Charting Method Pattern Strategy
An Introduction to
Japanese Candle Stick Candlestick Chart Charting Method Pattern & Strategy
By Erik Gebhard
Way to Look at Prices
Would you like to learn
about a type of price chart that is more effective than the
type you are probably using now? If so, keep reading. If you are brand new to
the art/science of chart reading, don’t worry, this stuff is really quite
simple to learn.
Technical analysis is
simply the study of prices as reflected on price charts. Technical analysis
assumes that current prices should represent all known information about the
markets. Prices not only reflect intrinsic facts, they also represent human
emotion and the pervasive mass psychology and mood of the moment. Prices are,
in the end, a function of supply and demand. However, on a moment to moment
basis, human emotions…fear, greed, panic, hysteria, elation, etc. also
dramatically effect prices. Markets may move based upon people’s
expectations, not necessarily facts. A market "technician" attempts
to disregard the emotional component of trading by making his decisions based
upon chart formations, assuming that prices reflect both facts and emotion.
Standard bar charts are
commonly used to convey price activity into an easily readable chart. Usually
four elements make up a bar chart, the Open, High, Low, and Close for the
trading session/time period. A price bar can represent any time frame the user
wishes, from 1 minute to 1 month. The total vertical length/height of the bar
represents the entire trading range for the period. The top of the bar
represents the highest price of the period, and the bottom of the bar
represents the lowest price of the period. The Open is represented by a small
dash to the left of the bar, and the Close for the session is a small dash to
the right of the bar. Below is a standard bar chart example.
You may be asking
yourself, "If I can already use bar charts to view prices, then why do I
need another type of chart?"
The answer to this
question may not seem obvious, but after going through the following
candlestick chart explanations and examples, you will surely see value in the
different perspective candlesticks bring to the table. In my opinion, they are
much more visually appealing, and convey the price information in a quicker,
What is the History
of Candlestick Charts?
Candlestick charts are
on record as being the oldest type of charts used for price prediction. They
date back to the 1700's, when they were used for predicting rice prices. In
fact, during this era in Japan, Munehisa Homma become a legendary rice trader
and gained a huge fortune using candlestick analysis. He is said to have
executed over 100 consecutive winning trades!
themselves and the formations they shape were give colorful names by the
Japanese traders. Due in part to the military environment of the Japanese
feudal system during this era, candlestick formations developed names such as
"counter attack lines" and the "advancing three soldiers".
Just as skill, strategy, and psychology are important in battle, so too are
they important elements when in the midst of trading battle.
What do Candlesticks
Candlestick charts are
much more visually appealing than a standard two-dimensional bar chart. As in
a standard bar chart, there are four elements necessary to construct a
candlestick chart, the OPEN, HIGH, LOW and CLOSING price for a given time
period. Below are examples of candlesticks and a definition for each
A black or filled-in
body represents that the close during that time period was lower than the
open, (normally considered bearish) and when the body is open or white,
that means the close was higher than the open (normally bullish).
Bar Compared to
Below is an example of
the same price data conveyed in a standard bar chart and a candlestick chart.
Notice how the candlestick chart appears 3-dimensional, as price data almost
jumps out at you.
|( 3a )
|( 3b )
The long, dark,
filled-in real bodies represent a weak (bearish) close ( 3a ), while a
long open, light-colored real body represents a strong (bullish) close
( 3b ). It is important to note that Japanese candlestick analysts
traditionally view the open and closing prices as the most critical of the
day. At a glance, notice how much easier it is with candlesticks to determine
if the closing price was higher or lower than the opening price.
The following is a list
of some individual candlestick terms. It is important to realize that many
formations occur within the context of prior candlesticks. What follows is
merely a definition of terms, not formations.
Spinning Tops -- candlesticks
with small real bodies, and when appearing within a sideways choppy
market, they represent equilibrium between the bulls and the bears. They
can be either white or black.
Just as many traders
look to bar charts for double tops and bottoms, head-and-shoulders, and
technical indicators for reversal signals, so too can candlestick formations
be looked upon for the same purpose. A reversal does not always mean that the
current uptrend/downtrend will reverse direction, but merely that the current
direction may end. The market may then decide to drift sideways. Candlestick
reversal patterns must be viewed within the context of prior activity to be
effective. In fact, identical candlesticks may have different meanings
depending on where they occur within the context of prior trends and
Hammer -- a
candlestick with a long lower shadow and small real body.
The shadow should be at least twice the length of the real body,
and there should be no or very little upper shadow. The body
may be either black or white, but the key is that this
candlestick must occur within the context of a downtrend to be considered
a hammer. The market may be "hammering" out a bottom.
Patterns -- Bullish -- when a white, real body totally covers,
"engulfs" the prior day's real body. The market should be
in a definable trend, not chopping around sideways. The shadows of the
prior candlestick do not need to be engulfed.
-- when a black, real body totally covers, "engulfs" the prior
day's real body. The market should be in a definable trend, not chopping
around sideways. The shadows of the prior candlestick do not need to be
Cover(bearish) -- a top reversal formation where the first day of the
pattern consists of a strong white, real body. The second day's
price opens above the top of the upper shadow of the prior candlestick,
but the close is at or near the low of the day, and well into the prior white,
Pattern (bullish) -- opposite of the dark-cloud cover. Occurs
within a downtrend. The first candlestick having a black, real body, and
the second has a long, white, real body. The white day opens sharply
lower, under the low of the prior black day. Then, prices close above the
50% point of the prior day's black real body.
formations consist of a small real body that gaps away from the real body
preceding it. The real body of the star should not overlap the prior real
body. The color of the star is not too important, and they can occur at either
tops or bottoms. Stars are the equivalent of gaps on standard bar charts.
Stars make up part of
four separate reversal patterns:
this is a bullish bottom reversal pattern. The formation is comprised of 3
candlesticks. The first candlestick is a tall black real body followed by
the second, a small real body, which gaps (opens), lower (a star pattern).
The third candlestick is a white real body that moves well into the first
period's black real body. This is similar to an island pattern on standard
-- a bearish top reversal pattern and counterpart to the Morning Star. Three
candlesticks compose the evening star, the first being long and white. The
second forms a star, followed by the third, which has a black real body that
moves sharply into the first white candlestick.
Doji Stars --
When a doji gaps above a real body in an uptrend, or gaps under a real body
in a falling market, that particular doji is called a doji star. Two
popular doji stars are the evening star and the morning star.
Evening Doji Star
-- a doji star in an uptrend followed by a long, black real body that closed
well into the prior white real body. If the candlestick after the doji star
is white and gapped higher, the bearishness of the doji is invalidated.
Morning Doji Star
-- a doji star in a downtrend followed by a long, white real body that
closes well into the prior black real body. If the candlestick after the
doji star is black and gapped lower, the bullishness of the doji is
Shooting Star --
a small real body near the lower end of the trading range, with a long upper
shadow. The color of the body is not critical. Not usually considered a
major reversal sign, only a warning.
not really a star, but does look like a shooting star. When occurring within
a downtrend, may be a turning signal. Body color is not critical.
Final Thoughts and
It is important to
realize that this introduction is just that, an introduction to candlestick
analysis. After having read this, you will have merely scratched the surface
of the many patterns and variables that can go into candlestick analysis. No
attempt was made to provide a thorough analysis of each and every pattern. In
fact, many formations were left out as they cross the border into more
complicated analysis. For a more complete overview of candlestick analysis, it
is highly recommended that you read the book that is referred to below.
A large portion of the
material in this introduction is taken from an excellent book called Japanese
Candlestick Charting Techniques: A Contemporary Guide to the Ancient
Investment Techniques of the Far East. In some cases, sentences were taken
almost verbatim, as there was no better way to say what Mr. Steve Nison, the
author, already said. In his book, Mr. Nison, completely explains candlesticks
and their formations, but more importantly explains how to combine candlestick
analysis with traditional technical analysis. It is highly recommended that
you consider purchasing this book.
As traders, we need as
many trading tools in our arsenal, and a basic knowledge of candlesticks
provides a trader much needed ammunition. Also remember that no matter what
the trading tool, no matter how advanced or ancient, it is only effective when
put into practice properly. This is, of course, your job as the trader.
Erik L. Gebhard
ALTAVEST Worldwide Trading,
| Nasdaq Comp | S&P
Picks | Swing
Trading Picks | Day Trading Picks
| Multiple Time Frame Trading
ETF: About ETFs | QQQ
Education: Dow Theory | Elliott
Wave | Japanese
Candlestick | Swing Trading