The traders use the Japanese Candlesticks to construct charts and analyse the price movement of financial instruments. The Japanese candlesticks were introduced by a Japanese rice trader named Munehisa Homma.
While trading rice, Homma realised that the market was affected by the traders’ emotions and determined the demand and supply effect on the price of rice.
So by acknowledging both the emotions of traders and fluctuation in the price of rice because of the demand and supply effect, Homma developed Japanese candlesticks. This tool displayed the nature of price movement graphically by displaying different colours to show the difference. Therefore, the traders also use the Japanese candlesticks to locate the price movement to make short term decisions in the market.
How do the Japanese candlesticks work?
In contrast with bar charts, the Japanese Candlesticks provide more accurate and detailed price movement information with a graphical representation of demand and supply of each period.
The body of the Japanese candlesticks that is the central portion of the candlestick represents the difference between the opening and closing value of the asset. The upper shadow of the real body represents the price distance between the top of the candlestick body and the high for the trading period.
On the other hand, the lower shadow shows the price distance between low for a certain period and bottom of the body.
The candlestick is bearish and bullish based on the closing price of the asset that has been traded. When the asset’s closing price is higher than the opening price, the closing price will move at the top of the body, and the opening price remains at the bottom of the candlestick body.
On the other hand, suppose the asset’s closing price that has been traded is lower than the asset’s opening price. Then the body of the candlestick will be filled with black colour. The closing price will move to the bottom of the body, and the opening price will move to the top of the body. In modern trading platforms, traders use different colours other than white and black, like green, red and blue.
Difference between candlesticks and bar charts
The Japanese candlesticks and bar charts both provide information about the price movement of the trading instrument. But the candlesticks and charts display a different graphical representation of the price movement.
Candlesticks represent more visual and clear information and also show the effect of demand and supply forces. Bar charts have the same reference points as candlesticks but candlesticks have peculiar patterns that guide traders in finding trends.
How to read the patterns of Japanese candlesticks?
To learn how to read the patterns of Japanese candlestick, one should now three of its elements that are: Candlestick’s body, wick and its colour
Candlestick’s body displays the opening and closing level of the asset. Its wick shows the high and low range. The colour of the candlestick tells about the direction of the movement within a specific period.
In modern charts, traders use red and green colours in which the green colour represents an upward movement of price and red represents the downward movement. However, in traditional candlesticks, white and black were used to display upward and downward movement.
On a red candlestick, the top of the body is open, and the body’s bottom shows a close price. Whereas on a green candlestick, it is the opposite of it. The wick on both red and green candlesticks known as shadow represents the highest range that the market hits within a period, and the bottom wick or shadow represents the lowest range.
By considering these three elements of a Japanese candlestick, traders would understand more about the upward and downward movement of price within a period.
The long body of green candlesticks will represent the bullish price action of the candlestick. If the wick is taller than the long body of the green candlestick, it will show a high level of volatility in the period. A red candlestick with a short body and a high wick determines that the bullish movement of the candle pushed a market range higher but was overwhelmed by bearish movement before closing.
If it represents no wick, that means opening and closing prices are high and low.
Common patterns of Japanese candlesticks
Japanese Candlesticks make patterns that traders use to analyse the price movement. Some of the common examples of candlestick patterns include:
Doji
This is formed when the opening and closing prices are very close to each other or are the same. But the shadows can be of different lengths.
Dragonfly Doji
This candlestick pattern is formed when the opening and closing prices of the market hit at a high range in a period. It represents a long shadow at the bottom that determines the reversal of the trend.
Gravestone Doji
As the name represents, it forms a pattern like a gravestone. This pattern is formed when the opening and closing prices are low in a period.
Hammer
This pattern is formed as a long tail at the bottom of the body and negligible upper shadow. It represents the reversal of the market both in a bearish and bullish movement.
Bullish Engulfing pattern
This pattern is formed when the downtrend ends. In addition, it shows a pattern with a larger bullish candle that engulfs a smaller bearish candle.
Bearish engulfing pattern
This candlestick pattern represents a bearish trend in the market. It is formed as a larger body engulfing the body of the previous candle. It represents that the closing price is lower than the opening price and signals a bearish reversal.
Bottom line
There are three parts of Japanese candlesticks that include body, wick and colour. In addition, there are many types of candlestick patterns that allow the traders to analyse the market price action within a period. Moreover, traders use these candlesticks to forecast the trends, continuations, and reversals in the future.