What are the Candlesticks Charts?
Candlestick charts are a visual aid for decision making in stock, foreign exchange, commodity, and option trading. Originated in Japan over 100 years before the West developed the bar and point-and-figure charts. Invented in the 18th century by a Japanese rice trader named Munehisa Homma. Candlesticks visually representing the size of price moves with different colors. They differ from bar charts and line charts, because they give more information and can be more easily read. Let’s take a look at the image below:
This simple sketch points out all the information a candlestick chart will give you. Candlestick chart represent market’s price daily that shows the market’s open, high, low and close price for the day. Candlesticks can also be constructed using the open-high-low-close of a specified volume range (for example, 1,000; 100,000; 1 million shares per candlestick).
Generally, the longer the body of the candle, the more intense the trading. A hollow body signifies that the stock closed higher than its opening value. A filled body signifies the opposite. The two candles displayed are a bullish (green) and a bearish (red) candle. Each candle shows the price at which the candle (the time frame) was opened, the price at which the candle was closed, the highest and the lowest price reached. Note that the bearish candles (red) move downwards, so “close” and “open” places are switched.
Candlestick patterns are classified within two types’ candlestick continuation patterns and candlestick reversal patterns. There’s also single, double, and triple pattern. We will now go through the most common reversal and continuation patterns and we will discuss their potential.
- Doji (reversal)
Doji is a very easy to recognize candlestick. We have a Doji whenever the price closes at the exact same level where it has opened. Thus, the Doji candle looks like a dash with a wick. The Doji candle has a reversal character when it is formed after a prolonged move. Just remember: when you get a Doji on the chart after a prolonged move, there is a chance that the price will reverse its direction.
- Spinning Tops (undefined)
This candle could be bearish and bullish. Have a look at the image. The Spinning Tops have undefined character. The reason for this is that this candle indicates that buyers and sellers are fighting hard against each other, but none of them could gain dominance. Nevertheless, if we get this candle on the chart during a downtrend, this means that the sellers are losing steam, even though buyers cannot prevail.
- Marubozu (continuation)
Marubozu candlestick has a body and no candle wick as shown in the image. The Marubozu candle is a trend continuation pattern. Since it has no wicks, this means that if the candle is bullish, the uptrend is so strong that the price in the candle is increasing and never reaches below the opening of the bar.
- Hammer and Hanging Man (reversal)
These two candles are classified as reversal patterns. The difference between them, though, is that the hammer indicates the reversal of a bearish trend, while the hanging man points to the reversal of a bullish trend.
- Inverted Hammer and Shooting Star (reversal)
The Inverted Hammer and the Shooting Star are the mirror images of the Hammer and the Hanging Man. Both pattern exhibit reversal behavior, where the Inverted Hammer refers to the reversal of a bearish trend, while the Shooting Star indicates the end of a bullish tendency.
- Bullish and Bearish Engulfing (reversal)
The Bullish Engulfing is a double bar candlestick formation, where after a bearish candle we get a bigger bullish candle. Respectively, the Bearish Engulfing consists of a bullish candle, followed by a bigger bearish candle. The two Engulfing candle patterns indicate trend reversal. The Bullish Engulfing indicates the reversal of a bearish trend and the Bearish Engulfing points the reversal of a bullish trend.
- Tweezer Tops and Bottoms (reversal)
The Tweezer Tops consist of a bullish candle, followed by a bearish candle, where both candles have approximately the same parameters. At the same time, the Tweezer Bottoms consist of a bearish candle, followed by a bullish candle. Both candlestick patterns have reversal character. The difference between these two formations is that the Tweezer Tops signal a potential reversal of a bullish trend into a bearish, while the Tweezer Bottoms act the opposite way. They could be found at the end of a bearish trend, warning of a bullish reversal.
- Morning Star and Evening Star (reversal)
The Morning Star candlestick pattern consists of a bearish candle followed by a small bearish or bullish candle, followed by a bullish candle which is larger than half of the first candle. The Evening Star candle pattern is the opposite of the Morning Star pattern. Both of these candlestick groups have reversal character, where the Evening Star indicates the end of a bullish trend and the Moring Star points to the end of a bearish trend.
- Three Soldiers (reversal)
The Three Soldiers candlestick pattern could be bearish or bullish. The Three Bullish Soldiers consists of three bullish candles in a row. At the same time, Three Bearish Soldiers should have three bearish candles (see images). The Three Soldiers candlestick pattern has a reversal character. The Three Bullish Soldiers candlestick pattern can end a bearish trends and can bring about a new bullish movement. At the same time the Three Bearish Soldiers could be found at the end of bullish tendencies, signaling an upcoming bearish move.
How to read candlesticks pattern?
Now that we have gone through some of the more reliable candlestick patterns in Forex trading, we can now see how some of these patterns look on a price chart and how we can use them as part of a price action trading strategy. Have a look at the chart below:
This is the 4-hour chart of the Aussie (AUD/USD) for the period Sep 17 – Oct 19, 2015. We start with a Bearish Engulfing after a price increase. As we know from above, bearish engulfing has reversal character and make the patterns going down. The bearish trend ends with a morning star, which points to an eventual reversal (goin up). The reversal of the trend follows in more of a consolidation phase. The price decreases to the same level and we get another reversal pattern a Bullish Engulfing. A strong bullish trend emerges after the Bullish Engulfing pattern and the price is increasing until we get a Doji reversal candle, which resulted decreased price.
Soon afterward we see another Bullish Engulfing formation. The price records dramatic increases on strong momentum. Furthermore, after a short corrective movement, the bullish trend gets confirmed by the Three Bullish Soldiers candle pattern, which makes the price increase higher. We stay in the market until we get the Bearish Engulfing at the end of the trend. Then, after a new increase, we get the Hanging Man candlestick pattern, which is followed by a new price decrease. By understanding to read and predict the candlestick chart, we have the opportunity to make high probability trade setups using candlestick patterns.
As you can see, trading Forex with Japanese candlestick patterns could be very profitable. Japanese candlesticks are the preferred way to display Forex charts, because of the depth of information it provides. Although we discussed 13 successful candlestick pattern trades, there can be many fake signals that show up as well. Therefore, it is always good to match your candlestick pattern signal with an additional trading tool. Try to use uncorrelated technical confluence when trading candlestick signals in order to eliminate as many false signals as possible. When adding an additional layer of confirmation to your candlestick trading strategy, you might even increase your candle pattern success rate to more than 60-65 %.
Source:
https://www.investors underground.com/stock-charts/candlestick-charts/
https://stock charts.com/school/doku.php?id=chart_school:chart_analysis:introduction_to_candlesticks
https://www.the balance.com/how-to-read-a-candlestick-chart-1031115
https://forex traininggroup.com/how-to-trade-forex-with-japanese-candlestick-patterns/
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informative tools for analyzing stock, great!