An Introduction to Japanese Candlesticks and How it Can Help Traders Make Better Decisions

Your ultimate guide to candlestick charting. We’ll walk you through the basic patterns and how to use them in trading and investing in cryptocurrencies. You’ll learn how to identify trends, find entries and exits.

Introduction: What is a Japanese Candlestick?

Japanese candlesticks are a graphical representation of the market price based on past data to predict the future movements of an asset. They represent price action over time and are typically composed of a body and its wick, just like an actual candlestick.

These candlesticks can provide helpful information such as market sentiment (supply and demand) and possible reversal of trends in the market by displaying price action.

Although it is one of the most basic indicators in technical analysis, candlestick charts can offer a more thorough perspective than the typical bar or line chart. Sometimes, it’s the only tool you might need in analyzing technicals besides volume indicators.

Each candlestick represents one unit of time within a timeframe. If you’re using a daily chart to analyze candlesticks, each candle represents one day. If you’re using a lower timeframe like the Hourly chart, each candle represents one hour of trading activity.

Since candlesticks are standardized and scaled across different timeframes, this indicator can be used to chart assets from every market, from cryptocurrencies to Forex, securities, commodities, and indices.

What are the Components of a Japanese Candlestick Chart?

Each candlestick consists of the following parts:

Body — The body is typically the most significant part of the candlestick and is distinguished by two colors representing the trading activity (demand and supply) per candle. This is where the most information is found and where the range varies between opening and closing prices.

Wick — The candlesticks’ wick, sometimes called the “tail” or “shadow”, is located at the upper and lower end of the body, representing the extremes: the highest and lowest price gained during a specific time frame.

The length of the wick can offer insights into what happened during that specific period which could signal a weakening, strengthening, or reversal of the current trend.

  • A candlestick with a long wick indicates that the asset is volatile and is very reactive to either side.
  • If the wick is relatively small, the price action is contained closely within the opening and closing price.
Candlestick Cheat Sheet

Color — The colors represent the buying and selling activity within each candlestick. This can be further customized according to the trader’s preferences but for the purposes of this article, we’ll use purple as bullish and pink as bearish.

If the candle is painted pink, that means there are more sellers than buyers in that period. Consequently, if the candle is printed in purple, there are more buyers than sellers of the asset.

OHLC — stands for Open, High, Low, and Closing Price.

  • Open (O) is the price at which the candlestick opens at each session. It usually precedes the closing price of the past session with a few exceptions (a big gap in price). The open price starts at the bottom of the body if bullish and on top if bullish.
  • The High (H) of a candlestick is the highest level reached by the price in a session. It is often marked by a wick but can sometimes close on the top of the body.
  • The Low (L) is the lowest level reached by the price in a given session.
  • Closing Price (C) is the price at which the candle closes at each session. The closing price is located at the bottom of the body if the candle is bearish, and vice versa.

Japanese Candlestick Patterns & How to Trade Them

We highlight below a few basic but essential patterns that you can use to understand more about candlesticks so that you can apply them in your trading arsenal.

Doji (Neutral)

Doji candlesticks form when the opening and closing price of an asset are almost or equal in size. The length of the upper and lower shadows can vary, which may look like a cross, an inverted cross, and a plus sign. A Doji indicates an indecisive action between buyers and sellers that may reverse the concurrent trend.

Trend reversal? In this weekly Bitcoin chart, one may forecast this after combining these two key pieces of information: the previous Resistance (2017) acting as Support, and the neutral Doji pattern that is currently printing on the far right of the chart.

Engulfing (Bullish)

A Bullish Engulfing pattern forms when a smaller or dark candlestick is followed by a large hollow or green candlestick that completely swallows the former candlestick. It indicates that the buyers have more control over the price than the sellers within the period.

The Bullish Engulfing pattern from the July 20 (red) and July 21 (violet) candlesticks on the daily Bitcoin chart kicked off the uptrend that resulted in more than 120% gain.

Engulfing (Bearish)

Bearish Engulfing Pattern forms when a smaller hollow or green candlestick is followed by a larger solid or dark Candlestick, which completely swallows the smaller candlestick. It indicates that sellers have more control over the price than the buyers within the period.

Multiple Bearish Engulfing candles (highlighted in yellow) appeared on Nov 2021 in the Daily Bitcoin chart which has repeatedly tested the resistance from April 2021.

Hammer or Pinbar (Bullish)

Hammer candlestick forms when a coin moves significantly down but bounces back with the closing price within or higher than the opening price. This indicates that buyers have stepped in at the last minute and could mean a reversal of the bearish trend.

Shooting Star (Bearish)

Shooting Star forms when a coin immediately moves higher in the first but eventually closes down below the opening price. It indicates exhaustion of buyers and could see more selling pressure following the pattern.

Conclusion

Japanese candlestick is one of the simplest, yet also one of the most important indicators in doing technical analysis.

While past performance is not indicative of future results, one may argue that these repeating patterns increase the probability of forecasting the next direction of an asset.

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Disclaimer: This article is for educational purposes only and must not be treated as financial or legal advice.

Please conduct due diligence and manage your risks accordingly.

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