Japanese Candlesticks

As you have already learned, the concept of Japanese Candlesticks originated in Japan as the name suggests and were used to accumulate great wealth on the rice futures exchanges. We also learned that they are very effective at displaying exactly what the price did when it traded at certain levels and give clues as to how the market was feeling at that time.

What we will do now is go into much greater detail and talk about how these candlesticks look and work in a real market environment.

Let’s begin with a visualization of what candlesticks look like.

An image of up and down Japanese Candlesticks.

A Candlestick is made up of 2 parts:

1. The body
2. The shadow

In keeping with the candlestick theme the shadows are also known as wicks or tails. In the image above the candle on the left represents an upward movement in price while the candle on the right represents a downward movement in price. You can see where the price was at the open of the candle and how low or high it got to in the candlestick's lifespan. You can also see where the price was when the candlestick closed.

This is a very visual way of potentially gathering quite a bit of useful information on how the price behaved during a certain period of time.

A candlestick measures what the price did during a certain period of time from when it opened to when it closed. This period can be any amount of time from 1 minute to 1 year and any combination in between. This is what it means when traders talk about time frames. If a trader is conducting their technical analysis from the 1 hour time frame this simply means that each candlestick on the chart they are looking at represents 1 hour of price action.

The terms of the candlestick patterns or individual candles are not important. It's the message the candle or patterns of candles give us that is important to pay attention to.

Candlesticks tell us a story about how other traders have acted with real money and what their past and current beliefs or expectations are about the direction of the market. We can use this information to gain an objective way to analyze what these candles are saying.

What is the story the candlesticks are telling and how is it important to us? Well, it’s important because candlesticks show us that actual money has changed hands right in front of us. Buy and sell orders were matched up and traders betting with real money. Candlestick charts are like fossilized bull and bear tracks showing the footprints that money left behind.

Candlesticks will always have the same messages no matter what time frame you are trading. The message will always be that momentum is increasing or momentum is decreasing. It’s that simple! This in turn tells us about the supply and demand relationship within each candle, or a series of candles, and how they relate to prior candles.

An arrangement of candles can form recognizable patterns that give traders insights into the potential direction of prices.

Long vs. Short Candlesticks

Each candlestick can have a totally different shape depending on how aggressively the market has been buying or selling a particular currency pair or other financial product. These shapes and sizes can also give us a lot of useful information.

An image of long vs. short candles.

If we look at the image above we can see that a white candlestick represents an upward move and buying while a black candlestick represents a downward move and selling. There is no universal rule on colour schemes for candlesticks. Your personal preference may be something totally different but for the purpose of your Wiki, we will use a simple black and white theme.

Long white candles show strong buying pressure and the longer it is the more intense the buying was. This also means that the close was further away from the open above it.

On the other hand, a long black candle is the opposite and shows strong selling pressure. The close was also further away from the open but below the open this time.

Bullish Candlesticks

Bullish price action can be defined as more people wanting to buy than people who are willing to sell. This is not entirely accurate for the simple reason that for every trader who wants to buy, there must be another trader willing to sell to the trader that wants to buy. Therefore, for every buyer, there must be a seller. What makes the price action bullish is that buyers are willing to bid up the price and sellers become unwilling to sell at lower prices.

Bullish price action occurs when there is more demand than there is available supply. Buyers are willing to pay higher prices because there is less supply at lower prices. If you were one of only a few sellers, and there are many buyers, who would you sell your inventory to? Simple, the guy willing to pay the highest price!

Keep in mind that even though all these candlesticks are bullish in nature, the degree of bullishness is very different for each one. They may be telling us that momentum is increasing or decreasing, speeding up or slowing down. You will need to see how these candles set up in relation to prior candles because this will make the messages very different.

An image of bullish candlesticks.

Candlestick 1: Extremely Bullish Candle

• This is a very potent candlestick as the buyers are dramatically overwhelming the sellers. This candle is telling you that momentum is very strong but we don't know yet if it's extreme. We will have to look at the prior candles to determine if it’s extreme or not.
• If this candle took off out of a base or consolidation of candles the message would be momentum is increasing and igniting a new move higher. This is definitely what you want to see if you are long.
• If this candle occurred after a series of up candles the message would be that momentum is increasing and the move is possibly getting overextended, at least in the short term. These types of moves usually mean that the crowd has just decided to join the fun. These are the people that have watched the market move higher and higher without them participating in the move. When they can’t bear watching the market rise anymore they finally jump in and just like a herd they do it all at the same time. At this point anyone who was going to buy has already bought, so who is left to buy? Well, this is when the trained professionals start to book profits or step into the market to open a new short if there is a good reason to do so. In this case, the market will likely need to consolidate or have a correction before moving higher again.

Candlestick 2: Moderately Bullish Candle

• Demand is still overwhelming supply but not at an extreme rate.
• We can see from the long upper tail that the candlestick was a long thick white bar before it closed lower than the high. The bulls were fully in control but the bears came in and pushed the market back down. If the next bars are bearish traders should be very careful with long positions.
• The close was higher than the open and can therefore be viewed as bullish but we need to look to the left on the chart and see what types of candlesticks proceeded this candle so that we can gain a more informed idea of what is happening to price.
• This is the kind of candlestick that we see when stops get taken out.

Candlestick 3: Moderately Bullish Candle

• The close was higher than the open and therefore makes this a bullish candle.
• This type of candle is very typical to see in a sideways consolidation or a base where there is a struggle between the bulls and the bears, each trying to make progress in one direction. It can be viewed as indecision.
• This is sometimes seen in the middle or near the end of a move if there was a multi-candle rally preceding it. It could be that the market needed to slow down and recharge itself before continuing higher. In this case, the message is that momentum is slowing down and you need to pay close attention to the kinds of candles that form next before making a new trading decision.

Candlestick 4: Moderately Bullish Candle

• Supply cannot overwhelm demand as the close is higher than the open which makes this a bullish candlestick.
• At one point before the candle closed the bears had full control over the bulls creating a long black candle with a topping tail. However, the bulls came in and forced the stock or currency back above the close.
• This type of candle is typical to see near the end of an up move as the supply begins to overtake the demand and as the bears attempt to transition the market into a downtrend. This doesn't mean that the market will change direction but it does mean to pay close attention to the slowing momentum.

Candlestick 5: Slightly Bullish to Neutral Candle

• This is a very typical candle found in a sideways consolidation or base and sometimes near the end of a move higher.
• The message is that momentum has slowed and the power is starting to shift from the bulls to the bears. Supply is starting to overwhelm demand.

Again, the most important thing to bear in mind hear is that it’s the message that the candle is telling you that is important. It’s also important to keep an eye to the left to see if there is any support or resistance as this may have an effect on what the price might do next.

As always, make sure that you have a very good fundamental or sentiment reason to trade in any particular direction. Candlestick messages are only important if they line up with your analysis of the currency pair.

Bearish Candlesticks

Bearish price action can be defined as more selling than buying. This is not entirely accurate for the simple reason that for every trader that wants to sell, there must be a trader that is willing to buy from the seller. Therefore, for every seller, there must be a buyer to absorb that supply.

Bearish price action occurs when there is more available supply than there is demand to buy that supply. This means that sellers are willing to accept lower and lower prices because there are fewer buyers willing to purchase at higher prices. If you want to buy who are you going to buy from? For most people, the answer will be you buy from the guy willing to sell for the lowest price!

Keep in mind even though all of these candlesticks are bearish in nature, the degree of bearishness is very different for each. They could be telling you that momentum is increasing or decreasing, speeding up or slowing down. You will need to look to the left on the chart to see these candles in relation to prior candles and areas of support or resistance. This could make the message of the candle very different.

An image of bearish candlesticks.

Candlestick 1: Extremely Bearish Candle

• This is a very potent candle as the sellers are dramatically overwhelming the buyers.
• This candlestick is telling you that momentum is very strong to the downside but we don't know yet if it's extreme. We will have to look at the prior candles to determine if the candle is extreme in nature.
• If this candle broke down out of a base or consolidation of candles the message would be that momentum is increasing and potentially igniting a new move lower. This is definitely what you want to see if you are short. It is not a good sign if you are long because this can be the kind of candle that kicks off a sustained down move especially if there is a good sentiment reason for the move.
• If this candlestick occurred after a series of down candles the message would be that momentum is increasing and the move is possibly getting overextended, at least in the short term. These types of moves usually mean that the crowd has just joined the party by selling a new short position or it could be that they are finally getting rid of long positions at a large loss. These are the traders that have watched the market fall and fall without them participating in the move lower. When they can’t bear watching the market fall anymore they finally jump in, and like a herd they do it all at the same time. At this point anyone who was going to short or sell has already sold, so who is left to sell short? This is when the smart money institutional players, who were in the move early, start to book profits on their shorts or start stepping into the market to open a new long position. The market will likely need to consolidate or have a correction before moving lower again.

Candlestick 2: Moderately Bearish Candle

• Supply is still overwhelming demand but not at an extreme rate.
• We can see that at one point the candle was a long thick white bar before it closed where the bulls were fully in control. However, then the bears came into the market and pushed it back down to close only slightly lower.
• The close is lower than the open and can therefore be viewed as bearish but we need to look to the left on the chart to see what types of candles preceded it to make a more informed trading decision. This is especially important if there was a previous area of support or resistance that the market is reacting from.

Candlestick 3: Moderately Bearish Candle

• The close was lower than the open and therefore makes this a bearish candle. However, it is not extreme and depending on where it is in the context of the overall trend it may be fairly neutral.
• This type of candle is very typical to see in a sideways consolidation or base where there is a struggle between the bulls and bears to gain control over the market.
• This is sometimes seen in the middle or near the end of a move if there was a multi-candlestick decline that preceded it. It may be that the market needed to slow down and recharge itself before continuing lower.
• The message is that momentum is slowing down and you need to pay close attention to the kinds of candles that form next.

Candlestick 4: Moderately Bearish Candle

• Demand cannot completely overwhelm supply as the close is lower than the open.
• At one point, before the candle closed, the bears had full control making this a long black candlestick. However, the bulls stepped in and pushed the market back up a little to close slightly lower.
• This type of candle is typical to see near the end of a multi-bar decline as demand starts to overtake supply while buyers are trying to step into the market with fresh buy orders. This does not mean that the market will change directions but it does mean to pay close attention because momentum is slowing.

Candlestick 5: Slightly Bearish to Neutral Candle

• This is a very typical candle found in a sideways consolidation or base and sometimes near the end of a move lower.
• The message is that momentum has slowed and the power is starting to shift from the bears to the bulls, demand is starting to overwhelm supply.

Tails, Wicks, and Shadows

Candlesticks show us good information because they visually let us know how aggressively the market was buying or selling around an extreme point in time around at specific prices. This is very useful to know. Perhaps the best information is found in the shadows, tails, or wicks. All three of these terms are used to describe the same thing. The wicks can tell us where most of the trading action took place.

An image of bullish and bearish long tails.

Taking a look at this image above you can see that the selling candle on the right closed below its open but not before the market tried desperately to push the price higher. On the left-hand side, we see the buying candle closed above its open but not before the sellers tried to take the price lower first. This price action produces a wick which leaves a trail of where the price went and what it tried to do before eventually closing as either an up or down candle. Wicks help to see the battles between the buyers and the sellers that take place in the markets.

Wicks will either increase supply or decrease supply:

• Topping tails will increase the supply because there were many buyers getting long at the top of the tail. If the market then moves lower after a topping tail many buyers are trapped and will want to get out of their long by selling if price gets back to their price. This creates an area that we want to watch on a retest to see how the price will react.
• Bottoming tails will decrease supply because there were many traders going short in the area of the tail. This creates an area of interest for us to watch if price comes back to retest it. We might see that there are some buyers ready to get out of their short position.

The most potent tails will have wider than average ranges when compared to the most recent candlesticks. A bottoming or topping tail may or may not be a range expansion candle. This will depend on the length of the candlestick from the high to the low of the tails which will tell you if the range has increased over the most recent candles. A range expansion can be an indication that momentum may soon slow or is close to reversing. A range expansion is a display of the commitment and emotions of the traders involved in the range expansion candlestick.

Bottoming Tails:

A bottoming tail after a multi-candle decline indicates that the balance of power in the supply/demand equation has shifted from the sellers to the buyers. Demand is starting to overwhelm the available supply.

An image of a multi-bar decline followed by a bottoming tail.

Bottoming tails can be very effective if they occur in well-established uptrends, especially near a support area. They tell you that demand has come back into the market. The best odds of successful trades will be on the long buy side if there is a good fundamental or sentiment reason to be trading on the buy side of the market.

Bottoming tails can be a sign that major professional buying has taken place and should be respected. When they occur after a several candle decline in an uptrend, the odds are that a rally is close at hand. Keep in mind that candlesticks are the footprints of real money changing hands. If the message is money is going into a market your odds of profitable trades will be with the flow of money on the buy side.

Bottoming tails are normal or wide range candles in which prices had been lower but demand forced prices to close well above the midpoint of the candlestick range. While there are different variations of bottoming tails, the message is always the same: Overhead supply has been removed and demand has entered the market.

Topping Tails:

A topping tail after a multi-candle rally indicates that the balance of power in the supply/demand equation has shifted from the buyers to the sellers. Supply is starting to overwhelm demand.

An image of a multibar rally followed by a topping tail.

Topping tails are very effective if they occur in well-established downtrends, especially near a resistance area. The odds of a successful trade will be on the short sell side if there is a very good fundamental or sentiment reason to be hunting for a short trade.

Topping tails can be a sign that major professional selling has taken place and are to be respected. When they occur after a several candle rally in a downtrend, the odds are that a decline of some kind is close at hand. Keep in mind that candlesticks are the footprints of real money changing hands. If the message is money is going out of a market then your odds of successful trades are with the flow of money.

Topping tails are normal or wide range candlesticks in which prices had been higher but supply forced prices to close below the midpoint of the candlesticks range. While there are different variations of topping tails, the message is always the same: Demand below has been removed and supply has entered the market.

Candlesticks could be an entire study course on their own. There are dozens of different types of candles and they can also be used in combination to form patterns. For the purposes of successful trading, it is enough to get a basic understanding of what they are and why we use them as a visual for what the price has been doing recently.

Candlestick Pattern Cheat Sheet

The following is a handy candlestick cheat sheet showing you the main candlestick formations. You can of course find much more information online if this is a subject that you wish to learn more about. Remember not to get too carried away with any one technical subject as technical analysis should only make at most 20% of your reason for placing a trade with fundamentals and sentiment being the other 80%.

An image of a candlestick pattern cheat sheet.

Key Candlestick Concepts

Before we leave candlesticks it is important to take a look at them on a chart and go through a few key points to bear in mind when using them in your trading before we move on to our next technical tool.

The key thing to bear in mind about candlesticks is that they show the direction and movement of price. An individual candlestick will show which way the price went in that specific period of time. If we only looked at the right hand side of a chart all it would tell us is that the price is currently at a specific number. It doesn’t tell us where the price has been previously or what it did at other prices and this is why we use candlesticks to give us a nice visualization of what the price has recently been doing.

It is useful to think of the candlesticks as giving you a story of the price. When we can see many candlesticks, groupings of candlesticks, and general flow as a larger picture this will help guide our analysis. Rather than focusing on the individual candlestick, we tend to put more emphasis on the groupings of candlesticks and how they relate to price.

Wicks are probably the most useful part of the candlestick. When you get a collection of candles with wicks this tells us that despite the market trying to push the price in one direction it kept getting pushed back in the opposite direction. This is useful because it can signal to us that the market might be running out of steam and the direction of price might change at least for the short term.

Candlesticks should not be used on their own because need to use candlesticks in line with the fundamentals and sentiment for them to have any effect on your trading. However, as a purely technical concept, the wicks give you nice information about what the buyers and sellers have been doing. Wicks also tell you which levels were particularly active. This gives you general areas where the buyers or sellers had overwhelmed the other group considerably and you might be able to use these levels as a trading opportunity if the price gets back there.

It’s important not to get sucked into using candlesticks on their own. Just because you see a downward candles doesn’t mean that the price will continue to go down and that you should sell the particular currency or market. Look at the overall picture of price to gauge where the price has been then use the fundamentals and Sentiment Analysis to actually tell you what you should be trading.