Japanese candles are a powerful tool for technical analysis. They provide a wealth of information about the price of an asset, including the direction of the trend, the strength of the movement, and the level of volatility.
In this article, we will explain the basics of Japanese candles and how to use them to interpret stock market trends. We will also discuss some basic trading strategies that can be used with Japanese candles.
So whether you are a beginner or an experienced trader, read on to learn how Japanese candles can help you make better trading decisions. And, if you’re eager for more knowledge, our next article, “Technical Analysis – Principles, Theories, Figures, and Indicators,” is a must-read resource to deepen your understanding.
What are Japanese candlesticks?
A Japanese candle is a figure that shows the evolution of the price of an asset over a given period. Unlike other technical analysis charts, Japanese candle charts give us four essential pieces of data when analyzing the evolution of a price: the opening price, the closing price, the maximum, and the minimum.
How to interpret a Japanese candlestick patterns? | What does OHLC mean?
OHLC is an acronym for open, high, low, and close. These are the four prices marked by a Japanese candle (opening, maximum, minimum, and closing).
In a Japanese candle, four session prices are indicated: the maximum price reached, the minimum reached, the closing price, and the opening price.
In the previous image, we can perfectly observe the four prices that we had indicated previously, and they are:
- The highest price attained by a Japanese candle represents the full quotation achieved within a specific time interval, such as a trading session. The candle is meant at the upper end of the wick.
- The opening price is the price at which the session begins (or the period of time that the candle represents). Its starting point is defined, by the closing point of the previous session (a GAP may exist) and graphically it would be the low point of the green bar or the high end of the red bar (careful, I talk about the bars, not the wicks)
- The closing price of a Japanese candle is the quotation value at which the session closes. Graphically in this case it would be the other way around, it would be the high point of the Japanese candle in a green bar (bullish) and the low point in a red candle (bearish)
- The lowest price reached is the minimum quotation that is registered throughout the session. On the graph, it would be the lowest part of the wick of the Japanese candle
On the other hand, it can also be appreciated that if the closing of the session has been above the opening, the figure is green and otherwise red. In other words:
- The green color indicates that the value of the asset has increased during the session and is called a bullish candle.
- The red color indicates that it has decreased and is called a bearish candle.
Components of a Japanese candlestick
Japanese candles are formed by two components, the body, and the shadows. Below is a more detailed image.
In the previous image, we see that the body of the candle is the difference between the opening price and the closing price. If the opening price is higher than the closing price, then we have a bearish candle with a red body. If on the contrary, if we have that Opening Price
The other component of the candles is the shadows. We call the upper shadow the difference between the maximum price of the session with respect to the opening or closing price (depending on whether it is a bullish or bearish candle).
On the other hand, the lower shadow is called the difference between the minimum price of the session with respect to the opening/closing price.
Types of Japanese candles
There are numerous types and variants of candles. Below, we will present the most basic types of candles, depending on the size of their body and shadow, and what data these figures can indicate. In the following image, you can see the different basic types of candles.
The types of candles can be classified as follows:
- Candles with a full and large body: These are candles with very large bodies and very short shadows, or imperceptible shadows, as seen in the figure. This type of candle indicates that the movement has been unidirectional and that there are not many doubts about buying or selling.
- Candles with a full and small body: These are candles with very small bodies and almost imperceptible shadows. They indicate that there has been little movement during the session.
- Empty candles: these are candles without bodies or shadows, they indicate that the 4 prices of the candles (maximum price, minimum price, closing price, and opening price) have not changed during the session. It usually happens when there has been no movement during the session.
- Candle with an empty body and long shadows: The body is empty because the closing and opening prices have been the same, but the maximums and minimums reached have been far from the body. That is, there has been a lot of volatility in that session, and it usually indicates a change in trend.
- Candle with an empty body and upper shadow: All prices have remained the same, except for the maximum price reached.
- Candle with an empty body and lower shadow: All prices have remained the same, except for the minimum price reached.
There are many more types of candles, but they are variants of the ones we have mentioned before. Anyway, it is not so important to know each type of candle existing, but rather the type of strategies to follow when we find one or a series of particular figures. Below, we will list some basic strategies on how to trade with Japanese candles.
|Type of Japanese candle||What does it indicate?|
|Full body and large candle||Little doubt about buy-sell. Unidirectional movement|
|Full body and a small candle||Little movement in the session|
|Empty candle||No variation in the session|
|Candle with empty body and long shadow||Change of trend|
|Candle with an empty body and upper shadow||The maximum price reached during the session has gone up|
|Candle with an empty body and lower shadow||The minimum price during the session has gone down|
Trading with Japanese candlesticks
The bullish triple formation consists of two large bullish candles with three smaller bearish candles in between them. It occurs in bullish trends, and the candles in the middle are just stopping before continuing with the bullish trend. It is a fairly reliable pattern. The bearish triple formation is exactly the same; only the trend is bearish.
A bullish engulfing candlestick pattern occurs when a small bearish candle precedes a larger bullish candle, typically within a previous bearish trend. They indicate a change in trend; in this case, it will be from bearish to bullish. It is a reliable pattern and often happens. For the bearish engulfing, the explanation is the same; only the trend change is bearish.
An abandoned baby bull is formed by a bullish candle preceded by a Doji (an empty body with small shadows) and a previous bearish trend. It is a pattern similar to the bullish envelope, only that an abandoned baby is a stronger and clearer trend change. An abandoned baby bear has the same explanation, except that the trend change is bearish.
As we have seen, Japanese candles are very powerful tools in technical analysis, since there are quite a few possibilities that certain patterns will occur like the ones we have mentioned before, and they are also quite easy to understand once you get used to them.
Although, it should be noted that basing our investment decisions on just candle analysis is very risky. Candles are just tools in technical analysis, so when investing, other factors must be taken into account, such as macroeconomic events, fundamental analysis, and return ratios such as PER, among others.
Can I combine Japanese candlestick patterns with other indicators to improve my trading strategies?
Absolutely! By using indicators like moving averages or RSI alongside candlestick patterns, you can strengthen your signals for when to enter or exit trades. This combination provides a more complete analysis of market conditions.
How can I determine if a Japanese candlestick pattern is reliable and what factors should I consider before making a trade?
Look at how the pattern aligns with the overall trend, if it matches known reversal patterns, and consider the volume associated with it. Additionally, take into account broader market conditions and fundamental analysis.
Do Japanese candlesticks patterns work equally well in stocks, forex, and cryptocurrencies?
While the basic principles of Japanese candle patterns apply to various markets, it’s important to consider each market’s specific characteristics and behavior. This ensures you interpret and apply the patterns accurately in the context of the market you’re trading in.