Japanese Candlestick Charting Techniques. Explained!

• 6 May 2020 | 1318 Views | By

Technical Analysis not only helps the traders to judge a particular stock or index but also helps them to define the trade keeping in mind the entry, exit, and risk perspective. Charts are helpful as patterns are formed within the charts and these patterns help a trader identify trading opportunities. Would you not like to learn a technical system cultivated by centuries of use, but virtually unknown? A technique, so versatile that it can be fused with any Western technical tool. Yes, we are talking about the very famous Japanese Candlestick Charting Techniques.

What is a Japanese candlestick charting technique? 

A Japanese candlestick chart is a type of financial chart used to define price movements of a security, derivative, or currency. As the name suggests, the candlesticks originated from Japan. The initial use of candlestick charts dates back to the 18th century by a Japanese rice merchant named Homma Munehisa. 

They are pretty similar to a bar chart. These charts serve as a technical tool that encapsulate data for multiple time frames into a single price bar. Japanese candlestick charts are much older than bar charts, point, and figure charts. Candlesticks make patterns that help predict price direction once completed. A proper color-coding adds meaning to these colorful charting techniques. Being heavily packed with information, these chats tend to represent trading patterns over short periods of time, often a few days or a few sessions.

Read this interesting article on why to invest in the stock markets.

What is the best candlestick-charting book? 

Though the candlestick technique had been in existence for a long time in Japan and is perhaps the oldest form of price analysis model, the western world traders were clueless about it. A trader named Steve Nison is believed to accidentally discover the candlesticks sometime around the1980s, and he introduced the methodology to the rest of the world. He authored the first-ever book on candlesticks titled “Japanese Candlestick Charting Techniques” which is still a favorite amongst many traders. There are two other books by the same author on the topics named “Beyond candlesticks” and “Candlestick course”.

There have been many books written on technical analysis and understanding of the charting techniques but some of them have become timeless classics that are invaluable to traders, some others being: 

Encyclopedia of Chart Patterns by Thomas Bulkowski :

This book is an encyclopedia that covers an exhaustive list of chart patterns and a statistical overview of how they have accomplished in predicting future price movements.

Candlestick Charting Explained by Gregory Morris :

This book provides insights into integrating Western charting analysis with Japanese candlestick analysis. It provides details about the grouping of candlesticks into families, more so, detecting and avoiding false signals, and much more.

How do you analyze a candlestick chart and What do the wicks on candlestick charts mean?

These charts are similar to a bar chart in the sense that each candlestick represents all four important pieces of information for that day: open and close in the thick body; high and low in the candlewick. Having acknowledged that the Open (O), High (H), low (L), and Close (C) acts as the best way to encapsulate the trading action for the given period. In any candlestick chart, candles can be bifurcated as a bullish or bearish candle commonly represented by blue/green/white and red/black candles respectively. Needless to mention that the colors can be customized to any color. We need to understand how this is represented in a candlestick chart using a few examples:

Let us try to understand a bullish candle first. 

In the diagram below we can spot a rectangular central area, which is the real body of the candle that connects the opening and closing price. The upper wick in the candle connects the high point to the close and the lower wick connects the low point to the open.

Let us try plotting a bullish candle with the following prices:

Open: 12

High: 20

Low: 8

Close: 17

Likewise, a bearish candle also has a rectangular central area, which connects the opening and closing price. However, the opening is at the top end and the closing is at the bottom end of the rectangle. The upper wick connects the high point to the open and the lower wick connects the low point to the close, as we can spot in the diagram below:

Let us try plotting a bullish candle with the following prices:

Open: 46

High: 60

Low: 10

Close: 25

Also to be noted that a long-bodied candle usually portrays a strong buying or selling activity. A short-bodied candle, on the contrary, displays less trading activity and hence a less price movement.

This is how a typical candlestick chart looks like if we plot them on a time series. The blue candle indicates the bullishness of the stock and red indicates bearishness.

What do Wicks tell you?

Also known as a “shadow”, or a wick is a line found on a candle in a candlestick chart that is used to indicate the price fluctuation of a stock relative to the opening and closing prices. Essentially, these shadows or wicks illustrate the highest and lowest prices at which a security has traded over a specific time period.

A long upper wicks signals that the buyers managed to push the price up to a significant extent before sellers lowered the price below the trading session’s high. Similarly, a long lower wick signals that the sellers have pushed the price down before the buyers jumped into the market and raised the price above the trading session’s low.

How accurate are Candlestick Patterns?

Using candlesticks will help improve one’s market analysis. Candlestick techniques are often used for speculation and hedging. They are also a good tool to analyze futures, equities, options, or anywhere else where technical analysis is applied. However, it’s important to acknowledge that many signals emitted by these candlestick patterns might not work reliably in the modern electronic environment. One has to be very careful with candlesticks. They can seem to be profitable but you have to combine them with other techniques. Sometimes markets do behave unexpectedly and that is when even the best indicator with right candlestick patterns can go wrong.

How do you read a Trade Chart?

People have used charts for as long as they have used numbers. A chart presents the information in a way that is instantly understandable or we may say it is a pictorial description of a numerical reality.

The different types of trading charts illustrate a few ways price movement is expressed over a period of time. There are four basic types of trading charts that are commonly used by investors to understand movement in the stock market and other trading markets:

• Monthly Charts: These are trading charts demonstrate the movement of price of a particular security over a long-term horizon. Monthly charts are more commonly used by long-term investors and will most often represent many years or even decades of price data for that particular security or market. 

• Weekly Charts: Weekly charts are commonly used to analyze periods in excess of six months. These too are used to analyze security over a long-term horizon.

• Daily Charts: Daily charts are commonly used to analyze periods in excess of six weeks. Daily charts depict the price action of a market, based on a single day interval. These are quite handy in evaluating the short to intermediate-term time periods.

• Intraday Charts: Intraday charts demonstrate the price movement of a market within the limits of the daily opening and closing bells of the markets.

How do you master Technical Analysis? 

The purpose of technical analysis is mostly to identify trading opportunities and capitalize on those. Technical analysis is nothing, but a study of charts and patterns, but it can also include aspects of behavioral economics and risk management. To start acing the technical analysis one should gather, study, and observe, as much information is available about the topic. 

After learning the technicalities and technical jargons of technical analysis, the next step is to take the principles from these courses and apply them in practice. The best way to learn technical analysis is to develop a strong understanding of the core principles and then apply that knowledge via back testing or paper trading. We live in a world where thanks to the technology available today, many brokers and websites offer electronic platforms that offer simulated trading that resemble live markets. This might be a good way to test our acquired knowledge about the subject.

Conclusion

To sum up, if a good charting technique is not applied, charts can get quite complex. Candlesticks help you to quickly visualize the relationship between the open and close as well as the high and low price points. They are easier to interpret in comparison to the bar chart. And preferred over other charting techniques. Candlestick patterns are technical trading tools that have been used for centuries to predict price direction. There are various candlestick patterns used to determine price direction and momentum, like the evening star, three-line strike, two black gapping, etc. Details about these are available in the books mentioned above.