How to learn fast the language of Japanese candlesticks
Candlestick charts are especially helpful in identifying market trend changes and are used to track prices in all financial markets. Learn how to interpret them fast.
When learning a new language, the first step is to learn the most often used words and the basic rules for building a sentence.
The same rules apply to the Japanese candlesticks language, but here it must be added a new ingredient for understanding the sense of the sentence: common sense.
There are many candlestick patterns, but what do you think if I tell you that I do not know their names? I have never been able to remember all the names associated with their patterns. And I am telling you, there is no need to know their names, the idea is to read them and use your logic and common sense when interpreting them. This way, you will not need to learn by heart.
Let’s start with the beginning:d
The most accepted colors are green for a bullish candle and red for a bearish candle. The body of the candle represents the difference between the opening and closing price. If we calculate the difference between the upper and lower wick values we get the range of the day.
Depending on the type of the used graph, one candle represents one month on the monthly chart, one week on the weekly chart, one day on the daily chart, and so on. Any weekly candle, if changing the time frame to a daily chart, will be transformed into 5 candles. Any daily candle, if changing the time frame to an hourly chart, will be transformed into 7candles. And so on.
As you can imagine, the bigger the time frame, the bigger the picture.
If you are looking at a Doji, the bigger the picture means the market direction is uncertain.
If you zoom in, you may notice that the price:
- From the middle of the candle, the price first went down (low wick) and then up and then back to the middle. This price action leans towards a bearish approach because the last part of the movement was a decreasing one.
- From the middle of the candle, the price first went up (high wick) and then down (low wick) and then back to the middle. This price action leans towards a bullish approach because the last part of the movement was an increasing one.
A group of candles, in any time frame, represents a price change influenced by:
- mass psychology acting or reacting to news
- algorithmic programs (automated transactions based on lines of code).
Having a psychological load behind it, under some conditions certain behavioral patterns tend to repeat themselves. The keen eye of the experienced trader will notice these changes and speculate by putting together all the information and adjusting the trading plan.
Until we detail the most used patterns in trading, let’s see how we can translate, in fact how we can understand mass psychology. As I already mentioned, I don’t recommend learning the candlestick sets (like Morning Star or Hanging Man) by heart, but to understand what is going on there from a behavioral point of view.
No candlestick formation predicts, but in conjunction with several conditions can provide a probabilistic estimate of further evolution. Interpretation is an art. Intuition develops after thousands of seen charts. It is not complicated, we are talking about a common-sense interpretation.
1Small candles, Big candles. A small green candle represents growth. A longer green candle is more reliable in “announcing” potential and a bigger increase. Translation: if a stock increase 1% and another one 10% in a day, if we want to make 1$ it is safer to bet on the second stock.
2Candles with or without volume. A green long candle with a big volume has more credibility in maintaining direction than one with the same body (or smaller) but no volume. A long green candle with volume can announce momentum, an accelerated continuation. A long candle without volume is suspect. I think you get the idea: candles and volumes must make sense. See, again, it is about common sense. Institutional buying = big volumes = wide green candles. This is what we are looking for: signs of institutional buying. Of course, the reverse is also valid. In a bear market, we might see: Institutional selling = big volumes = wide red candles.
3Extended candles. A small green candlestick extended against support or an average may signal a correction in time (i.e. the average is expected to reach a level close to the current price). Especially if the volumes are low. If the volatility is low, the buyers agreed on the price with the sellers. You may consider adjusting the Stop Loss at the wick low. But along green candlestick extended against support or an average may signal a correction in price, an exhaustion move. A reversal (a change in trend, hence a decline) is likely to occur.
4Candle’s wicks. A very small green (or red) candle, but with a long wick at both the top and bottom, represents weakness. This is a Doji candle that we already talked about. You understand now that indecision is the keyword.
5Top / Bottoming tails. A green (or red) candle with a very long wick at the bottom (bottom tail) may indicate a reversal. The market has opened, there has been a sharp drop, but buyers have appeared and sent the price back to the opening areas. Basically, the price has not been allowed to fall, so it is a bullish signal. If it had the long fuse at the top (top tail) we would be talking about a potential fall, because the price was not allowed to rise, immediately the sellers appeared and brought the price back to the opening areas.
6Continuation candles. Several consecutive candlesticks of the same color indicate a direction. If candles become smaller and smaller (and volumes as well), the trend might decrease in intensity and we expect a reversal.
7Long candle and retracement. After a very long candlestick with volume, a retracement with low volume is expected (those who made a nice profit will mark their advantage). There is nothing wrong with the share price and a retracement of 24% — 38% — 50% — 62% (Fibonacci numbers) is “normal”. Above 70% the chances of a false breakout increase, and the price might come back to the base of the long candlestick.
8Ignored candles. In a trend, we can have an ignored candle. Basically, when there are several candles of one color and one of the opposite colors appears, it is immediately canceled with candles of the color of the most candles. When this happens, the ongoing trend is a very strong one. For example: if we see three green candles, then one red candle, and then a green candle igniting and closing above the red candle this situation might signal a stronger continuation. Buyers saw the dip and bought more immediately.
9Volume and candles. Volume is a key element in candle analysis. All the changes must be in line with the volume. Use common sense, for big movements, we expect big volume. If we see small advances with big volumes or big advances with small volumes, these aspects are not correlated, the movements might not be sustainable.
Usually, there is a continuity of price level between trading sessions, i.e. yesterday’s close will represent today’s open. However, due to or because of overnight events (news, lawsuits, a new patent, earnings, etc.) the opening price may be higher (gap up) or lower (gap down) than yesterday’s close.
Learning this candlestick language is long-lasting. The most used method is the individual study and following each candlestick with its corresponding volume. What is the connection between them? Is it a powerful movement? Do we have a long candle and a big volume bar? Or do we have a divergence, a price advance of more than 10% (so a long candle) but the volume is below the average of the last 50 days?!
No matter what the conclusions might be, we are not making predictions, we are just imagining scenarios.
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