Traders often rely on Japanese candlestick charts to observe the price action of financial assets. Candlestick graphs give twice as much information as a standard line chart. They also allow you to interpret price data in a more advanced way and to look for distinct patterns that provide clear trading signals.
- What are Japanese Candlesticks?
- Bullish vs. Bearish Candles
- Types of Candlestick Patterns
- What Common Candlestick Patterns Mean
- Build Your Trading Strategy
- Frequently Asked Questions
What are Japanese Candlesticks?
Japanese candlesticks are chart units that display price action for a given period.
Each candlestick represents a specific time frame and gives data about the price’s open, high, low and close during the period.
Each candlestick represents a specific time frame. It also gives information about the asset’s opening, high, low and closing price during the period. Standard candlesticks consist of a candle body plus an upper and lower wick.
The candle body extends from the closing price to the opening price of an asset for a particular period. The tip of the upper wick of the candle shows the highest price attained during the period. The candle’s lower wick starts at the lowest price seen during the period and rises up to the body of the candle.
Bullish vs. Bearish Candles
Candles are either bullish or bearish depending on the direction of the price during the period they are drawn for.
A bullish candlestick forms when the price opens at a certain level and closes at a higher price. This type of candlestick represents a price increase over the period in question. The default color of a bullish Japanese candlestick is green, although white is also often used.
A bearish candlestick forms when the price opens at a certain level and closes at a lower price. This candlestick shows a price drop. The default color of the bearish Japanese candle is red, but black is also popular.
As an asset’s price is plotted over time using Japanese candlesticks, they form a Japanese candlestick chart of many candlesticks. The graph you see below is a 4-hour candlestick chart where each of the candlesticks represents a 4-hour period.
You can use many different chart time frames or periods to plot candlestick charts in your technical analysis system or trading platform. The most common are:
- 1-minute (M1)
- 5-minute (M5)
- 15-minute (M15)
- 30-minute (M30)
- 1-hour (H1)
- 4-hour (H4)
- Daily (D1)
- Weekly (W1)
- Monthly (M1)
The smaller the time frame you use, the closer you look into the price action of the asset. It’s like you are zooming into the chart. Let’s say you are looking at an H4 chart like the one shown above. When you switch to the H1 chart, you will have 4 times more candles. Each H4 candle period expands into 4 H1 candles.
Now, let’s get back to the H4 chart. Let’s say you switch to a daily or D1 chart, where each candle represents 24 hours. Every 6 H4 candles group into a single D1 candle. You will feel like you are zooming out of the price action as you increase the time period of your candlestick chart.
Types of Candlestick Patterns
Candles are constructed from 4 prices, specifically the open, high, low and close. They also form different shapes and combinations commonly known as candlestick or candle patterns. Candle patterns can be single, double or triple patterns that consist of one, two or three candles respectively.
Single Candle Pattern
A single candle pattern involves only 1 candlestick. The more famous single candle patterns are:
- Hammers: the hammer, inverted hammer, hanging man and shooting star
- Spinning top
- Spinning bottom
- Bullish marubozu
- Bearish marubozu
Double Candle Pattern
Double candle patterns consist of two Japanese candlesticks. The more famous double candle patterns are:
- Bullish engulfing
- Bearish engulfing
- Bullish harami
- Bearish harami
- Tweezer top
- Tweezer bottom
Triple Candle Pattern
Triple candle patterns are formed from three candlesticks. Some of the more well-known triple candle patterns include:
- Morning star
- Evening star
- 3 white soldiers
- 3 black crows
What Common Candlestick Patterns Mean
Each candlestick pattern has a specific interpretation that reflects the attitude of market participants. The patterns can also provide trading signals since traders are human beings who tend to act similarly in the same situations.
1. Doji Candlestick
The Doji is a single candle pattern. It is the only candlestick that is neither bearish nor bullish. This is so because the Doji represents a neutral state where the price closes exactly where it has opened. For this reason, the Doji has no candle body and it looks like a dash.
Why is the price closing exactly where it opened? Because the bullish and bearish pressures in the market have reached equilibrium. Since these forces on the price are roughly equal, it is very likely that the previous trend will end. This situation could bring about a market reversal, which is a price move contrary to the preceding trend.
Thus, seeing the Doji candle will often indicate an upcoming price reversal.
2. Hammer Candlestick Family
The hammer candlestick family also consists of related single candlestick patterns. Hammers have a long upper or lower wick and a small candle body on the opposite side. Like the Doji, a hammer candlestick pattern indicates that a price reversal might be on its way. Members of the hammer family of candlesticks include the following:
A hammer candle will have a long lower candlewick and a small body in the upper part of the candle. Hammers often show up during bearish trends and suggest that the price might soon reverse to the upside.
The inverted hammer has a long upper candlewick and a small body in the lower part of the candle. Same as the hammer, an inverted hammer appears during bearish trends. It suggests a price reversal.
The hanging man looks the same as the hammer, but it appears during bullish trends and suggests that a correction to the downside might soon materialize.
The shooting star has the same structure as the inverted hammer. When it appears during bullish trends, it indicates that the recent rise could stop and the market will start correcting lower.
This image will give you a better idea of the hammer candle family. The green arrows represent moves higher, while the red arrows represent price declines.
As you can see, the candle might look the same but the previous trend and its direction give different signals. Notice that each candle pattern in the hammer family is a reversal pattern that could be bearish or bullish depending on what directional move preceded it.
3. Engulfing Candlestick Patterns
Engulfing candlestick patterns are double candle patterns. They consist of a random candle and another bigger candle that fully encompasses or “engulfs” the price action contained within the first.
Bullish Engulfing Pattern
The bullish engulfing pattern appears during bearish trends. It consists of a bearish candle followed by a bullish candle that engulfs the first candle. This pattern suggests a bullish move will soon occur.
Bearish Engulfing Pattern
The bearish engulfing pattern appears during bullish trends. It consists of a bullish candle, followed by a bearish candle that engulfs the first candle. This pattern indicates a bearish move may soon be forthcoming.
4. Morning and Evening Star Candlestick Patterns
The morning and the evening star are triple candle patterns. They also forecast reversals.
The morning star pattern occurs during bearish trends and signals an upside reversal. It starts with a bearish candle and is followed by a small bearish or bullish candle that gaps down. Then the price gaps up and forms a bigger bullish candle. The third candle of the pattern should cover at least half the body size of the first candle.
The evening star is the opposite of the morning star. It appears during bullish trends and signals a downside reversal. The pattern starts with a bullish candle, followed by a small bearish or bullish candle that gaps up. Then the price gaps down and forms a bigger bearish candle. The third candle should cover at least half the body size of the first candle.
Build Your Trading Strategy
Recognizing candlestick chart patterns is the first step toward understanding this useful and popular method of analyzing market price action. If you know what these patterns could mean and what signals they generate, it’ll help you build a more advanced trading strategy.
These are certainly not all the candle patterns that exist. There are many more patterns that range from simple to more complex, and you’ll probably encounter some of them over the course of your trading experiences. You could even discover a candle pattern of your own!
Frequently Asked Questions
Should I consult other tools beyond candlestick charts?
Generally, yes. No candle pattern predicts the resulting market direction with complete accuracy. Whenever making trading decisions based on technical analysis, it’s usually a good idea to look for confirming indications from multiple sources.
Also, remember to set aside some time to learn more about trading. If you are new to trading or have little time to devote to technical analysis, you can use social trading platforms to copy the transactions of successful traders. You can also enroll in online courses to expand and update your trading knowledge. Another great idea is to subscribe to trading news like BenzingaPro to get customizable market news and research.
How can I get started trading?
A simple trading guide and a trading strategy built around a reliable candlestick pattern can get you started off on the right foot when it comes to forecasting price movements. You’ll also have to decide what markets and assets you’ll be trading and how much money you can afford to put at risk before you jump in.
You don’t have to have huge amounts of money to be a financial markets trader, especially if you want to trade forex since many online brokers only require modest margin deposits. However, if your stock trading behavior is ever flagged as pattern-day trading, then you must have a margin account with at least $25,000 deposited in it to continue trading in that manner.
You can get started trading quickly by opening an account with a reputable broker, although you should look around carefully to find the right broker. Evaluate your needs and consult Benzinga’s guide to the market’s top brokers to get started today.
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