Super quick history lesson!
Did you know Japanese candlesticks can be traced back to the 17th century? Rice traders used them to track market prices and predict their future movement.
However, it was only introduced to the West in the 1990s through Steve Nison's book, "Japanese Candlestick Charting Technique."
Since then, this charting technique has become a staple in online traders' strategies.
In this lesson, you'll explore the three main parts of Japanese candlesticks and learn how to interpret them to make a profitable trading decision.
Japanese candlesticks trading is the most popular way to trade the forex chart. The reason behind its popularity is the intuitiveness it offers.
Unlike the traditional line or mountain chart, Japanese candlesticks provide more information about the price action that's easy to interpret. This includes the market's HLOC—the highest point, lowest point, opening price, and closing price.
Each part of the candlestick gives you a reference to the market's OHLC (open, high, low, close). Here are the three main parts of Japanese candlesticks:
Also known as the upper shadow, the upper wick represents the highest price that the market traded during the period.
The formation of the upper wick signifies that the asset trades higher than its opening price.
The candle's real body represents the range between the asset's closing and opening prices.
The real body's color can be green or red, depending on the movement of the asset.
Say the EUR/USD opens at 1.2000 and closes at 1.2300 - the color of the body will be green to indicate an uptrend during the period.
If the price opens at 1.2300 and declines to 1.1900 at its closing, the period will form a red body that indicates a bearish market period.
The length of the real body depends on the stretch of the asset's opening and closing price. The wider the spread between the open and closing price, the longer the candle will be. If the asset opens and closes at the near levels, it forms a little to no real body.
Also known as the lower shadow, the lower wick represents the lowest price that the asset reached during this period. This is the counterpart of the upper wick.
The lower wick forms at the bottom of the real body and extends lower.
The color of the candlestick reveals the battle between the bulls and the bears.
If the bulls are taking over the market, the price will form a green candle. This candle color represents an uptrend because the price closes at a higher level than its opening.
Conversely, a red candle suggests otherwise – it's the seller dragging the price down due to immense selling pressure. When this happens, the price will close at a lower level than its opening.
Note: In some charts, Japanese candlesticks are represented by a set of black-and-white candles. A black candle is bearish (red candle), and a white is bullish (green candle).
Ther are more than 10 candlestick patterns out there. However, you don't really have to familiarize yourself with all of them- that would be just a waste of effort and brainpower.
Here are the three primary types of candlestick patterns and what they're telling you about the market.
The shooting star signals a potential of the bullish market to have a declining price – just like the shooting star that falls from the sky.
This market pattern has three Must-Spot elements to ensure the accuracy of the pattern:
Again, this pattern formation suggests that a bullish market will run its course and will push the price down. But what really happens to the market during this formation?
Look at the three candles that form during this formation:
The hammer candlestick signals a bullish reversal in the market.
This hammer-shaped candle should have little to no upper shadow, a small real body, and an extended lower shadow. Additionally, this hammer candle should appear at the bottom of the bearish market and must be followed by a bullish candle.
The formation of this candlestick pattern suggests that the prevailing selling pressure (represented by the first candle) is about to end (represented by the hammer candle) and the market will become bullish (represented by the third candle).
A doji candlestick pattern appears rarely in the market. Unlike the two patterns mentioned above, the formation of a Doji pattern signals little to no information about the trend reversal.
Why?
Because neither the bulls nor the bears push the price in their preferred direction. When that buyer-seller tug of war happens, the market will have a roughly equal higher and lower shadows and a small real body.
Additionally, a doji candle is a single-candle pattern that resembles a cross, inverted cross, or a plus sign.
Basically, the market enters its consolidation phase during this pattern formation. This happens when the prevailing price pauses because of market indecision – neither the bulls nor the bears push the market enough to make a significant movement.
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