All about Japanese Candles
Today, candlesticks are the de facto standard for most trading platforms and monitoring systems. They deserve such popularity due to their informativeness and ease of presentation of information on market trading. This is a truly advanced tool for forecasting market trends, all the advantages of which Western traders were able to appreciate only at the beginning of the last century. We are allowed to enjoy all the benefits of a wide Japanese heritage at absolutely no cost. Japanese candles are in today's material.
The roots of candlesticks, as you might guess, come from Japan. Japanese traders began to apply technical analysis in the 17th century, almost from the very beginning of exchange trading. Rice traders of that time were able to notice a high potential in the newly invented way of representing price dynamics. At the same time, Homma Munehisa, who is considered the first inventor of the candlestick chart as such, made a considerable contribution to the popularization of Japanese candles.
Indeed, the candlestick chart has some obvious advantages over the traditional linear and bar charts used by Western traders at that time. This continued until the nineties of the last century, when Steve Nison's materials were released on the basis of a graphical analysis of financial markets based on Japanese candles. He also discovered dozens of ready-made candle formations to the Western world, which in themselves are a signal for action. These include the patterns “Evening Star”, “Morning Star”, “Triple Strike”, “Three Crows” and many others.
This topic was covered in more detail in the book “Japanese Candles” by Gregory Morris, where a substantial part of the material is devoted to the practical use of candlestick charts.
Unlike the traditional line chart, in one element - a candle, we get as many as four indicators instead of one. The visibility of the candle, in turn, allows you to almost instantly identify complex graphic patterns on the chart. This significantly increases the information content of the chart and allows for a comprehensive market analysis.
The nature of the candle helps in understanding the psychology of traders, which is an important aspect of candle analysis. The candlestick chart allowed us to identify standard patterns of behavior of traders and, accordingly, to predict their subsequent decisions. As a result, primitive, at first glance, analysis allowed its creator to significantly increase its capital.
Each candle on the chart indicates the price range for a certain period, also called the timeframe. The candle itself consists of a body, usually white or black, and two shadows (tails), above and below the body. The shadow of the candle indicates the maximum and minimum prices for the period.
A bullish candle (usually white) means that the closing price of the period was higher than the opening price, in other words, the price rose. A bearish candle (black, as a rule) means that the price at the close was lower than the open, that is, the price fell.
In some cases, the candle body may be completely absent if the opening price for the period is equal to the closing price, that is, at the end of the period the price has not changed. Such a candle is also called Doji.
The other extreme is when the candle is missing one or both of the shadows. This happens when the price of opening and closing a period is its maximum and minimum value.
Psychology of traders
For one type of candle, we can determine the behavior of buyers and sellers and, accordingly, evaluate their future intentions. There are many candle patterns, the identification of which is an important component of technical analysis, but since everything lies on the surface, you can learn to “read” candles without even knowing about traditional candle patterns.
The size of the candle is the first parameter that you should pay attention to. The larger the relative size of the candle body, the stronger the pressure of buyers or sellers. A candle with a large white body indicates the prevalence of bullish moods. This means that at the end of the period buyers prevailed. The dark candle indicates the predominance of sellers.
Short candles, on the contrary, indicate the formation of consolidation or stagnation. Usually this happens when the number of buyers and sellers is approximately equal and the market has not yet decided which direction to move on to.
Thus, the relative positioning of the candle plays an important role. A large white candle after a long downtrend may indicate a change in direction of the main trend. If such a candle breaks through the resistance level, this may mean fixing a new price level.
At the same time, we cannot say with certainty what happened in the process of candle formation. The price movement from the opening point to the closing point can be either rectilinear or zigzag. Usually, to determine the nature of the movement, it is enough to go down one or two timeframes below, if possible.
A large tail at one end usually indicates a change in the bullish mood to a bearish one (and vice versa) in the process of candle formation. A candle of this form is popularly called a pin-bar, and it is formed at extremes, as a rule, portending a change in the short-term direction or the continuation of the trend after correction. Often, such candles can be observed at important key levels, which the price could not break through, with its big tail resting towards the level.
As mentioned earlier, in order to track the price movement inside the candle, it is enough to go down to a lower timeframe. For example, if a pin-bar formed on the daily chart, then to see the process of candle formation, just go down to the hourly timeframe.
The hourly chart shows the typical pin-bar movement. The price rises first, and from about the middle of the period it begins to fall, closing near the opening level.
Sometimes the struggle between buyers and sellers reaches its zenith, as a result of which we observe on the Doji chart with very large shadows. This indicates a high level of indecision in the market, when trade is very active, but without a visible result.
To more accurately determine the nature of the candle, the Price Action expert, Lance Begs, introduced the concept of the “mood” of the candle. This approach has some advantages against the traditional classification of candles, since it does not focus only on the color of the candle, but takes into account the nature of the price movement. There can be 3 types of mood: bullish, bearish and neutral. In addition, each of the moods additionally has 3 gradations (levels): high, medium and low.
If the candle closes above the previous high, it has a bullish mood. On the contrary, if the closing price of the period is below the previous low, the candlestick has a bearish mood. A neutral mood candle is formed when the closing price is within the range of the previous candle. That is, the closure of the current candle should fall into one of 3 zones relative to the previous period.
Next, we can determine the level of mood of the candle. To do this, it is necessary to identify the area of the candle closure: high closure, medium or low. To determine the level, the current candle must be divided into three zones. Depending on in which part of the range the candle has closed, the level of its mood will depend.
Here are examples of candles with high closure, where the closure of the period falls on the upper third of the range.
Examples of candles with average closure, where the closure of the period falls on the middle third of the entire range.
And also examples of low-closing candles, where the candle closes in the lower third.
Japanese candles have not just gained their popularity. This once again proves that the point is not in the information itself, but in the way it is presented. Even today, after several centuries, the candlestick chart does not lose its effectiveness in determining the desires of traders. In fact, the first thing every newcomer to the market should do is learn to “read” the candles. Without this skill, no trade will be complete and successful.