When Munehia Homma first created candlestick charts in they 1700s, he had no idea it’d change the way we look at stocks 300 years later.
To him, candlestick charting was meant for the rice trade.
He’d record the opening day’s price of rice, the low and the close. And over time, he’d begin to see price patterns in his recordings, mapping out repetitive signals in the price bars. He soon gave them names, like spinning tops, dojis, and hanging man – candlestick names we still use to this day. Furthermore, the discovery of such patterns helped him to successfully predict the future direction of rice prices, giving him a significant advantage over other traders.
Japanese Candlestick Patterns
Japanese Candlesticks pattern charts are potent tools for efficient technical analysis. They are vital tools for analysts to time the entries and exits. Therefore, it assists them in anticipating the trend reversals. Additionally, it provides them with an idea of what might happen next in the market.
Japanese candlesticks charts are famous but hardly anybody knows how and where they started.
A Brief History of Candlestick Patterns
This method of technical analysis emerged in Japan during the 17th century in the rice trading industry. This initial method of technical analysis differs significantly from their US counterpart. Charles Dow started the current version in the 1900s. However, the two variations are similar in many respects:
- They both considered the ‘what’ aspect (price action) to be more significant than the ‘why’ aspect (earnings and news).
- They both reflected most of the information through their prices.
- The market fluctuated in both cases.
- The driving force moving the markets were the emotions and expectations of the buyers and the sellers (greed and fear).
- For both, the underlying price was not reflected in the actual price.
According to Steve Nison, it was during the 1850s that the candlestick charts first appeared. For the charting and candlestick development, people give credit to Homma who hailed from Sakata town and was a legendary rice trader. His original ideas continued to be refined and modified over the years as trading blossomed. Therefore, it resulted in the pattern of candlestick charting that we see today.
To create a candlesticks chart, one needs the data set containing the low, high, close and open values as per each display time period. The filled or hollow portion of the candlestick is the ‘body’ or even the ‘real body’.
The long and thin lines that are present above and below the candlesticks represent the high/low range. The industry knows them as shadows (often also called ‘tails’ or ‘wicks’).
Furthermore, to create the high, traders use the top part of the upper shadow. For marking the low, traders use the bottom part of the lower shadow. In the scenario when the stocks end up closing at a higher level than their opening price, a hollow candlestick represents the results. In this pattern, the top portion of the body represents the closing price and the bottom portion of the body represents the opening price.
When the stocks end up closing at a lower level than their opening price, a filled candlestick represents the scenario. The top portion of the body represents the opening price and the bottom portion of the body represents closing price.
Use of Candlestick Patterns
In comparison to the traditional bar charts, traders usually consider the candlestick charts to be easier to interpret and visually appealing. Every candlestick offers a very clear picture of the price action in the market. Using the candlestick pattern, traders can efficiently assess the relationship between the high and low and compare the relationship between the open and close values.
Essentially the candlesticks represent the open and close relationship, which is crucial information in the industry.
In the case of hollow candlestick patterns, where the open is less than the close, the picture reflects buying pressure. In the case of filled candlestick patterns, where the close is lesser than the open, the picture represents selling pressure.
Main Japanese Candlestick Patterns
1. Spinning Tops
Japanese candlesticks with a longer lower shadow, longer upper shadow, and smaller real bodies are known as spinning tops. In this pattern, the real body color is not significant. This kind of pattern is indicative of the indecision that is present between the sellers and the buyers.
The Marubozu pattern reflects the absence of any kind of shadows emanating from the bodies. Depending on the body (whether hollow or filled), the representation of the high and low is similar to the open and close.
Out of the two types of Marubozu, the white one with a white body indicates that the low price is the same as the open price and the high price equals the close price. On the contrary, the black Marubozu reflects that the low price is the same as the close price and the high price equals the open price.
The bodies of the Doji candlesticks are very short. Therefore, it shows that the close price and the open price are the same. Their bodies should be so small that they appear as a thin line. Doji candlesticks represent the struggle or indecision regarding the turf positioning between the sellers and buyers.
There are 4 kind of Doji patterns, the long-legged Doji, the dragonfly Doji, the four price Doji and the gravestone Doji.
4. Blending Candlesticks
In this kind of candlestick pattern, the whole emerges from one or more candlesticks blended together to form one candlestick. Blending Dark cloud cover can provide a shooting star pattern and blending a piercing pattern can result in a hammer pattern.
5. Hammer and Hanging Man
Both have small bodies (white or black), short or completely absent upper shadow and longer lower shadows.
The hammer pattern develops during a downtrend and signal that the price is falling. In the hanging pattern, it is evident that there are less buyers than there are sellers and the price is rising.
6. Inverted Hammer
This pattern presents small bodies (hollow or filled), a small or completely absent lower shadow and a longer upper shadow. This pattern represents falling prices and the possibility of a reversal.
7. Shooting Star
This pattern contain small bodies (hollow or filled), a small or completely absent lower shadow and a longer upper shadow. This pattern indicates that prices are rising.
8. Tweezer Tops and Bottoms
This kind of candlestick pattern is usually present after an extended downtrend or uptrend. Therefore, it indicates a high probability of a reversal occurring.
Japanese candlestick patterns are exceptionally useful tools for traders. They provide a vivid picture of the relationship between the high and low. Additionally, they help to efficiently chart the market trends.
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