Japanese candlesticks and the patterns they create represent a visualization of financial data that is very popular with financial traders and technical analysts. Referred to as candlesticks based on their appearance, these tools show how an asset’s price swings between two extremes and therefore may offer bullish or bearish market insights into a traded asset’s future behavior that could be used for financial gain. A candlestick on crypto exchanges can represent price movement on various timeframes, as small as one minute, and as long as one month or more.
History of Japanese Candlestick Patterns
While their usage had already proliferated across every corner of the globe, Japanese candlesticks are actually the brainchild of Munehisa Homma, a trader who lived four centuries ago.
In the 1700s, Homma, a Japanese rice merchant, observed a connection between how rice price followed three things; supply, demand and traders’ emotions.
After its successful introduction into the Japanese stock market, the method found its way into the U.S. market, where it first appeared in a book authored by Steve Nisson, a technical analyst called “Japanese Candlestick Charting to the Western World.”
Notably, its arrival in the U.S. paved the way for the technique’s global adoption when interacting with financial instruments. Countless traders now regularly use candlesticks as a primary tool to determine when to enter or exit a trading position.
What Information Is Represented by a Japanese Candlestick Pattern?
A candlestick shows the direction of a particular commodity’s price. Significant indicators include opening and closing prices. Moreover, they show whether there has been a price increase or decrease within a selected timeframe.
The patterns take a candle-like shape with a body and a tail/shadow/wick attached to it (the body). Tails on the upper part display the closing and high prices, and vice versa.
A green or white candlestick body shows a positive price, while a negative price movement turns the body color to either black or red. Modern trading platforms allow traders to choose their preferred colors to represent bullish or bearish movements.
Different Japanese Candlestick Patterns
Candlesticks realistically represent market conditions by taking form in various patterns. They can be divided into single, double and triple candlestick patterns.
Single Candlestick Patterns
These form the basis of the other patterns. Notably, understanding single candlestick patterns helps in extracting market trends from double and triple patterns. Apart from the Marubozu (which will be explained below), the rest of the single patterns represent a reversal of the current trend.
In this category, there are eight basic candlestick patterns.
- Doji – First, note that Doji means “the same as” in Japanese. Doji represents a formation when the opening and closing price is equal or has a very minimal difference. In this case, the body is compressed (almost like a dash), and the tail is the most prominent. Unlike traditional markets, which often operate on scheduled hours from Monday to Friday, candlesticks in crypto can actually represent a more realistic visualization of a traded asset’s movement, as crypto trading is exclusively online and price movement on shorter timeframes, e.g. 15m, 30m, 1h and 4h, can be depicted without any breaks in trading activity, unlike traditional stock exchanges.
If the price doesn’t move, a Doji resembles a dash and has no tail. Doji shows a reversal or a neutral occurrence.
- Gravestone candlestick pattern – Its name stems from its resemblance to a gravestone. Here, the body is followed by a shadow on the upper part.
Apart from taking the shape of a gravestone, its name indicates a strong bearish force.
- Dragonfly – Also called the inverted gravestone, it is represented by a body with only a tail on the downside. It shows that the bullish power is diminishing.
- Hammer – The hammer Japanese Candlestick pattern is formed when the body is attached to a long wick on the bottom, rather than the top. In most cases, the upper tail is almost negligible.
The hammer shows the end of a controlling force from either the bears or the bulls. Note that a hammer representing a surrender to the bears is called a “hanging man.”
- Spinning top – This candlestick forms when the market experiences little movements and is indicated by a short body and wicks with near-identical lengths. A spinning top pattern often shows a consolidating market.
In addition, it indicates that bears and bulls are fighting for control, but neither of them has the upper hand.
- Standard line – A typical candlestick pattern with a stronger body and weaker tails on both ends. However, standard lines don’t pack important clues on the next market direction.
Instead, they indicate that the wind blowing in a particular direction has sustaining power. A standard line candlestick pattern can either be bullish or bearish.
- Marubozu pattern– This candle pattern has a body without tails. A Marubozu shows the advancement of a bullish or bearish trading atmosphere.
- Inverted hammer – An inverted hammer represents a reversing trend. It is the opposite of the hammer and the hanging man. The inverted hammer has a longer upper wick and a smaller body.
When indicating the end of the road for the bulls, it’s called a shooting star, while the inverted hammer shows the bears have had enough and it’s time for the bulls to take over.
Double Japanese Candlestick Patterns
Candlesticks in this category are read in pairs to unearth the current state of the market. The most used patterns in this category are bearish/bullish engulfing and tweezers.
Engulfing Japanese Candlestick patterns indicate that a market trend is being overpowered or consumed by the other in the opposite direction. Two adjacent candles display it, indicating which movement, between bullish and bearish, dominates the other. For instance, a bullish engulfing candlestick will have a bearish candle followed by a bullish candle with a larger body. These patterns show a reversal in market behavior.
Tweezers also indicate a reversal but with a difference. Two candlesticks represent them with the same body and wick length. Tweezer can either be at the top (tails are on the lower side) or bottom (shadows are at the upper part). Note that tweezer bottoms signal a change of guard from bullish to bearish and vice versa.
Triple Japanese Candlestick Patterns
Here, in order to deduce the message from the chart, three adjacent candles are read as an item. Two important patterns are the morning/evening star and the three soldiers. Although they both indicate a reversal, their representation is different.
For example, the evening star starts with a bullish candle followed by a small bearish/bullish star followed by a bearish candle longer than the first bullish sign.
Three soldiers, on the other hand, form a staircase-like pattern with three steps. For a bullish trend, it starts with a small candle, followed by a noticeably bigger candle, then an even bigger candle. They indicate a trend shift from bullish to bearish and vice versa.
Why Are Japanese Candlesticks Important?
Japanese candlestick patterns have historically given traders a reliable visual display to chart how a particular asset behaves. In addition, they’ve helped traders anticipate their next moves and position themselves in the line of profits in order for them to know when to sell, buy or hold.
Today, understanding patterns helps traders read complex charts presented by asset trading platforms such as cryptocurrency exchanges. Consequently, this allows crypto traders to incorporate charts in trading strategies.
While Japanese candlestick patterns can be a very useful tool to review the history of a cryptocurrency or stock or chart its potential future, it is important to understand that there are other factors to consider when employing them, such as fundamental analysis (such as their team, funding and community), overall market sentiments and trends, major news and the timeframe you’re using. Don’t just rely on one tool, but pick the best one and make an informed decision before trading.