Japanese Candlestick Patterns In Forex Trading

Learn How to Read Forex Candlestick Charts Like a Pro

March 26, 2017 Forex Trading Articles

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Learning to read candlestick charts is a great starting point for any technical trader who wants to gain a deeper understanding of how to read forex charts in general. As you may already know, Candlestick charts were invented and developed in the 18th century. The earliest reference to a Candlestick chart being used in financial markets was found in Sakata, Japan, where a rice merchant named Munehisa Homma used something similar to a modern Candlestick patterns to trade in the Ojima rice market in the Osaka region.

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Although bar charts and line charts were quite popular among Western traders, Japanese Candlestick charts and additional patterns were introduced to the Western financial markets in the early 1990’s, by a Chartered Market Technician (CMT) named Steve Nison.
The popularity of Candlestick charts has soared among Western market analysts over the last few decades because of its highly accurate predictive features. Candlestick charts can play a crucial role in better understanding price action and order flow in the financial markets.

Reading a Forex Chart with Candlesticks

Figure 1: A Single Candlestick Provides Four Important Values

Before you can read a Candlestick chart, you must understand the basic structure of a single candle. Each Candlestick accounts for a specified time period; it could be 1 minute, 60 minute, Daily, Weekly exc. Regardless of the time period, a Candlestick represents four distinct values on a chart.

1. The opening price at the beginning of the time period
2. The closing price at the end of the time period
3. The highest price during the time period
4. The lowest price during the time period

As you can see in figure 1, when you read a candle, depending on the opening and closing prices, it will provide you information on whether the session ended bullish or bearish. When the closing price is higher than the opening price, it is called a Bullish Candlestick. By contrast, when the closing price is lower than the opening price, it is known as a Bearish Candlestick. And the upper and lower shadows of the Candlestick represent the highest and lowest price during the time period.

Pros and Cons of Using Candlestick Charts Compared to Line and Bar Charts

Compared to Western line charts, both Bar and Candlestick charts offer more data to analyze.
Although the same four values are also found in Western-style bar charts, the bar chart uses horizontal lines on the sides of a vertical line to project the opening and closing prices. But, a series of Candlesticks on a chart can help traders identify the character of price action more definitively, which helps in the decision-making process.
With Candlesticks, it is much easier to interpret the price action during the time period because a Bullish Candlestick shows a full body with a pre designated color and a Bearish Candlestick a full body with a different pre designated color. As a result, many professional traders have moved to using Candlestick charts over bar charts because they recognize the simple and effective visual appeal of candlesticks.
However, while Candlestick charts make it much easier to interpret price action, it lacks the smoothness of the line chart, especially, when the market opens with a large gap. Hence, professional traders often end up using a short time period moving average to get the “feel” of a smooth trend, or lack of trend, in the market. So, it can be a good idea to add a moving average to the chart while using Candlestick charts.

Different Types of Candlestick Patterns Convey Different Messages

Each Candlestick represents an Open, High, Low, and Close value. The location of the opening price, how high or low price reached during the candle session, and where the price closed at the end of the time period are all factors in understanding candlestick charts.
Over the years, Japanese traders had developed various Candlestick patterns based on historical price movements. Every trader should invest their time and learn these patterns as it will provide a deeper knowledge and understanding of reading forex charts in general. Candlestick patterns can help you interpret the price action of a market and make forecasts about the immediate directional movements of the asset price.
While there many different patterns, we will discuss some of the most popular Candlestick patterns that can help in reading a price chart like a professional trader.
A candlestick reading can provide us with information on the three market sentiments: bullishness, bearishness, and a neutral or tentative market condition.
Below are some candle formations that can help us gauge market sentiment:

Figure 2: Various Types of Simple Candlestick Formations

Referring to the above illustration, A bullish Candlestick like the Big White Candle indicates bullish trend continuation, while a bearish Candlestick like the Big Black Candle indicates bearish trend continuation. On the other hand, a Doji Candlestick represents a neutral or tentative market condition.
So when you are reading candlestick charts, you need to keep in mind which Candlestick patterns indicate additional bullishness and which ones indicate further bearishness, as well as which ones indicate a rather neutral market condition and act accordingly.
The list of simple Bullish Candlestick Patterns include Big White Candle, Hammer, Inverted Hammer, and so forth. By contrast, the list of simple Bearish Candlestick Patterns includes Big Black Candle, Gravestone Doji, Hanging Man, Inverted Black Hammer, etc.

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If you are chart reading and find a bullish candlestick, you may consider placing a buy order. On the other hand, if you find a bearish candlestick, you may choose to place a sell order. However, while reading Candlesticks if you find a tentative pattern like the Doji, it might be a good idea to take a step back or look for opportunities elsewhere.
When you are reading a Candlestick price chart, one of the most important things to consider is the location of the Candlestick formation. For example, a Gravestone Doji appearing at the top of an uptrend can indicate a trend reversal. However, if the same pattern appeared during a longstanding downtrend, it may not necessarily mean bearish trend continuation.
We will further discuss the importance of location of Candlestick patterns in some example trades later.
In the next section we will discuss some complex candlestick patterns. Let’s take a look at the illustration below:

Figure 3: Examples of Some of the More Complex Candlestick Patterns

Once you have mastered the identification of simple Candlestick patterns, you can move on to trading more complex Candlestick patterns like the Bullish and Bearish 3-Method Formations.
The main difference between simple and complex Candlestick patterns is the number of Candlesticks required to form the patterns. While a simple Candlestick pattern, like the Hammer, requires a single Candlestick, the more complex Candlestick patterns usually require two or more Candlesticks to form.
For example, the Bullish Harami requires two Candlesticks, the Three White Soldiers pattern requires three Candlesticks, and the Bullish 3 Method formation requires 4 candles.
Once again, remember that regardless of the complexity, the location of all these simple and complex Candlestick patterns is one the most vital aspects of reading forex charts while using Candlesticks.

Candlestick Chart Reading Like a Pro

By now, you should have a good idea about what a Candlestick is and how to read simple and complex Candlestick patterns. So, let us now try to read trading charts to see how we can trade using these patterns.

Figure 4: Forex Chart Reading Using a Simple Engulfing Bullish Candlestick Pattern

In this example in figure 4 of the GBPJPY daily chart, we can see that the GBPJPY price was bouncing around a strong support level but failed to break below it. On the third try, the GBPJPY did penetrate the support level, but the market swiftly reversed and formed an Engulfing Bullish Candlestick pattern that signaled further bullishness in the market.
At this point, some beginner traders may recognize the bullish setup and immediately enter a buy order. However, professional traders are not only waiting for Candlestick patterns to form around key pivot zones, like this support level in figure 4, but they will also wait for the proper confirmation to enter the trade.
The next day, the GBPJPY price penetrated above the high of this Engulfing Bullish Candlestick, which confirmed that there would be additional bullishness in the market over the next few days.
Professional traders wait for this confirmation because they understand the concept of order flow and self-fulfilling prophecy.
You see, most large banks and hedge funds also watch key market levels and price action around critical levels. Once the Engulfing Bullish Candlestick formed around this crucial support level, it prompted a significant number of pending buy orders just above the high of this Engulfing Bullish Candlestick. Once the price penetrated above the high, it triggered those orders, which added the additional bullish momentum in the market.
Hence, waiting for the price to penetrate above the Candlestick pattern can help you increase the odds of winning on the trade.
As you can see in figure 4, once the buy order confirmation came, it did trigger a large uptrend move over the next few days.
As we briefly discussed earlier, the location of the Engulfing Bullish Candlestick for this particular trade was the most important factor. First, it formed around a major pivot zone, where the GBPJPY Bears had failed to break the support area in the previous two attempts. When you apply Candlestick patterns with additional technical confluence, it provides for a powerful combination of factors that can help increase your odds of winning. And this is exactly what professional traders try to do.
If the same Engulfing Bullish Candlestick pattern appeared at the top of a longstanding uptrend, it would have also signaled additional bullishness in the market, but that signal would be much less powerful. Since the market was already in an uptrend, it may not have had the legs to push the price much higher.
However, on this instance, the market was already trading in a range for several days. As you may know, when the market consolidates for a while, it is basically setting up to breakout in one direction or the other. The formation of this bullish Candlestick pattern provided a signal as to of which way the market was about to break.
If you knew how to read a simple Candlestick pattern like the Engulfing Bullish pattern, you could have entered this trade at the right time and earned a handsome profit with this high reward to risk ratio setup.

Figure 5: Three White Soldiers Candlestick Trend Reversal Pattern

In figure 5, we can see two different Candlestick patterns triggering two different trades. On the first occasion, the Engulfing Bearish Candlestick pattern appears during a downtrend that provides traders with a trend continuation signal. On the second occasion, a Three White Soldiers Candlestick pattern emerges at the bottom of the downtrend, which triggers a new bullish trend.
In the first trade, the AUDUSD was already moving to the downside. Once the Engulfing Bearish Candlestick broke below the support level, it opened up the possibility of a trend continuation. The next day, AUDUSD price penetrated below the low of the Engulfing Bearish Candlestick and confirmed the trade, which triggers the sell order.
It is strongly recommended that beginning traders stick to using Engulfing Bearish or Bullish patterns to confirm a trend reversal, as those tend to be higher probability trades. However, this particular example in figure 5 demonstrates that if you know how to use the confluence of support and resistance levels along with Candlestick patterns, these can be used to trigger trend continuation signals as well.
In the second trade, the Three White Soldiers Candlestick pattern emerged near the bottom of this downtrend. At this point, professional traders for preparing for the market to reverse the prevailing downtrend. The prudent course of action would be to wait for the market to confirm this signal, which means that unless the price broke above the high of this Three White Soldiers Candlestick pattern, you would not have entered the trade.

Combining Technical Analysis Indicators with Candlestick Patterns

Candlestick chart reading is largely based on the principle of technical analysis, which assumes that regardless of the underlying fundamental or economic conditions, the current market price reflects “all known information” regarding the asset.
Hence, the reason why an asset is moving in a certain direction is often not necessarily important to technical traders. Instead, they are more interested in interpreting what the price action is doing at the current moment and how they can take advantage of that. Furthermore, technicians know that the underlying reasons for market fluctuations over time can be many, and often the market does not always act “rational.”
Candlestick chart reading can be most useful during these volatile periods of irrational market behavior.
Traders can apply overbought and oversold technical indicators like Stochastics or Relative Strength Index (RSI) to find out when such irrational market conditions may be present.
For example, by using oscillating technical indicators, a trader will first wait for a signal that the market has moved into an overbought or oversold condition. At that point, they would look for a reversal signal of the prevailing trend. Many times, this reversal signal will come in the form of a candlestick formation.
Formation of a simple or complex Candlestick pattern during such market condition confirms and verifies the impending contrarian price action for the trader. Placing their order in the market using this combination of technical factors can significantly improve the accuracy of their trades.
Once you learn how to correctly read Candlestick patterns and combine this skill as part of a broader trading strategy, then you will likely improve the consistency of your market entries and your overall performance as a trader.

Conclusion

By now, you should be able to see the value of investing your time to learn how to read a Candlestick chart, and how to interpret the various simple and complex Candlestick patterns that we discussed. So before you start trading with Candlestick patterns, it is important to understand why and how these patterns work.
Once you master the basics of Candlestick chart reading, it can help you integrate this unique knowledge into your existing trading strategy and lead to better accuracy and improve your trading performance in the long run.

 

 

 

 

 

 

 

Japanese Candlestick Patterns In Forex Trading

Japanese Candlestick Patterns
• A Brief History of Japanese Candlestick Charting Patterns.
Candlestick charts originated in Japan during the 18th century. Since no defined currency standard existed in Japan during this time rice represented a medium of exchange. Various feudal lords deposited rice in warehouses in Osaka and would then sell or trade the coupon receipts, thus rice become the first futures market. In the 1700s legendary Japanese rice trader Homma Munehisa studied all aspects of rice trading from the fundamentals to market psychology.
Homma subsequently dominated the Japanese rice markets and built a huge fortune. His trading techniques and principles eventually evolved into the candlestick methodology which was then used by Japanese technical analysts when the Japanese stock market began in the 1870s. The method was picked up by famed market technician Charles Dow around 1900 and remains arguably the most popular form of technical analysis chart in use by today’s traders of financial instruments.
• Why use Candlestick Charts?
Candlestick charts show the same information as bar charts but in a graphical format that provides a more detailed and accurate representation of price action.
Candlestick charts visually display the supply and demand situation by showing who is winning the battle between the bulls and the bears.
Candlestick charts reveal another dimension of the given period’s price action by pictorially displaying the force (or lack of force) behind each price bar’s movement.
Candlestick formations make all single bar and multi-bar patterns significantly easier to spot in real time, thus increasing your chances of catching high probability trade setups. In addition, because candlestick charts use the same data as bar charts (open, high, low, and close), all Western technical signals used on a bar chart can easily be applied to a candlestick chart.
Candlestick charts offer everything bar charts do and more, using them is a win-win situation because you can use all the trading signals normally used on bar charts with the added clarity and additional signals generated by candlesticks.
Candlesticks charts are more fun to look at.
• The Anatomy of a Candle
Candlesticks have a central portion that displays the price distance between the open and the close. This area is known as the real body or simply the body.
The price distance between the open and the high for the period being analyzed is called the upper shadow, sometimes referred to as an “upper wick” as well. The highest price paid for a particular period is the marked by the high of the upper shadow.
The price distance between the close and the low for the period being analyzed is called the lower shadow, sometimes referred to as a “lower wick”.
The real body displays the opening and closing price of the security being traded. Closing prices have added significance because they determine the conviction of the bulls or bears. If the security closed higher than it opened, the real body is white or unfilled, with the opening price at the bottom of the real body and the closing price at the top. If the security closed lower than it opened, the real body is black, with the opening price at the top and the closing price at the bottom. Depending on the price action for the period being analyzed a candlestick might not have a body or a wick.
To better highlight or visualize price movements, modern candlestick charts (especially those displayed digitally) often replace the black or white of the candlestick real body with colors such as red (for a lower closing) and blue or green (for a higher closing).

• Core Candlestick Patterns
There are multiple forms of candlestick patterns; here is a brief overview of the most popular and widely used single and multi-bar patterns commonly used today.
Bullish Candle
Signals uptrend movement, they occur in different lengths; the longer the body, the more significant the price increase

Bearish Candle
Signals downtrend movement, they occur in different lengths; the longer the body, the more significant the price decrease.

Long Lower Shadow
These candles provide a bullish signal, the lower shadow must be at least the size of the real body; the longer the lower shadow the more reliable the signal.

Long upper shadow
These candles provide a bearish signal, the upper shadow must be at least the size of the real body; the longer the upper shadow the more reliable the signal.

Hammer
The hammer is a bullish signal that occurs during a downtrend. The lower shadow should be at least twice the length of the real-body. Hammers have little or no upper shadow. When a hammer occurs during an uptrend it is known as a “hanging man” and is a bearish signal. Because of the bullish long lower shadow however, this pattern needs bearish confirmation by a close under the hanging man’s real body.

Shooting Star
This candle has a long upper shadow with little, or no lower shadow, and a small real body near the lows of the session that develops during or after and uptrend.

Harami
The Harami is a two-candlestick pattern in which a small real body forms within the prior session’s larger real body.

Doji
The Doji is a candlestick in which the session’s open and close are the same, or almost the same. There are a few different varieties of Dojis, depending on where the opening and closing are in relation to the bar’s range.

Dragonfly doji
The Dragonfly Doji has a long lower shadow, the open, high, and close are at or very near the session’s high. This pattern often signals reversal of downtrend.

Gravestone doji

The Gravestone Doji has a long upper shadow, the open, low, and close are at or very near the session’s low. This pattern often signals reversal of an uptrend.

High wave candle / long-legged doji
This candle has a very long upper or lower shadow and a small real body. If the opening and closing price are the same the candle has no real body and is then called a Long-Legged Doji. The first picture is a high wave candle the second is a Long-Legged Doji.

Engulfing candles
The bullish engulfing pattern consists of large white real body that engulfs a small black real body in a downtrend. The bearish engulfing pattern occurs when the bears overwhelm the bulls and is reflected by a long black real body engulfing a small white real body in an uptrend.

Spinning tops
Spinning tops are simply candles with small real bodies.

• How Candlestick patterns translate into Nial Fuller’s Price Action Setups

My favorite price action setups consist of the pin bar, the inside bar, and my proprietary fakey setup. The above candlestick patterns can easily be condensed down to one of my three price action setups or may be applicable to more than one of my price action setups. It can be difficult to keep track of the various forms of candlestick patterns. This is why I feel like my three main price action setups do a great comprehensive job of including all the relative candlestick patterns and make them easier to understand in the context of daily price action. Let’s take a look at some charts with examples of some of the various candlestick patterns converted into my price action setups.

Pin Bars
The pin bar can include the following previously described candlestick patterns; long lower shadow candles and long upper shadow candles, hammers and shooting stars, dragonfly and gravestone dojis.

Inside Bars

Inside bars can technically encompass any candlestick pattern because they are simply a series of at least two candlesticks where the first candlestick completely engulfs the entire range of the subsequent candlestick, however, more often than not inside bars end up being spinning tops or dojis. Note, the inside bar is different from the “engulfing pattern” because it includes the entire range of the bar, from high to low, where as the engulfing pattern only includes engulfment of the real body of the candle. I generally trade inside bars in the context of a strongly trending market as they are often great entry points into trends. However, often times inside bars will occur at major market turning points as well as the previous trend loses momentum, pauses and forms an inside bar, and then changes direction.

The Fakey Setup

My fakey setup is essentially a multi-bar pattern that consists of a false break from an inside bar pattern or a key level. The fakey can consist of a number of different candlestick patterns. Often times the fakey setup will consist of a bullish or bearish engulfing pattern which is completely engulfing the range of a spinning top or doji candle which gives rise to a false break bar that can take the form of any of the candlesticks above that qualify as pin bars.

In Conclusion
Candlestick charts offer a more vivid depiction of price action than what a standard bar chart can provide. Candlestick patterns in and of themselves are useful, however there are many different names and interpretations of candlestick patterns which often can induce confusion and can be hard to keep track of. You will find that my price action educational material condenses all of the important candlestick patterns into 3 simple yet highly effective price action setups. I feel that my take on candlestick patterns expressed via my proprietary ideas on price action trading is a much more efficient, simple, and profitable way to trade candlesticks and I think after studying my forex trading course you will feel the same way.
Good trading,
Nial Fuller – Learn To Trade Forex
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