A little something about japanese candlesticks

Origin

Candlestick origin descends back to XVIII century Japan. They were invented by a legendary man named Munehisa Homma. He was trading rice at the time and was one of the wealthiest people in all of Japan.

Munehisa Homma

Despite their early origin, japanese candlesticks were not so well known on the West up untill the end of the XX century. They were popularized by Steve Nison.

Nison was one of few, who were familiar with japanese candles in the U.S. He wrote an introductory article in the late 1980s’ which had raised big interest around candlesticks.

Now candlesticks are one of the most popular trading instruments in the world and you won’t find even one trader, that doesn’t know what they are.

Why should you use japanese candles?

Although japanese candles aren’t the only option, they are definitely one of the best. We all use different trading methods and some people just might not combine their method with candlesticks. But I know one thing for certain — almost every trader I know uses either candlesticks, either bars (which are practicaly the same thing as I wrote here, but with slight differences).

This phenomena is quite easy to explain: candlesticks are much easier to interpret than, for example line or zone charts, they contain so much information, not only on the chart itself, but in each candle individually. Candles show four points of interest in every candle: opening price, closing price, lower price, higher price. They show you who is in control of the market at the moment and help you understand what will, most likely, happen in the future.

Enough talk, let me show you an example:

GBPJPY D1 candlestick chart

You can see two grey zones on the chart, but I’d advise to focus on the top one. That’s a very strong key resistance zone or an offer zone (zone, where people are more willing to sell, than buy). Those kind of zones have strong influence on price movement and candlesticks help us understand, how to act near them and what to wait.

I have marked a specific area near our influential zone with a read circle. Pay attention to three candles with long shadows, especially the third one with the largest bearish (black) body out of all three of them. These candles indicate, that price was rejected by our zone, and if that wasn’t an offer zone, it wouldn’t be of such importance to us. But here, those kind of candles, show that people are more willing to sell, than buy, aswell as those candles show, where exactly we have to sell.

As you can see later, price moved lower for more than a month with a few pullbacks.

Now let me show you how the same picture would look with a line chart:

GBP/JPY D1 line chart

Same chart, same timeframe but much less information about what’s happening and who is in control. You can see aswell, that there is no evidence of price rejection before it went up again and reversed to the opposite direction from the highest local point, there was no background on what’s going to happen. We just see, that price slowed down a bit, reversed for a few days, went back up and ejected to a new downtrend movement.

And yes, an experienced trader could have used this opportunity even with a line chart, but it would be harder to set the best risk/reward ratio with this chart, than using a candlestick chart.

Context

Context is a very important feature while you analyse charts through candles. It’s not like you see the same candlestick with a long shadow, as showed above, and make a false assumption, that you just got to buy or sell here, because you think it’s a good place for a trade. That’s where price action comes in.

Japanese candlesticks are like a very friendly dog and price action is your leash for that dog. If you make that leash to loose, your dog will jump on everyone, even strangers (every candle is a signal for you in this case. If you make it too short, your dog won’t be able to say hello to your friends (good candles). That’s why you have to pick the most optimal lenght for the leash. That way it’s much easier to control your dog, without loosing his moments with you friends.

What a beatiful bearish candle, but why didn’t it work it’s almost the same as the candle on the example above? Because it’s out of the right context. First of all there is an upside trend (price is moving up) and trading counter trend is suicide, especially for beginners. Second — there where no influential ares nearby, from which we could trade. Those two reasons are pretty much all, but they are so damn important, that they mean almost everything.

Conclusion

Japanese candlesticks are pretty handy if you use them wisely. If you read one or two articles about them, look at a few candle models and think that you are ready to trade — you are most likely wrong. You have to study them and price action by practicing each day looking on your chart. You have take into account all the other factors like the trend, support/resistance areas and etc.

You can’t just trade every setup because it’s just there, you have to consider why is there and is it important. It’s not a long term solution for you.

One clap, two clap, three clap, forty?

By clapping more or less, you can signal to us which stories really stand out.