selling pressure against buyers is growing, so reversal patterns may be on the way.
There was strong resistance to sellers’ control of the market. The resistance, however, only kept the price in check. It didn’t continue the bull run. This may indicate a change in sentiment.
While both red and green hanging men are considered bearish candlestick patterns, red is usually considered a stronger indicator.
The doji sign occurs when the opening and closing prices are nearly (or exactly) the same for a given period. The buyer and seller will have cancelled each other out no matter how the price moves within the period.
The best way to spot a doji is to find a candlestick with a skinny body: usually less than 5% of the range for that period.
You can then determine the type of doji by looking at the wick:
- Gravestone doji is when a long upper wick is visible above the body
- When the wick extends below the body, it’s a dragonfly
- When the wicks are long on both sides, it’s a long-legged doji
- When the candle has no wick at all, it is a four-price doji
On its own, a doji is not very informative. Yet when viewed in context, it becomes more meaningful.
During an uptrend, for instance, you may notice gravestones forming. Although the upper wick indicates that the bull run may have continued at the start, its thin body suggests that sellers took over by the end of the session. It seems likely that the trend will reverse.
If your candlestick has a narrow body and a long wick above and below, you have a spinning top. Consequently, the market had an extensive trading range but only slightly between open and closed.
When forming a spinning top, it does not matter whether the stick is red or green – all that is needed is a small body and a long wick.
The buyers and sellers compete against each other on a spinning top. Although the bulls and bears are cancelling each other, there hasn’t been much movement.
Technical traders view a spinning top as an indication of weakness in an ongoing trend.
After a long bull run, a market may spin a top, which indicates the positive sentiment may have worn off. Instead, bullish sentiment appears to be gaining strength following a downtrend.
Double Japanese Candlestick Patterns
Whenever a signal follows two consecutive periods, it’s called a double candlestick pattern. The use of these double candlestick patterns is often used to predict trend reversals, as well as to identify continuation patterns.
The engulfing pattern occurs when one candlestick is followed immediately by another one in the opposite direction.
Japanese Candlesticks – Bullish Engulfing pattern
An engulfing candle is a bearish candle that closes lower than the last candle but has a noticeably longer close than the previous candle, engulfing it and its range. As the bullish candle grows longer, the more it “engulfs” or exceeds the range of the prior bearish candle, the more bullish it becomes. As always, context and timing play an important role. In addition to a long downtrend appearance, a pair at strong support is more bullish since these are other signs that the downtrend may be over.
Japanese Candlesticks – Bearish Engulfing pattern
Bearish engulfing consists of a bullish candle (higher close) followed by a noticeably long bearish candle (lower close), which “engulfs” the range of the previous bullish candle. As a bearish candle burns longer, it encompasses or exceeds the previous bullish candle’s range, which increases its bearish pattern. Considering context and timing in the bullish engulfing pattern is always important. There is a greater risk that the uptrend has already exhausted itself if this pair appears after an extended uptrend when there is strong resistance or both.
An engulfing pattern characterized by candlesticks that follow much smaller candles in the other direction is known as a harami.
Some believe the pattern resembles the gestational phase of a pregnant woman, hence the name harami.
Bullish haramis are characterized by a red candle followed by a green candle that is entirely contained within its body. When this occurs, it is considered a sign that a downtrend is ending.
The opposite happens in a bearish harami, with a green candle followed by a smaller red candle. To determine the strength of the signal, the size of the second candle’s body is used: the smaller the stick, the stronger the signal.
Harami crosses are formed when a harami is followed by a doji – the smallest candle body possible.
Triple Japanese candlestick patterns
This article covers the longest patterns, or triples, made across three successive periods. There are several reasons why triple candlestick patterns are regarded as some of the strongest indicators of future price movement.
A morning star demonstrates a fairly clear shift in sentiment with three candles.
- The first candle– a long red stick indicates continuation patterns
- The second has a short body in contrast to the first candle – indecision is undermining the trend
- The third is a long green candle, as a bullish reversal pattern forms
There is a key candle in the middle of the Japanese candlestick chart. It indicates an ending of the downward trend, typically by forming a spinning top. Moreover, the signal becomes even stronger if the middle candle pattern is a doji.
A morning star can be verified by checking that the third candlestick crosses the first’s mid-price.
Morning stars represent bull markets, showing a point of indecision followed by a retracement. Evening stars represent indecisive bull markets.
As in a morning star, it starts with a green candle – after an extended uptrend – and ends with a red candle.
You can form both evening and morning stars with a doji in the middle. Sometimes it is interpreted as a sign that the subsequent move will be more pronounced after a lengthy period of indecision.
Three black crows pattern
There are three black crows on the opposite side of the pattern, as there are three white soldiers. After an uptrend, it is characterized by three consecutive longer red candles and is a strong sign that the bull market has ended.
In the second candle, the lower wick should be short or nonexistent, while in the third candle, the wick should almost be nonexistent.
If the three black crows are seen in the market, a technical trader may try to profit from the following bear market by opening a short position.
Three white soldiers
An extended downward movement is followed by a small consolidation pattern which shows three white soldiers. As one of the clearest signs that the bear market has ended, technical traders use it as a guide.
The three soldiers are:
- A green candle following a downward move
- Another green candle with a larger candle body and a shorter upper wick than the first
- Lastly, a green candle with a comparatively short body similar to the second one and no wick whatsoever
Three black crows
Three black crows make a different pattern from three white soldiers. Typically, it is seen after an uptrend, consists of three consecutively longer red candles, and signifies the end of a bull market.
In the second candle, the lower wick should be short or nonexistent, while in the third candle, the wick should almost be nonexistent.
Trading the three black crows can be viewed as an opportunity to open a short position for profits during the next bear market.
How accurate is candlestick trading?
Since they provide detailed information and are easy to use, candlestick patterns are popular among beginning traders. They mainly use candlestick patterns to reveal where prices are likely to move. However, these predictions are not always accurate.
You can’t learn everything from candlesticks. Using candlesticks, for example, it’s impossible to determine why the open and closed data points are similar or different. Therefore, candlesticks aren’t suitable for analysis alone.
You should use additional analysis methods to enhance your trading experiences, such as market structure, oversold or overbought conditions, trend direction, and support and resistance levels.
By incorporating candlestick patterns with technical analysis and advanced computing, you can improve your trading strategies, making them more efficient.
Are candlestick patterns reliable?
The candlestick pattern is one of the ways traders use it to predict price movements. However, in some cases, the patterns themselves may not be accurate enough, resulting in less reliable signals from the patterns.
In addition to their massive popularity, candlestick patterns have reduced their reliability significantly since hedge funds analyze them using their algorithms to entice retail traders to take advantage of high-odds gains.
You may consider using candlestick patterns with other trading strategies instead of solely using them as a trader. However, using candlestick patterns effectively is still an excellent method of understanding the market’s driving forces.
Several factors impact the reliability of candlestick patterns, but you can trade with more confidence if you note these factors. They include:
- The timeframe: Short-term timeframes are less reliable than long-term ones due to the more considerable volatility since trader sentiment tends to change more frequently on a short-term basis. In contrast, daily or weekly timeframes offer more reliable long-term effects.
- The instrument: Different instruments behave differently, but the crucial factor is the traded volume (liquidity). Generally, the more volume traded, the more reliable the candles will be. Hence, some candles work better for forex, while others are better for stocks.
- The trade chart patterns: Look at the environment in which the candlestick occurs. Trades that are supported and challenged nearby have a good chance of working.
- The pattern size: The larger the pattern, the more accurate it tends to be. Significant price movements also generate strong signals.
- The candlestick pattern: Certain candle patterns are more reliable than others. On the other hand, a formation that contains more candles tends to be more reliable. Unfortunately, this formation doesn’t occur very frequently.
Which candlestick pattern is the most reliable?
No one candlestick pattern consistently predicts price action, but some appear to do so more than others. This article has a few popular patterns, but the Doji patterns are often considered the most reliable.
Do candlestick patterns work?
Candlestick patterns are effective – just not in every case. However, you should always use a stop loss and confirm the move, whichever pattern you choose to trade. Then, if the pattern fails, you are at a lower risk.
How many different Japanese candlestick patterns are there?
Many more Japanese candlestick patterns are not covered here, but we have covered two. Of course, each technical trader uses a different pattern, and more and more new examples appear daily. So you might better focus on a few basic patterns for those just getting started and build from there.
How are candlestick patterns used in day trading?
You can use Japanese candlestick patterns in day trading the same way you would anywhere else spot a pattern on the market, confirm the move and then enter a position. Day traders often use short-term charts to spot opportunities, but the principle remains the same overall.
You can gain a competitive edge in the market by using Japanese candlestick trading patterns for technical analysis. Therefore, the key to using patterns is understanding how to use them. Open your position and start trading after ensuring you have the right risk management strategy in place.
This is because it gives you an understanding of the market’s potential trends and the ability to make decisions based on those conclusions. You can use these trading patterns to your advantage if you use them properly.
Jason Morgan is an experienced forex analyst and writer with a deep understanding of the financial markets. With over 13+ years of industry experience, he has honed his skills in analyzing and forecasting currency movements, providing valuable insights to traders and investors.
Forex Content Writer | Market Analyst