What is a Japanese Candlestick Trading Chart?

Japanese candlestick patterns originated in Japan during the 18th century. They were first used for rice trading during a period when there were no automatic calculators to keep tabs of trading volumes and prices. In time, they became useful in the financial markets, especially FOREX. What made them so good to work with was their ability to predict potential price movements. Having said that, there is no way to accurately predict any future price movement in trading. It is more likely that Japanese candlesticks provided a ready analysis tool that could spot patterns.

Today, Japanese candlestick patterns in FOREX trading and other forms of trading serve as a useful method for deciding on possible trade entry and exit points. You can also use them to identify reversals or continuation of trends, and to understand market psychology. There are well over two dozen patterns, and each shows the push-and-pull relationship between buyers and sellers within a specific time frame. As you come to understand how the patterns work in markets better, you can also learn who is gaining the trading advantage between buyers and sellers. At this point, it is important to note that no pattern guarantees success, and each requires proper interpretation within its market context. In this article, we will discuss the 21 most important Japanese candlestick patterns.

What is a Japanese Candlestick?

A Japanese candlestick is a visual representation of price movements within a certain trading timeframe. Candlesticks can provide a clear, visual understanding of market dynamics.

Each candlestick consists of a “body,” which shows the opening and closing prices, and “wicks” or “shadows” at either end, representing the highest and lowest prices reached during the period. If the closing price is higher than the opening price, the candlestick is typically filled or colored (often green or white), indicating a price increase or a “bullish” or positive market. On the other hand, if the closing price is lower than the opening price, the candlestick is usually empty or differently colored (often red or black), signaling a price decrease or a “bearish” or depressed market.

Japanese candlesticks offer a quick way to read market sentiment. By studying the pattern of candlesticks over time, traders can get a sense of whether buying or selling pressure is dominating and this can help them more intelligently guess at possible price movements.

Overview and History of Japanese Candlesticks

As we have mentioned, Japanese candlestick charting techniques were invented by rice traders in 18th-century Japan. The beauty of their use was to reflect the concepts of the open, close, high and low prices into a single candlestick figure. This graphical representation made it much easier for traders to read price patterns instantly.

For centuries, Japanese merchants and traders used candlesticks as a normal part of their daily lives until in the 1980s a technical analyst from the Western world picked up on these ideas and wrote a book about them. Today, Japanese candlesticks are widely used in global financial trading, including FOREX, stocks, and commodities.

Traders use these patterns to decide on the best entry and exit points for their trades, giving them the chance to more accurately manage their risk and potentially increase their returns. We should say at this point that no single tool can predict market movements. However, Japanese candlesticks, when used with other technical analysis tools and indicators, can significantly improve a trader's ability to capture market trends.

Importance of Technical Analysis in Trading

Here at Arincen, we often speak about the importance of technical analysis, which is crucial in retail trading for several reasons:

Identifying trends: By analyzing the market, you can spot trends in market prices. Trendspotting is one of the most common calls to action in trading. Once you identify a trend, you can make a call to go long in an uptrend or short in a downtrend.

Timing trades: You can decide on what will be the best entry and exit points for your trades. By analyzing patterns and using technical indicators, you can develop a good understanding of when the trading direction of the price is likely to change.

Risk management: If you can easily decipher the prevailing support and resistance levels of a financial asset, you can become better at setting stop loss and take profit levels, which can help you manage risk.

Predict future price movements: No analysis method is foolproof, but with good technical analysis, you can use historical price movements to make educated guesses about future price behavior. Patterns often repeat in markets, so this can be a useful tool for forecasting. In fact, as you become more experienced, much of your skill will be based on knowing how to respond to patterns you have seen before.

Independence: You can make independent decisions without relying on external advice or tips. This is a powerful ability to have. Yes, there is a lot of helpful advice out there, such as trading signals, but reading and interpreting price charts and indicators will help give you an edge over other traders.

Applicable to any market: Japanese candlesticks are not just a FOREX thing. Whether you are trading stocks, commodities, FOREX or cryptocurrencies, the principles of technical analysis stay the same and can be applied in any market.

Efficiency: With modern charting software and trading platforms, technical analysis can be carried out consistently and highly efficiently. This allows traders to respond quickly to changing market conditions.

Technical analysis is a vital part of modern retail trading. It gives traders like you the tools required to interpret price movements, manage risk, and make informed decisions. When all this is combined with a stress-tested strategy, you can increase your chances of success in the markets.

Components of a Candlestick

These items make up a Japanese candlestick pattern:

Body: The body of the candlestick represents the range between the opening and closing prices during the specified period. If the body is filled (or colored), it means the closing price was lower than the opening price. This is a bearish movement. If the body is empty (or a different color), then the closing price was higher than the opening price. This is a bullish (upward) movement.

Open: The open is the price at which a specific time period begins. In a bullish candlestick, the open is the bottom of the body. In a bearish candlestick, the open is the top of the body.

Close: This is the price at which a specific time period ends. In a bullish candlestick, the close is the top of the body. In a bearish candlestick, the close is the bottom of the body.

Wick (or Shadow): The wick of the candlestick represents the highest and lowest prices reached during the specified period. Wicks can easily provide information about price volatility and how much buying or selling pressure is being exerted on the market. If a candlestick has a long upper wick, for example, it suggests that buyers pushed prices up during the period, but sellers ultimately drove prices down again.

Taken together, these components give a handy view of the struggle between buyers and sellers. The size and color of the body, combined with the length of the wicks, can give traders important clues about potential future price movements. Japanese candlesticks are essentially a kind of shorthand that allows traders to understand at a glance what is happening in the markets.

Different Types of Candlestick Patterns

There are different types of candlestick patterns. Japanese candlestick patterns can be broadly listed into three categories: Bullish patterns, Bearish patterns, and Indecision or Neutral patterns.

This has been the case since the beginning of the time these were used. Each pattern represents a certain market sentiment and can help traders make decisions about potential future price movements.

Bullish patterns: These patterns signal that buying pressure exceeds selling pressure and prices may rise. Traders look for these patterns in a downtrend as an indication that the trend might reverse. Examples include the hammer, bullish Harami, and morning star.

Bearish patterns: These patterns signal that selling pressure exceeds buying pressure and prices may fall. Traders look for these patterns in an uptrend to potentially signal a trend reversal. Examples include: Shooting Star, bearish Harami, and Evening Star.

Indecision or neutral patterns: These patterns signal market indecision, where buying and selling pressures are relatively balanced and a clear trend is not apparent. Traders look for these patterns to signal potential reversals or trend continuations. Examples include the Doji, Harami Cross, and Spinning Top.

These patterns can provide valuable insights into market sentiment and potential price reversals or continuations. However, they should always be used in conjunction with other technical analysis tools to increase their reliability. Next, we will discuss 21 of the top Japanese Candlestick patterns.

Top 21 Candlestick Patterns

1. Doji

A Doji candlestick looks like a cross or plus sign. The opening and closing prices are almost exactly the same. Imagine the market has been in an uptrend and a Doji forms. This is often the result of market indecision that could mean that buyers are losing control and a reversal may be upcoming. It could be a the right time to close long positions. Dojis are popular because they are very simple to read. They give a clear signal that the market in undecided. How effective a Doji is at influencing your trading success depends on the context and its position within the broader market trend.

2. Hammer

If you see a Hammer after a downtrend, it suggests that the market is attempting to find a bottom. The hammer's long lower wick shows that sellers pushed prices down, but buyers managed to push the prices back up to near the open. This could be a good time to consider entering a long position. The Hammer is an example of a popular reversal indicators. A Hammer signals a bullish reversal after a downtrend, while a Hanging Man, which we will explain next, indicates a bearish reversal after an uptrend. Their limitations are that they are single-candle patterns, which might lead to false signals.

3. Hanging Man

If a Hanging Man forms during an uptrend, it could mean that sellers are beginning to outnumber buyers. It's possibly a good time to close long positions or enter a short position.

4. Shooting Star

The Shooting Star, appearing after an uptrend, signals potential bearish reversal. Its long upper shadow shows buyers pushed prices up, but sellers took control and pushed it back down. If confirmed, this might be a good point to initiate a short trade. The Shooting Star is one of those patterns that are often used because of their strong reversal implications. But again, as single candle patterns, it can sometimes provide false signals.

5. Engulfing Pattern

In a downtrend, if a small bearish candle is followed by a larger bullish candle (bullish engulfing), this could mean strong buying pressure. It could be time to make a purchase. On the other hand, in an uptrend, if a small bullish candle is followed by a larger bearish candle (bearish engulfing), it might be a good time to sell. The Engulfing Pattern is well-liked by traders because it can signal a strong reversal. The main disadvantage is that it requires confirmation from subsequent candles to confirm the signal.

6. Harami Pattern

A bullish Harami forms when a small bullish candle follows a larger bearish candle in a downtrend, which could suggest a good time to buy. A bearish Harami occurs when a small bearish candle follows a larger bullish candle in an uptrend, indicating a potential time to sell. The Harami is frequently used because it can appear in either uptrends or downtrends. However, it is considered less reliable than some other patterns and often needs confirmation.

7. Piercing Pattern

If you see a Piercing Pattern in a downtrend, where a bullish candle opens lower but closes above the midpoint of the previous bearish candle, it could be a good time to buy.

8. Dark Cloud Cover

The Dark Cloud Cover, appearing in an uptrend, is a bearish reversal pattern. It suggests that it you should consider selling or closing long positions.

9. Morning Star

A Morning Star pattern appearing during a downtrend indicates a potential bullish reversal. The small candle or Doji suggests the trend is slowing, and the following large bullish candle suggests a reversal, possibly making it a good time to buy. The Morning Star, like the Evening Star which we discuss next, are both reliable reversal indicators over three periods, which makes them more trustworthy than single-candle patterns. The downside is that you are likely to see them less often.

10. Evening Star

If an Evening Star forms during an uptrend, it suggests a bearish reversal. It might be a good time to sell or close long positions.

11. Three White Soldiers

If you see Three White Soldiers following a downtrend, it indicates strong buying pressure and a potential complete bullish reversal. It could be a good time to enter a long position. Three White Soldiers, just like Three Black Crows, are strong signals of a continued trend, but they don’t appear often, which limits their usage.

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Three White Soldiers Candlestick pattern

12. Three Black Crows

The Three Black Crows pattern signals strong selling pressure after an uptrend. This might be a good time to sell or enter a short position.

13. Bullish Marubozu

When this sign appears with no shadows, it shows that buyers controlled the trading from the opening bell to the close of the day, thus it might be a good time to buy or hold existing long positions. Bullish Marubozu candles are popular as they indicate strong buying or selling pressure. However, they do not provide information about potential reversals, which can be a drawback.

14. Bearish Marubozu

A Bearish Marubozu with no shadows shows that sellers controlled the trading from the opening bell to the close of the day. This might be a good time to sell or enter a short position. Like the Bullish Marubozu, the Bearish Marubozu does not provide information about potential reversals, which is a disadvantage.

15. Tweezer Tops

Tweezer Tops form when two consecutive candles have the same high in an uptrend. This may indicate that the buyers have lost control and a bearish reversal may occur, possibly a good time to sell. Traders like these patterns for their reversal implications, but they may also give false signals in a quiet market.

16. Tweezer Bottoms

This pattern forms when two consecutive candles have the same low in a downtrend. It may indicate that sellers are losing control, possibly a good time to buy.

17. Rising Three Method

This sign in an uptrend signals continuation of the trend. After a long bullish candle, there are three shorter bearish candles, followed by another bullish candle. It suggests the market is taking a breather before continuing upward, so it might be a good time to hold existing long positions or consider buying. Continuation patterns like this are helpful to confirm an existing trend, but they have limited usefulness when the market is slow.

18. Falling Three Method

The Falling Three Method in a downtrend is the opposite of the Rising Three Method. After a long bearish candle, there are three shorter bullish candles, followed by another bearish candle. This might be a good time to hold existing short positions or consider selling.

Falling Three Method Candlestick pattern

19. Bullish Harami Cross

This sign is a bullish reversal pattern where a doji follows a large bearish candle in a downtrend. It indicates a loss of downward momentum, suggesting a possible reversal and thus a potential buying opportunity. These patterns are useful in predicting potential reversals but, like other Doji patterns, they require confirmation from subsequent candles.

Bullish Harami Cross Candlestick pattern

20. Bearish Harami Cross

The Bearish Harami Cross is a bearish reversal pattern where a doji follows a large bullish candle in an uptrend. It suggests loss of upward momentum, indicating a potential reversal and a potential selling opportunity. These patterns are useful in predicting potential reversals but, like other doji patterns, they require confirmation from subsequent candles.

Bearish Harami Cross Candlestick pattern

21. Inverted Hammer

An Inverted Hammer during a downtrend suggests a potential bullish reversal. The long upper wick indicates that buyers tried to push the price up, hinting at a change in momentum. It might be a good time to consider buying.

As a trader you should always remember that the popularity of Japanese Candlestick patterns does not necessarily translate to higher success rates in trading. Effective trading often involves combining candlestick patterns with other forms of technical analysis like trendlines, moving averages, Fibonacci indicators, and Bollinger bands to confirm signals and improve the chances of success.

Reading Candlestick Patterns

Reading Japanese candlestick patterns involves understanding the price action that each pattern represents, which can be broken down into two parts - single candlestick patterns and multiple candlestick patterns:

Single candlestick patterns:

As the name suggests, these consist of just one candlestick and are often easier to spot. They can provide valuable information about market sentiment.

Doji: A Doji has a very small or non-existent body, meaning that the opening and closing prices were nearly identical. This pattern shows that there is indecision in the market, suggesting a potential change in the direction of the price trend.

Hammer/Inverted Hammer: A Hammer candlestick occurs when a security trades significantly lower than its opening, but gets stronger later in the day to close either above or close to its opening price. You will see a hammer-like shape with a long lower wick and small body. An Inverted Hammer looks the same but happens at the bottom of a downtrend. Both patterns suggest a potential bullish reversal.

Shooting Star/Hanging Man: A Shooting Star and Hanging Man have small bodies near the low with a long upper shadow and little-to-no lower shadow. The Hanging Man graphic is normally formed during an uptrend and can suggest a potential reversal downward, while the Shooting Star occurs during a downtrend and can signal a potential reversal upwards.

Multiple candlestick patterns:

These patterns are made of two or more candlesticks and can give traders a deeper understanding of market dynamics.

Bullish/Bearish Engulfing: These patterns occur when a small candle is followed by a large candle of the opposite color that completely engulfs the prior candle. A Bullish Engulfing pattern indicates a possible reversal from a downtrend to an uptrend, while a Bearish Engulfing pattern suggests a possible reversal from an uptrend to a downtrend.

Morning Star/Evening Star: These are three-candlestick patterns. A Morning Star pattern occurs after a bearish trend and signals a possible bullish reversal of which you should be aware. It consists of a large bearish candle, a small candle or a Doji, and a large bullish candle. An Evening Star pattern is exactly the opposite, signaling a potential bearish reversal after a bullish trend.

Harami: This pattern consists of a large candle followed by a smaller candle that is entirely within the range of the first candle's body. You should know that the Bearish Harami occurs at the top of an uptrend, and the Bullish Harami occurs at the bottom of a downtrend, signaling possible reversals.

Application of Japanese Candlesticks in Trading

Japanese candlesticks are a valuable tool in trading because they can help identify potential trend reversals and provide insights into market psychology. Here's how some key elements apply:

Identifying Trend Reversals: Reversals indicate that an ongoing trend might be ending and a new one beginning. Japanese candlestick patterns, such as Doji, Hammer, Inverted Hammer, Hanging Man and Shooting Star, can often signal these potential reversals. Think of this example - a Doji candlestick at the top of an uptrend may suggest that the bullish momentum is getting weaker and a bearish reversal may happen soon. On the other hand, a Hammer at the end of a downtrend can signal a potential bullish reversal.

Hammer and Hanging Man: The Hammer and Hanging Man are single candle patterns and are used to identify potential price reversals. The Hammer occurs after a downtrend and signals a potential bullish reversal.

Visually, it has a small body and a long lower wick, representing a period during which sellers were outperformed by buyers, pushing the price back upward. By contrast, the Hanging Man happens after an uptrend and suggests a potential bearish reversal. It also has a small body and a long lower wick, showing that even though there was a big sell-off during the period, buyers successfully pushed the price back upward. Remember, the presence of selling pressure during an uptrend can suggest a trend reversal.

Engulfing Patterns: Engulfing patterns are two-candle patterns that can signal potential reversals. The Bullish Engulfing pattern, shown by a small bearish candle completely engulfed by a subsequent larger bullish candle, reveals that buyers have overtaken the sellers and a bullish reversal may occur. It's often observed at the end of a downtrend. Quite the opposite, the Bearish Engulfing pattern, marked by a small bullish candle completely covered by a larger bearish one, signals that sellers have overwhelmed buyers and a bearish reversal may be on the horizon. It is often spotted at the end of an uptrend.

Pros and Cons of Japanese Candlesticks

Pros:

1) Versatility: Candlestick patterns can be used in any market, including FOREX, commodities, stocks, etc., and on any timeframe, from 1-minute charts to monthly charts. Further, you will often find clear visualization of price action.

2) Visual appeal: Candlestick charts are visually intuitive and easy to understand, making them appealing to many traders. They have very clear visualization. The various shapes and colors can quickly convey the dynamics of price movement.

3) Insight into market psychology: Candlestick patterns provide insights into market sentiment and trader psychology, offering clues about potential reversals or continuations.

4) Combination with other indicators: Candlestick patterns can be effectively combined with other forms of technical analysis, like trend lines, resistance and support levels, or technical indicators. This gives them more predictive power.

Cons:

Subjectivity and bias: Interpreting candlestick patterns can be a little subjective. Two traders may not always agree on the identification of certain patterns, leading to different trading decisions.

1) False signals: Like all technical analysis tools, candlestick patterns can sometimes provide false signals. A pattern that usually indicates a trend reversal might not always lead to a reversal, leading to potential trading losses.

2) Lack of quantitative indicators: Candlestick patterns are primarily qualitative and don't provide numerical such data as volatility, momentum or relative strength that other technical indicators offer.

3) Need for confirmation: Candlestick patterns often need confirmation from additional candles or other technical analysis tools, which might delay trading decisions. For this reason, candlesticks are sometimes known for giving false signals.

While Japanese candlestick patterns are a powerful tool for understanding market psychology and suggesting possible price movements, they should always be used as part of a comprehensive trading strategy that includes other technical analysis tools, risk management and sound trading principles.

The Bottom Line

Japanese candlesticks have survived from centuries-old rice markets to become an integral part of modern retail trading, especially FOREX. Their clear visual representation of price action offers a clear insight into the tug-of-war between buyers and sellers.

Each candlestick and pattern tells a unique story about the market sentiment, providing traders valuable insights into potential trend reversals or continuations. However, while they offer numerous advantages, their usage comes with some challenges, and the signals they provide are not infallible.

Therefore, as a responsible trader, you must combine them with other forms of technical analysis to confirm signals and enhance trading decisions. This helps you control for risk. Regardless of these complexities, the continued relevance of Japanese candlesticks just shows how useful they still are in today’s fast-paced world of trading. If you are intrigued by Japanese candlesticks and want to learn even more about these tools, we've written an even more comprehensive Japanese candlestick guide, which you can access here. Learning and mastering their meaning is an important skill for the modern retail trader.

FAQ

What are the basic components of a Japanese candlestick?

A Japanese candlestick is made up of a “body,” which shows the opening and closing prices. The “wicks” or “shadows” show the high and low prices during the given period. The body is filled (colored). If the asset closed lower than it opened (bearish candle), and empty (or differently colored) if the asset closed higher than it opened (bullish candle).

How do you read and interpret Japanese candlestick patterns?

Reading Japanese candlestick patterns entails understanding the price action that each pattern carries. A pattern can indicate market sentiment, potential price reversals, or trend continuations. For instance, a doji” pattern normally suggests market indecision and this might precede a trend reversal, while a “bullish engulfing” pattern can suggest the start of an uptrend.

What are some common bullish and bearish Japanese candlestick patterns?

These include the Hammer, Bullish Engulfing, and Morning Star, all of which can signal a potential upward trend reversal. Bearish patterns include the Hanging Man, Bearish Engulfing, and Evening Star. These all suggest potential downward trend reversals.

How can Japanese candlestick patterns be used to identify trend reversals?

Certain candlestick patterns indicate potential trend reversals. For example, a Doji or Hammer pattern following a downtrend could suggest a potential bullish reversal. On the other hand, a Hanging Man or Bearish Engulfing pattern following an uptrend might signal a bearish reversal. These patterns should be confirmed with other technical analysis tools.

What are the pros and cons of using Japanese candlesticks?

The big pros include their versatility, visual appeal, ability to reveal market psychology and compatibility with other technical indicators. The cons include the fact that they have subjective interpretation. They also risk providing false signals, while they lack true quantitative indicators. All this means Japanese candlesticks often require confirmation from additional signals or tools.

Can using Japanese candlesticks guarantee trading success?

Nothing guarantees trading success. The financial markets are beset by risk, and trading always exposes you to the possibility of losing money and winning money. Japanese candlesticks are merely one example of analysis that traders can use to get ahead in the markets.