Forex charts show the fight between the bulls and bears in the market. Buy orders of the bulls boost the rise in price, while orders to sell placed by the bears engender the decline in price. Examining and analyzing the balance of forces between the bulls and the bears, a trader makes a decision either to buy or sell. Japanese candlesticks chart is one of most popular weapon in the fight between the two animals, as this chart gives more market information than the traditional European charts like the charts of lines and bars. Today we will learn how to get information and analyze Japanese candlesticks.
What are Japanese candlesticks?
The first charts in the European stock markets appeared over a hundred years ago. They showed closing price in the linear form, opening\closing prices and trading highs and lows in the bars within a specified time period. Such charts are still used today, but they are more applicable for the superficial analysis. The line chart shows:
Closing price of USD/CHF (Euro/Swiss franc) on the line weekly chart
The same chart depicted in the bar chart
- Opening price — the price of the first trade
- Closing price — the price of the last trade
- High — the highest price within a specified time period
- Low — the lowest price within a specified time period
- Market trend — movement direction of the price. Bullish trend means that the price goes up; bearish trend means that the price goes down.
By examining regularity of the price behavior, changes in the opening and closing prices and highs and lows, a trader can predict direction of the price movement and based on the results of the forecast enter the market.
Japanese candlesticks have been developed much earlier than the European charts, back in XVIII century, with the development of exchange market for trading rice. It is believed that the chart was invented by the Japanese rice trader Homma Munehisa, who offered the most simple and convenient way of keeping history of trades, which also provides a lot of the other useful information, such as opening\closing prices, highs and lows, price behavior within a specified period of time.
A trader can determine whether the price will go up or down over a specified period of time by tracing changes in the color of the candle body. White, green, or transparent colour of the candle shows the rise in price; black or red colour indicates that the decline in price. The color of the candles depends on the settings.
If a candle is white or green (depending on the settings) — the price has grown within a specified time period
Black or red candle means that the price has dropped
Upper wick or a shadow of a candle means the highest level of price
Lower wick or a shadow means the lowest price level
Opening price of the white candlestick is below, while closing price is above
Opening price of the black candlestick is above, while closing price is below
The same chart depicted as the Japanese candlestick chart
- White candlestick is a signal of the rise in price
- Black candlestick is a signal of the decline in price
- Long legged upward shadow is a signal of the rise in price; the longer is a shadow the more reliable the signal is
- Long legged downward shadow is a signal of the decline in price; the longer is a shadow the more reliable the signal is
In order to make an accurate prediction it is required to review more than just one candlestick. Experienced traders analyze several candlesticks within a specified period of time; the sequence of these candlesticks forms a pattern. Let’s consider the most popular patterns:
1. Bullish or bearish engulfing
There are two candles: black and white. In the case of bearish engulfing, black candlestick with a large price range will engulf the white one, which can be a signal of development of the bearish trend. In case of the bullish engulfing, the white candle with a large price range will engulf the black one, indicating that the price may go up, which means that bullish trend is developing. At the same time shadows of the candlesticks may not left untouched.
2. Dark cloud cover
This name was given to a reversal candlestick pattern, which shows that the uptrend will shift into the downtrend. How can an inexperienced trader determine when the dark cloud starts?
Dark candlestick follows after the light one (bearish trend after the bullish one)
Both candlesticks are long
Dark candlestick opens above the light one
Dark candlestick closes above the light one
Dark candlestick closes below the center of the body of the light candlestick
3. Hammer and hanging man patterns
Are you scared? These names were given to the reversal patterns formed by the candlesticks, which bodies are twice as less as the lower shadow. The hammer is a bullish reversal pattern showing reversal to the downtrend; the hanging man is a bearish reversal pattern showing reversal of the downtrend to the upward. Color of the candlestick is not important; nevertheless white hammer or hanging man shows deeper reversal trend.
Safety information and useful tips
As you can see, candlestick analysis is not complicated. However, it is important to understand that each signal shall be confirmed by the other signals in the market. Do not rush to open a position as soon as you see a hammer pattern or a dark cloud cover, wait until the trend is confirmed.
You can learn more about candlestick patterns from the book of a professor of New York Institute of Finance and a Professor of Chicago chamber of Commerce Steve Nison. The book’s title is "Japanese candlesticks". The book is widely popular among the beginners and more experienced traders, as it contains a lot of examples and commentaries from the market as well as extensive theoretical knowledge.
Candlestick analysis is the first step in making professional market analysis, and it is important to learn the basics of it very thoroughly. Over time, you will find out that the patterns can replace each other and quickly change during the trades, you will learn to make your own trading analysis.
Meantime, learn, test, trade and may the Profit be with you !
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.