How to Read and Analyze Japanese Candlestick Chart Patterns – An Important Technical Analysis Tool for Day Trading

Who Invented the Japanese Candlestick Chart?

What are Candlestick Patterns?

How Accurate Are Candlestick Patterns?

The candlesticks visually represent the traders’ emotions with different colors depending on the size of the price movement. If you are a novice trader, one of the most important things you’ll need to learn is how to correctly read and analyze candlestick charts. They can seem daunting at first but this guide will provide all the basics on what each element in the chart means and how to read them in order to use historical price data to your advantage.

How to Interpret and Understand Candlestick Chart Patterns

How Do Candlestick Charts Work?

The following data sets or price points are required to create each candlestick:

Candlestick charts give an advantage over bar charts as they are more visual. Additionally, bar charts make it difficult to visualize which direction the price moved, which candlestick charts help with.

How to Read Candlestick Charts?

How Can You Tell If a Candle Is Bullish or Bearish?

Look at either a candle’s appearance or its opening and closing prices to gauge whether it is bullish or bearish.

Bullish: The closing price is higher than the opening price, and indicates there is buying pressure. A bullish candle is usually shown as green, white, or hollow.

Bearish: The closing price is lower than the opening price and indicates there is selling pressure. A bearish candle is normally shown as red, black, or filled.

How to Identify Trading Opportunities in 5 Steps With Candlestick Pattern Analysis?

Candlestick patterns help you to identify and confirm price trends. However, it’s best to follow a tried and tested routine to help you minimize emotion and make the best decisions.

Follow these five general steps to identify trading opportunities through candlestick pattern analysis:

1. Determine the trend: Identify if the market is in an uptrend, downtrend, or sideways trend before you look at patterns to identify possible trends.
2. Spot candlestick patterns: Look for single candlestick patterns, double candlestick patterns, or triple candlestick patterns indicating potential reversals or continuations of the trend, specifically such as the doji, shooting/morning/evening star, and three soldiers.
3. Confirm the pattern: Now, use other forms of technical and fundamental analysis to confirm the pattern. This will help you avoid most false signals and boost your chances of success in your trade.
4. Always set up entry and exit points: Crypto markets can be incredibly volatile and you need to have boundaries in place to avoid getting REKT. Establish clear entry and exit points for the trade based on your analysis, and execute them with stop-loss and take-profit sell orders. Use your head at all times, not your heart, and don’t chase your losses.
5. Monitor the trade: Keep a close eye on the trade and adjust your exit points as necessary. For example, if you’re up big, you can move your stop-loss order to lock in some profits, or if you feel that the trend is so strong, you can set your take-profit order higher in order to realize bigger gains. Again, do not get seduced by emotions like greed, but make logical and smart decisions.

How Many Candlestick Patterns Are There?

Candlestick charts can be divided into single, double, and triple candlestick patterns, with each pattern representing different market trends.

Single Candlestick Patterns

This pattern forms the basis of the other two. Understanding single patterns can help you pick up market trends from double and triple patterns. There are eight basic single candlestick patterns:

• Doji - “Doji” means “the same as” in Japanese and is formed when the opening and closing price within a certain time frame is the same or almost identical. The body of the candle will be compressed and the tail will be very prominent.

• Gravestone - Resembles a gravestone and represents bearish conditions, there will be a long wick above the body.

• Inverted gravestone/dragonfly - Represented by a tail below the body and indicates that the bullish power is diminishing.

• The hammer/hanging man - There is a very long wick below the body with a very slight upper wick. The hammer indicates the end of a bullish or bearish force. The hammer representing a bullish force is called a “hanging man”.

• Inverted hammer/Shooting star - This represents a reversing trend and is visualized by a long upper wick and smaller body. When indicating a change to a bearish market, it’s called a “shooting star”, while the opposite is called an “inverted hammer”.

• Spinning top - This pattern forms when the market has experienced very little movement. A short body represents it with wicks on either side that are almost identical in length.

• Standard line - this pattern has candles with long bodies and very short tails at either end. This pattern doesn’t give important market cues but instead indicates that whatever direction the market is headed - bullish or bearish - it has the power to sustain it.

• Marubozu pattern - this pattern is represented by a body with no tails. It indicates the advancement of a bullish or bearish atmosphere.

Double Candlestick Patterns

These candlestick patterns are read in pairs. The most common double candlestick patterns are:

• Bearish/bullish engulfing - engulfing patterns that indicate a reversal in market conditions and illustrate that one trend is being overpowered by the other in the opposite direction. Two neighboring candles display this trend, indicating whether bullish or bearish movements are dominating - a bullish engulfing pattern will have a bearish candle followed by a bullish candle with a bigger body.
• Tweezers - this pattern also represents a reversal in market conditions. Both candles will have the same body and wick length but tweezers can be at the top (wicks are underneath) or bottom (wicks are at the top) with tweezers at the bottom signaling a change from bullish to bearish, and vice versa.

Triple Candlestick Patterns

As the name suggests, three candles make up these patterns. The two most important triple candlestick patterns, which both represent a trend reversal, are the:

• Morning/evening star - the evening star pattern starts with a bullish candle, followed by a small bullish/bearish star and then a longer bearish candle that is longer than the first bullish one of the set.

• Three soldiers - this pattern is a staircase with three steps. For a bullish trend, the first candle is small and the pattern gets increasingly bigger, which indicates a shift from a bearish to a bullish trend and vice versa with the alternating pattern.

What Are Heikin-Ashi Candlestick Charts?

Above, we have discussed Japanese candlestick charts, what they are, and how to read them. However, the Heikin-Ashi technique is another way to calculate candlesticks.

Heikin-Ashi means “average bar” in Japanese, and as such, these types of charts rely on average price data. Whereas traditional Japanese candlestick charts don’t give details as to what happened between the market open and close or which price occurred first - the high or low one. Heikin-Ashi can make it easier to spot market trends, price patterns, and possible reversals.

This is why some traders prefer to use both traditional Japanese candlestick charts and Heikin-Ashi, to get a more overall, well-rounded view of the markets.

In a Heikin-Ashi chart, an average of the open, high, low, and close prices are used to calculate the candle, creating a smoother representation of price movements which in turn makes it easier for a trader to identify trends.

Green Heikin-Ashin candles with no upper wicks generally mean a strong uptrend, while their red counterparts which also lack an upper wick often indicate a strong downward trend. However, since this technique of price charting uses average price data, patterns can take longer to develop. These charts also don’t show price gaps.

Is Heikin-Ashi Reliable?

Heikin-Ashi charts are as reliable as the mindset with which it is analyzed. They can be useful for identifying trends as they simplify their appearance, but they are not always reliable, especially when used with markets subject to fundamental factors.

Heikin-Ashi is a lagging indicator using historical data, and its use of averages can be both seen as good or bad, depending on what time frame you’re trading on and the level of price movement you want to see. As Heikin-Ashi flattens out price movements, you’ll likely see clearer longer time frame trends, since it stays green in an uptrend and red in a downtrend for longer than traditional candlesticks.

Like any other TA charting tool, traders should combine them with other forms of analysis to validate trading signals.

Is Heikin-Ashi Good for Day Trading?

Heikin-Ashi vs Candlestick Charting

Traditional candlestick and Heikin-Ashi charts are both useful with their own strengths and weaknesses, which should be understood by traders in depth before making big decisions based on them.

On the other hand, Heikin-Ashi charts can be especially useful to identify certain trends faster and more clearly, they are not meant to replace traditional candlestick charts, but rather to supplement them. No TA tool is perfect and traders should use the method that works best for them, then use other resources such as moving averages, Bollinger bands, and the Relative Strength Index (RSI) to confirm their findings.

FAQ: Candlestick Chart Analysis

Which Candlestick Pattern Is the Most Reliable?

No single pattern is considered the most reliable, as it depends on market conditions and the time frame analyzed. It’s OK to have your favorite indicator and patterns, but traders should use different time frames and a toolkit of multiple techniques found in technical and fundamental analysis to validate or invalidate their findings.

How Do You Read Candle Patterns?

Candlestick patterns in essence visualize the emotions of traders during a specified time frame. Each candlestick reflects the open, high, low and close price of a traded asset. The body represents the distance between the open and close prices, while the wick or shadow represents the distance between the body and the high and low prices.

If the candlestick’s body is green, it means the asset closed higher than it opened, while conversely if the body is red, it closed lower than it opened. By analyzing a string of these candlesticks, we can try to determine certain behavioral trends in the asset’s price over time.

Do Candlestick Patterns Really Work?

Candlestick patterns can be useful in identifying market trends and potential trading opportunities, but they should not be used in isolation or be considered absolute indicators. It is important to use multiple techniques from technical and fundamental analysis in tandem with candlestick pattern analysis to make informed trading decisions.

What Is the Three Candle Rule?

The 3 candle rule states that the first candlestick sets the trend, while the second and third candlesticks confirm it and determine the potential for a trade. It’s best that each candlestick doesn’t have a very long shadow and opens within the previous candle’s body.

Are Heikin-Ashi Candles Better for Day Trading?

Heikin-Ashi candles can be utilized for day trading, swing trading, and scalping, but should not be used in isolation. They simplify price movements and identify trends, but don’t represent real prices, and as shorter time frames are usually preferred in day trading, you might miss out on some important smaller movements.

Comparing Japanese Candlestick Charts to Other Popular Chart Types

While Japanese candlestick charts are one of the most popular charting types for traders, there are many other useful chart types out there. As you can see in the image below, the popular charting suite, TradingView, hosts a wide range of chart types, some more popular than others.

For example, the Line Chart is a charting type commonly used by beginners, while Renko charts are popular amongst more sophisticated trend traders. Let’s take a closer look at some of these chart types and see how they compare to traditional Japanese candlesticks.

What Is a Line Chart?

Line charts are commonly used by novice traders and investors to aid their trading decisions. Contrary to candlestick charts, line charts do not change colors based on the direction of a price move. Instead, they draw a line between the closing values of an asset for each specified period of time.

For example, a daily line chart draws a continuous line between the prices at the end of each week. The below image shows Bitcoin’s price action presented in a weekly line chart.

Line charts have one advantage over candlestick charts: they reduce noise, offering a clearer picture. By drawing a continuous line between the closing values of each period, the price action between those closes is ignored – contrary to candlestick charts, which use wicks to represent price action that happened outside of the candlestick body.

While advantageous for some, most traders consider the line chart to be overly simplistic – preferring to use it merely for a quick scan of the markets.

What Is a Renko Chart?

As we mentioned, Renko charts are a popular chart type amongst professional traders. This Japanese charting type prints a so-called brick whenever the price moves a predetermined amount, without consideration for the passage of time. In other words, regardless of how long it may take, a new brick is only printed when the price moves a certain amount.

Trend traders love this chart type, because it displays trends and their reversals in a very simple way, without noise. The below image shows Bitcoin price action presented on a Renko chart. In this chart, each brick represents a move of $2500.

Since the price can whipsaw significantly without any signs of it on a Renko Chart. For this reason, most Renko users combine the tool with other forms of analysis, such as traditional Japanese candlestick charts.

What Is a Point-and-Figure Chart?

Point-and-Figure charts are another popular chart style that – in the same fashion as Renko – does not account for the passage of time. They print columns of Xs (bullish) and Os (bearish) stacked on top of each other, with each symbol representing a predetermined price move.

Again, regardless of how long it may take, a new symbol is only printed when the price moves a certain amount. In this, a strong downtrend consists merely of Os, even if there are small bounces on the way up – resulting in very little noise.

The chart below, once again, shows Bitcoin price action - this time displayed on a Point-and-Figure chart, where each symbol represents a move of $1000.

The Point-and-Figure chart type is very similar to Renko, and, therefore, has the same shortcomings. Its failure to account for the passage of time has critics wondering if the technique is overly simplistic. Nevertheless, this charting style has stood the test of time, and many traders have built a successful trading strategy around mere Xs and Os.

What Is a Kagi Chart?

Finally, a Kagi chart is another Japanese chart type that does not account for the passage of time. It changes direction when there is a price reversal of a predetermined amount or more. Until that happens, Kagi charts continue to move in the same direction.

Nevertheless, this chart type is slightly different from Renko and Point-and-Figure, because the color of the line only changes to green when the price breaks above the previous high, and only flips red when the price breaks below the previous low. These changes in line color can, therefore, be interpreted as buy or sell signals. The picture below shows Bitcoin price action displayed on a Kagi chart, where the minimum move is $1000.

Kagi charts are considered a simple chart style favored primarily by trend traders. The lack of noise on the charts is considered an advantage (like Renko and Point-and-Figure charts). At the same time, some traders wonder if it is overly simplistic to build a successful trading strategy.

Final Thoughts

Japanese candlesticks are a very useful tool to dissect both past and current price action in the time frame of your choice in order to identify trends and potential trading opportunities. However, it’s vital not to become over-reliant on any specific trading indicator and rather to use multiple tools to support or invalidate your findings. Crypto markets can be heavily volatile for many reasons, such as manipulation, macroeconomic policies, or tokenomics to name a few. Therefore, add some fundamental analysis to your toolkit and look at economic, political, and financial trends that might impact the performance of the asset you’re analyzing.

Ask yourself the question, if you could choose, would you rather earn an extra $10,000 in trading or save $10,000 by eliminating some bad trades over the course of a year? Both yield the same result on your bottom line.

To illustrate this further, let’s once again look at the Land of the Rising Sun. If you’re familiar with Japanese martial arts like karate and aikido, you’ll know that defense is as important as attack. Remember this next time you slide in front of your computer and start drawing lines across those candlesticks!