An Introduction to Japanese Candlesticks

Just to give you a brief overview of the origin of how candlesticks came about.  They were invented by a rice trader called Munehisa Homma (1724-1803) who was from Sakata, Japan.  He traded on the Dojima Rice Exchange, which the first exchange ever to trade coupons (what we call Futures in today's terminology).  He was so successful at what he did that he later was employed by the government as an advisor and promoted to the rank of honorary Samurai during his time there.  He is widely regarded as the father of Technical Analysis, but it wasn't however till centuries later that these ideas were brought over and used in modern finance.  It was a man called Steve Nison, through his book Japanese Candlestick Charting Techniques published in 1991, which introduced the candlesticks and their advantages which were quickly adopted by chartists globally.

Japanese candlesticks are by far the most commonly used graphing tool in modern day trading, not only   due to their complexity, displaying more information for a given time period than any other, but also because they look the nicest from a visual perspective.  Their main advantage is that the reader can tell instantly what the open, close, high & low of the trading window was, described below.

There are deemed to be only 8 different candlesticks that can possibly exist, they are listed below,

1. Marabuzo - Continuation Pattern - Market has opened at the low and closed the high (for bullish/green Marabuzo), opposite would be true for a bearish/red candle

2. The Standard Line - Continuation - The most commonly occurring of all candle sticks, good conviction of direction of the market

3. Opening Bozu - Continuation Pattern - Theres was significant movement on the day giving the direction it was moving some impetus to continue into the next trading session.

4. Closing Bozu - Continuation Pattern - Same as above, heres was significant movement on the day giving the direction it was moving some impetus to continue into the next trading session.

5. The Hammer / Hanging Man - Reversal Pattern - The lows of the day were rejected pretty convincingly, usually first signs for change of direction

6. Shooting Star / Inverted Hammer - Reversal Pattern - The highs of the day were rejected, usually first warning signs for change of direction

7. The Spinning Top - Neutral - slight movement on the day, shows indecision, not convincing from either bulls or bears have control of the market

8. Doji - Neutral - Open and closed at the exact same point in the day, there are a  bullish & bearish derivations of this, when you open / close at the high / lows of the day, which can be good continuation / reversal indicators depending on the trend direction.

_____________________________________

Now we know what we're looking at and what information they are telling us, it is  the combinations of these candlesticks that really interests us in order to really know what has happened in a trading session, as only limited information can be deduced from them in isolation.  From these candlestick patterns / combinations, we have a much better understanding of what is really happening behind the scenes in the market and thus can develop trading strategies around them and ways to manage our risk better in order to conserve more P&L.  

There are infinitely many combinations of candlesticks but I will give you an overview of arguably the more significant ones and which to watch out for.  I think the beauty of this exercise is that once that you can understanding what is happening in each situation and going through the traders mind at that point in time, you should be able to interpret them for yourself so you should never have to consult a reference book again!

   2 Candle Patterns

3 Candle Patterns