Japanese Candlestick Patterns
Candlestick patterns are useful when trading in securities, derivatives, commodities, or currencies. The patterns display market trends at a glance. Japanese candlestick patterns identify bullish or bearish sentiment.
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What Are Candlestick Patterns?
Japanese candlestick charts allow traders of any asset, such as securities, derivatives, commodities, or currencies, to view price action and market sentiment at a glance.
Japanese candlestick charts are used extensively by technical traders to spot continuations, reversals, and trends, and they are preferred over bar charts because they provide a more detailed visual representation of a market.
In bar charts, the horizontal axis reflects a time period, such as a day, and the vertical axis represents prices. Each vertical line on a bar chart represents the high and the low achieved by the asset, with a black or green bar reflecting that the asset went up during that time period, and a red bar reflecting that the asset went down in price.
Source: Image created by author
Bar charts feature little "twigs" that extend to the left and right of each bar. The vertical position of the left twig indicates the opening price, and the vertical position of the right twig indicates its closing price.
Source: filo/istockphoto
Japanese candlestick charts display the same information as bar charts, but in a slightly different format. Patterns formed by the candlesticks forecast the supply, demand, and price direction of an asset, which, in turn, influences trading decisions.
History of Japanese Candlestick Charts
Japanese candlestick charts were first developed during the 18th century by a Japanese rice trader named Munehisa Homma. In 2001, analyst Steve Nison brought Japanese candlestick charts to the attention of the Western world with his book, Japanese Candlestick Charting Techniques.
How To Read a Japanese Candlestick Chart
Like bar charts, Japanese candlestick charts display four vital pieces of information involving the prices achieved by an assets over a specific period of time:
- Open
- Close
- High
- Low
The horizontal axis of these charts reflects time, and the vertical axis reflects price.
For a stock chart, a typical time period would be one day, and each candlestick is said to "form" over the course of that day. On a Forex chart, which displays currency prices, a single candlestick might form in just 15 or 30 minutes.
Source: Image created by author
Candlestick Body
In Japanese candlestick charts, the body of each candlestick displays the opening and closing prices of the asset.
- A long candlestick reflects a large difference between the opening and closing prices.
- A short candlestick indicates only a small difference between the two.
- An open or green-colored candlestick indicates that the asset closed at a higher price than it opened. In that case, the closing price appears at the top of the candlestick, and the opening price appears at the bottom.
- A solid or red candlestick indicates that the asset closed at a lower price than it opened. The closing price appears at the bottom of the candlestick with the opening price appearing at the top.
Candlestick Wicks
Just like real candles, Japanese candlesticks have "wicks" both at their top and bottom. The top wick displays the highest price achieved by the asset during the course of the time period, and the bottom wick displays the lowest price achieved during that period. A candlestick without either a top or a bottom wick indicates that the opening or closing price was also either the high or low.
The longer the wicks, the greater the price volatility of the asset. Investors can determine the price range for the time period simply by subtracting the lowest price from the highest.
What Candlestick Patterns Tell Investors
Japanese Candlestick patterns have long been used by hedge funds to create the algorithms that allow them to execute lightning-fast trades against both retail investors and traditional fund managers.
While investors may not be able to read Japanese candlestick patterns and execute trades as quickly as a hedge fund, knowing how to interpret candlestick patterns can give investors a distinct advantage.
At a glance:
- A series of unfilled, or green, candlesticks indicates an upward price trend and a bullish market.
- A series of filled, or red candlesticks, indicates a lower price trend and a bearish market.
- A short upper wick on a down candlestick indicates that the opening price was near to the high of the day.
- A short upper wick on an up candlestick indicates that the closing price was near to the high of the day.
Key Takeaway: The longer the candlestick, the greater the price volatility the measured security has experienced.
Bullish & Bearish Candlestick Patterns
Below, we're going to take a look at the most common Japanese candlestick patterns and what they mean.
Pattern name | Image | Meaning | ||
Spinning Top | 
| The short body but long wicks indicate a large trading range but little difference in the opening and closing prices; this signifies weakness in an ongoing trend, whether upward or downward | ||
Marubozu | 
| From the Japanese word for "bald", this candlestick has no wicks which means for a green candlestick that the asset opened at its low and closed at its high, and for a red candlestick that the opposite is true; marubozu candlesticks signify that either the upward or downward trend will continue | ||
Doji | 
| The opening and closing prices are very similar, with the bulls and bears canceling each other out | ||
Gravestone Doji | 
| The opening and closing prices are very similar and are at the low price of the period | ||
Dragonfly Doji | 
| The opening and closing prices are very similar and are at the high price of the period; this can signal the reversal of an upward trend | ||
Four-price Doji | 
| The opening, closing, high, and low prices are all the same | ||
Hammer or Shooting Star | 
| The negligible wick at the top but long lower wick signifies a market reversal either in the bearish or bullish direction; the shooting star appears at the crest of an upward trend and indicates that bears are pulling the price back down | ||
Inverted Hammer or Hanging Man | 
| These two patterns appear the same, and their upper wick shows that buyers were met with resistance from sellers, however, for an inverted hammer, an upturn may be on the way; for the hanging man the opposite is true, and a downturn may be on the way | ||
Bullish or Bearish Engulfing Pattern | 
| A candlestick is immediately followed by another larger candlestick in the opposite direction; if the second candlestick is an up one, a significant run-up may be on the way, if the second candlestick is a down one, negative opinion might be forming | ||
Bullish or Bearish Evening Star | 
| The last candlestick, which is down, opens below the previous day's short candlestick, which can either be up or down, and the last candle closes somewhere within the body of candlestick two days prior; this indicates that buyers are stalling, and it could indicate more selling | ||
Bullish or Bearish Harami | 
| From the Japanese word for "pregnant", it is a candlestick is followed by a much smaller one in the opposite direction; in a bullish harami, a red candlestick is followed by a green one, indicating that a downward trend may be ending, in a bearish harami, the opposite is true | ||
Bullish or Bearish Harami Cross | 
| A harami followed by a doji | ||
Homing Pigeon | 
| Similar to a harami, however, both candlesticks are down, with the second candlestick being contained wholly within the first candlestick; this pattern indicates that a downturn may be weakening and an upturn may be about to begin | ||
Three Line Strike | 
| The three filled candlesticks denote a down trend, but while the fourth candlestick opens even lower, it closes above the high of the first candlestick, which expert on chart patterns Thomas Bulkowski has found to predict higher prices 83 percent of the time | ||
Two Black Gapping | 
| This pattern appears after the top of an uptrend, with the gap between the two down candlesticks indicating that the decline will continue downward, Bulkowski predicts this trend will occur 68 percent of the time | ||
Three Black Crows | 
| Starting near the high of an uptrend, three down candlesticks predict that the price decline will continue, trapping buyers who had following the uptrend; according to Bulkowski, this pattern predicts a downturn 78 percent of the time | ||
Three Inside Up and Three Inside Down | 
| Features a long down candlestick that is continuing a down trend, an up candlestick having a body that closes at least halfway up the previous candlestick's body means that the market has recovered half of the last period's drop; an up candlestick that closes above the high of the first candlestick signals an uptrend, while Three Inside Down is the opposite, signaling a downturn. | ||
Morning Star | 
| This pattern is comprised of a long down candlestick followed by a down spinning top, which indicates bulls might be coming in, followed by a long up candlestick, which is a sign of an up trend | ||
Evening Star | 
| The opposite of the Morning Star, a tall up candlestick followed by a doji indicating indecision, and the third candlestick is a tall down one; according to Bulkowski, lower prices will occur 72 percent of the time | ||
Abandoned Baby | 
| This pattern occurs after a series of lows, with the doji candlestick reflecting a lack of new sellers, then the third candlestick, which is up, predicts a recovery; according to Bulkowski, this pattern correctly predicts higher prices 50 percent of the time. | ||
Tweezers | 
| Two identical candlesticks in opposite directions appear after either a downturn or an upturn, they signify a coming reversal | ||
Three White Soldiers | 
| One of the clearest signs that a downtrend is over, this pattern is comprised of an up candlestick after a downturn, a second up candle with a longer body and a short top wick, and a third up candlestick with no wicks | ||
Rising and Falling Three | 
| In the Rising Three, three down candlesticks appear that are all within the range of the previous up candlestick followed by a long up candlestick, it reflects a pause by buyers; in Falling Three, a long down candlestick is followed by three up candlesticks which are within the body of the down candlestick, followed by another long down candlestick. | ||
Advantages of Using Candlestick Patterns
- Tells investors how others have been trading a particular asset recently. This is important if investors are planning to buy or sell that asset soon.
- Can help investors avoid buying or selling during the worst times of a day, a week, a month, or even a year.
Limitations of Using Candlestick Patterns
- Can lull traders into a false sense of confidence. It's important to remember that the information displayed on the charts is price-based, and price is just one component of market action.
- Apophenia is the tendency to perceive a connection or meaningful pattern between unrelated or random things. Undoubtedly, candlesticks do form patterns, however, the meaning of those patterns can be up for interpretation.
- Less useful for Forex traders because they mostly wait until the close of a candle before entering a trade. This leads to uncertainty on the next price movement.
Warning: Candlestick Patterns and other charting is based solely on historical stock information, which may be oblivious to fundamental risks regarding the investment security.
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