Japanese candlestick patterns are a crucial element when trading in the stock market using technical analysis strategies as they will allow you to analyze price movements quickly. In addition, traders use them to identify trends and reversals, as well as continuations in the future.
These patterns can be applied to any financial market, be it Forex, commodities or crypto-currencies.
Although past price performance does not guarantee future movements, Japanese candlestick patterns can be very useful in spotting great opportunities.
In this post we will unpack this concept, starting with its meaning followed by an analysis of the main patterns.
What are Japanese candles in trading?
Japanese candles are graphical figures that show the price changes of an asset in a given period. This analytical system was invented by Japanese rice traders centuries ago and was popularized among Western traders in the 1990s by a stockbroker named Steve Nison.
Today, Japanese candlestick charts are the most popular way to quickly analyze the movement of an asset’s price over a period of time. They offer much more visual information than traditional line charts, showing the highs, lows, opening prices and closing prices of a market at a glance.
In addition to tracking price movements, these figures are often used to find clues about where a market is headed.
How to read Japanese candle patterns
There are three key elements to keep in mind when reading Japanese candle patterns: color, body and wick or shadow.
Japanese candles are usually red or green— although you can set your own color. Red candles indicate that the closing price is below the opening price, while those that are green indicate the opposite.
Moving onto its composition, the body of the candlestick shows the opening and closing levels of the market, demonstrating the variation in price during that time.
Finally, the length of the wick indicates the overall price movement in that period between open and close, with the top of the wick representing the highest price point achieved, and the bottom representing the lowest.
By learning to invest in the stock market through a good trading school, you will certainly become familiar with each of these elements, be able to put them into practice, and effectively interpret the movements of the financial markets within any given time period.
Finally, before going in depth on the main Japanese candlestick patterns, it is important to consider the three categories, each of which are based on the number of candles that make up the pattern. These are known as single, double and triple.
Single Japanese candle patterns comprise of only one single trading period. Conversely, when a signal is formed from two consecutive periods, it is known as a double candle pattern. These often indicate upcoming trend changes, but can also be used to identify continuations of the current trend. Finally, the longest patterns we will cover are triples, which form in three consecutive periods. Triple candle patterns are often seen as some of the strongest signals of an upcoming move.
Main Japanese candle patterns
This pattern is formed when a candle— green or red— has a long wick both above and below it. What this indicates is that there was little price difference between the opening and closing of the market. As a result, spinning tops are also interpreted as indicating weakness in an ongoing trend.
In this case, the opening and closing prices are exactly the same. There are three main types of dojis to consider:
- Long-legged: long wick both above and below the body.
- Tombstone: long wick above the body and no wick below.
- Dragonfly: long wick under the body and little or no wick above.
Dojis often indicate indecision and as a result, an upcoming change in trend
Hammers are formed by a long wick under a short body, with little to no wick on top. The body should be about two or three times shorter than the lower wick.
A hammer that forms after a prolonged downward movement can mean a bullish counterattack.
Inverted hammers look exactly like hammers, but in reverse. That is to say, there is a short body underneath a tall upper wick, with little to no wick underneath.
This Japanese candle pattern appears after a downward trend and is a sign that a reversal is coming. With all hammers though, it is always advisable to wait for the formation of a bullish candle immediately after, before opening a buy position.
A shooting star is very similar to the inverted hammer, except it will appear at the top of an uptrend rather than at the bottom of a downtrend.
The asset price is withdrawn just above the opening price when the shooting star is green and below the opening when it is red.
The only difference between this pattern and a hammer is where it arises. A hammer appears just after a bearish market movement, whereas a hanging man appears just after an upward trend. In both cases, there may be an immediate reversal.
In addition, although both red and green hanging men are considered to be bearish patterns, a red hanging man normally indicates a stronger signal than a green one.
The name of this pattern comes from a Japanese word which indicates that it has no wick at all.
A green marubozu opens and closes at its lowest and highest levels respectively. A red one, on the other hand, opens and closes upside down, i.e. at its highest and lowest levels respectively.
Therefore, if the candle is green, the marubozu indicates an uptrend that will continue or a downtrend that will end in a reversal.
Conversely, if the candle is red, it is the exact opposite; a downward trend that will continue or an upward trend with an eventual reversal.
The harami pattern is formed by a candle followed by another much smaller candle in the opposite direction.
The name comes from the Japanese word “pregnant” as some perceive that in its shape.
Haramis can be bullish or bearish. The former are formed from a red candle followed by a green one inside the body. This means that the downward trend may be ending. In the latter, the opposite occurs: a green candle is followed by a smaller red one.
This pattern is very similar to the harami but with both candles in red.
The body of the second candle is inside the body of the first one and indicates that an upward trend is about to begin.
This pattern is considered unhelpful in very volatile conditions.
These Japanese candle patterns are formed by two equal but different colored candles that appear after an upward or downward trend indicating a coming reversal.
The first candle always coincides with the previous trend. If the trend is upward, the first candle would be green and the second red (vice versa if the trend is downward).
In both cases, the two candles should have a short upper body and a long wick below.
A morning star is formed when a point of indecision is reached after a prolonged downward trend, before beginning to recover.
It contains a total of three candles:
- A red candle with a long body, which is part of the downward trend.
- A green candle with a short body, usually a spinning top pattern, which indicates the entry of the uptrend.
- A green candle with a long body that confirms that a reversal has begun.
This pattern can be seen as a sign that the recovery will turn into a long-lasting uptrend.
This is a pattern totally opposite to the morning star. The evening star shows a bullish market that reaches a point of indecision before beginning its retreat.
It looks very similar to a morning star, but with a green candle at the beginning, a slightly extended uptrend, and a red candle at the end.
Three White Soldiers
The pattern of the three white soldiers appears after a continued downward trend and a small consolidation. This is one of the clearest signs that the downward trend is over.
The three soldiers are:
- A green candle following a downward trend.
- A green candle, with a longer body than the first and little to no upper wick.
- Another green candle, with a body that at least matches the second one along with a small wick or none at all.
Three Black Crows
This pattern is the opposite of the three white soldiers. It appears after an uptrend and is a strong signal that the uptrend is over.
The three black crows are:
- A red candle following an uptrend
- A red candle, slightly longer than the first with a short or non-existent lower wick.
- Another red candle, with a longer body than the second and no wick at all
If you’ve made it to the end, you now already know quite a bit about Japanese candles. In order to start trading with these patterns though, the first thing you will need to do is learn the ins and outs of trading and technical analysis.
Remember to spend time practicing with a demo account before you start trading with real money. These Japanese candlestick patterns will help you find great opportunities, which once you launch your live account, can bring you substantial profits.