October 16, 2017
Candlesticks are the most popular way to display the price of a financial instrument. Invented by Japanese rice traders in the 17th century, their popularity rose in the West in recent decades. Whereas the “western” bar and line charts focus primarily on the open and close price, candlestick charts truly represent the psychology and supply/demand of the markets. Their biggest advantage is in their excellent way to graphically display price-action in relation to prior candlestick bars. With their bodies, which represent opening and closing price, the experienced trader (and beginners alike) immediately “feel” the market in a way best to see trading opportunities.
Knowing candlestick patterns is a rewarding tool for all traders. In the following lines we will show you the most common candlestick patterns and their meaning, so you can use them in your daily trading.
Japanese Candlestick Anatomy
As you already know from the previous article where we introduced the major types of forex charts, candlesticks are based on OHLC (Open-High-Low-Close) of the price. The opening and closing prices are displayed as the body of the candlestick, whereas the lowest and highest prices of the entire trading day are displayed as the “wicks” on the upper and lower side. If the price closes above the opening price, the body of the candlestick will be light. If it closes below the opening price, the body will be dark, or filled in.
Single Candlestick Patterns
Single candlestick patterns are formed with just one candlestick. Two of the major single candlestick patterns are the “Hanging Man” and the “Hammer” pattern. A “Hanging Man” pattern forms at the top of an uptrend, while a “Hammer” pattern forms at the bottom of a downtrend (i.e. “the price is hammering out”). As these are reversal candlestick patterns (just like the majority of them), a “hanging man” formation signals that we might be at the top of an uptrend, while a “hammer” pattern tells us the price reached the bottom of a downtrend and might reverse soon.
These candlestick patterns have a small body and long lower shadows, and it’s not important if they are bullish or bearish. The following picture shows the “Hanging Man” and “Hammer” patterns.
A formation of these single candlestick patterns shows that after the price opened, the sellers had enough power to outperform the buyers, thus moving the price downward. During the session, buyers regained their buying power and the price moved upward again, closing near the opening price (therefore the small body.)
It sends the message that an upward or downward trend lost steam and a reversal is likely to happen. I would like to ask you to open your trading platform and spot some Hanging Man and Hammer patterns to get a feeling of how they behave. You will probably be surprised after you see how often they form after an uptrend or downtrend finishes!
Test Your Knowledge: Japanese Candlesticks
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Understanding Japanese candlesticks!
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Question 1 of 3
Which of the following is NOT a Single Candlestick Pattern:Correct
Question 2 of 3
What does the peak of the upper shadow of a candlestick indicate?Correct
Question 3 of 3
The opening and closing prices are displayed as the “wicks” of the candlestick, whereas the lowest and highest prices of the entire trading day are displayed as the body on the upper and lower side.Correct