The Japanese Candlestick Chart is the most popular choice among the stock traders. One of the main reason they are so popular is that the amount of information they give is sufficient. Secondly, they are easy to read, understand and interpret to make a stock prediction.
If you have to learn something when it comes to stock market that would stay with you for the rest of your life then it should be Japanese Candlestick Chart.
Candlestick has become one of the most essential of every trading platform, charting software and learning discourse. Japanese candlestick chart can literally be used for any financial instrument in the world.
The history of the candlestick chart dates back to 18th-century when a Japanese rice trader Munehisa Homma created to use for his rice trading business. Over the period of time, the candlestick as a tool has evolved and adjusted to the current market need and scenario.
Technical analysis, on the whole, is only tough on the outlook once you start understanding and using this would be the one tool that you would need all the time.
Algo Trading and Quants can also be applied in Japanese Candlestick chart pattern.
- 1 Japanese Candlestick Chart
- 1.1 History of Candlestick [Infographic]
- 1.2 Basics of Candlestick Chart
- 1.3 How to Read A Candlestick Chart
- 1.4 What is Candlestick Pattern in Stocks?
- 1.5 Candlestick Chart
- 1.6 Most Popular Candlestick Pattern
- 1.7 Candlesticks Patterns Strategy
- 1.8 Conclusion
Japanese Candlestick Chart
A candlestick includes tail and body which give the price movement detail for a specific period, usually selected by the chartist, which have the high, low, open & close price points of the underlying financial product.
Combination of different in high, open, low & close price points creates different types of candlesticks. Interpretation of these candlesticks plotted on a times series chart helps us analyze the underlying price movement to predict the future price of the stock.
History of Candlestick [Infographic]
Basics of Candlestick Chart
Bullish Candle – When the close is higher than the open (Candle is either Green or White)
Bearish Candle – Exactly the opposite of the bullish candle when the open is higher than the close. (Candle is either Red or Black)
Upper Shadow – The vertical line or the stick above the real body is the difference between the high of the day and close or open (Close in case of bullish candle and Open in case of bearish candle)
Lower Shadow – The vertical line or the stick below the real body is the difference between the low of the day and close or open (Close in case of bullish candle and Open in case of bearish candle)
Real Body – This is the colored portion of the candlestick (red/black or green/white) which is the difference between the open and the close for the day.
John J Murphy in his Book Technical Analysis of the Financial Market explains, “You can see how the name “candlesticks” came about. They look somewhat like a candle with a wick. The rectangle represents the difference between the open and close price for the day and is called the body. The different shapes for candlesticks have different meanings. The Japanese have defined primary candlesticks, based upon the relationship of high, open, low and close prices. Understanding the basic candle is just the beginning of the candlestick analysis”
How to Read A Candlestick Chart
Days, when the difference between the open and the close price of the candle is great, are called Long Days. Likewise, when the open and close of the price is small, are called Short Days.
This is just to the reference to the size of the body and made no reference to a bearish or bullish candle.
When the close is higher than the open it’s bullish candle and when the close is lower than the open it’s bearish candle.
A combination of such many candlesticks for a day make a chart. A chart could consist of the candle right from as low as 1min to 1hour or even as high as 1 week or 1month. This is totally the choice of the chartist what his purpose of the study is.
What is Candlestick Pattern in Stocks?
Candlestick pattern very often confused with chart pattern. When we talk about Double Top or Double Bottom we talking about the chart pattern and not candlestick pattern.
Candlestick pattern is created by a single candlestick or multiple candlesticks with variations with open, high, low and close.
Wikipedia’s explanation on candlestick pattern is, “In technical analysis, a candlestick pattern is a movement in prices shown graphically on a candlestick chart that some believe can predict a particular market movement. The recognition of the pattern is subjective and programs that are used for charting have to rely on predefined rules to match the pattern. There are 42 recognized patterns that can be split into simple and complex patterns.”
Some of the most popular candlestick patterns are:
Bullish Engulfing Pattern
Bearish Engulfing Pattern
Dark Cloud Cover
Tweezer Tops & Bottoms
Explaining each of the above candlestick patterns would not be the scope of this post. These candlestick patterns are very important and hence would be explained in details later in another post.
Until then I would share a Candlestick pattern cheat sheet for your reference.
With the above cheat sheet one would be able to understand how candlestick pattern is first broadly classified into three:
Bullish Candlestick Pattern
Neutral Candlestick Pattern
Bearish Candlestick Pattern
Under each type, they are again classified into three types.
Single Candlestick Pattern
Two Candlestick Pattern
Three+ Candlestick Pattern
Each an every candlestick is unique in its own sense. There is a different story to each candlestick which is a result of a tussle between the bulls and bears, demand and supply, buyers and sellers, greed and fear. Candlesticks independently talk a lot about the expected outcome but will not suffice in decision making.
Majority of first time trader start taking a decision based on the single candlestick. Ideally to get the best an entire chart has to be analyzed and only then decision taking should be done. A shooting star candlestick at the end of the trend or top of the trend makes all the difference.
Most Popular Candlestick Pattern
If you happen to read Thomas Bulkowski’s bestselling Encyclopedia of Chart Patterns—and structured in the same way. You would be amazed the total number of permutations and combinations they can form and there are so many candlestick patterns to rememeber.
Nevertheless, there are some which are very popular and quite often used. They are mentioned below.
Three Black Crows
It consists of continuous three black candlesticks where one candle closing is another candle’s opening. This usually signals a trend reversal. Exactly opposite three white candles are called Three White Soldiers.
Trading stock all the time without any signal can lead to wrong decisions. This situation arises when neither the buyer nor the sellers have won. The market is indecisive regarding its trend. It is best to stay away during this time of the market since the market is trendless and it could possibly break on any side of the trend.
A black or a white candlestick that consists of a small body near the high with a little or no upper shadow and a long lower tail. The lower tail should be two or three times the height of the body. Considered a bearish pattern during an uptrend.
Consists of three candlesticks. First is a large white body candlestick followed by a Doji that gap above the white body. The third candlestick is a black body that closes well into the white body. Its presence at the top of the chart is a sign of reversal signal. It signals more bearish trend than the evening star pattern because of the doji that has appeared between the two bodies.
Candlesticks Patterns Strategy
Now the real question is there are 100’s of stocks with forming various candlestick pattern all the time.
Narrowing down the number of candlestick pattern is only half problem sorted. Still, the total number of stocks are so many that it would take so much time to just figure out the pattern and you would end up times only searching the pattern.
In such a case we can eliminate the low volumes stock and narrow down the total number of stocks to either only Futures or Top 100.
The Real solution to this is a Technical Stock Screener.
Technical Stock Screener would work in the background screen the patterns in its cloud server and as pre-configured, the screener would bring the top candlestick pattern with the most probable outcome.
Learn from other traders have to say about the candlestick strategy.
Learning Technical Analysis one of the most important chapter is Candlestick and Candlestick Pattern.
Candlestick pattern are not mandatory for technical analysis but it is complementary to your analysis. If confirms your decision on technical analysis and can be an added advantage.
Now that you’ve had a chance to see more of how the Candlestick Pattern functions, let us know what you think about it.
Do you think it will make your technical analysis easier?
Let us know in comment.