In this 3rd lesson of the trading course to learn from scratch, we talked about reading Japanese candles, excellent graphical tools for interpreting information on price variations or score. I recommend you visit the first lessons before continuing.
Trading Course: Japanese Candles
What are they?
Originally from Japan, specifically in the 18th century, they have an initial objective: the graphic representation of the rice trade.
They are currently one of the most widely used technical analysis techniques. They were popularized by Steve Nison, after learning from a fellow Japanese runner.
The best way to explain what they are is through the following image:
Each Japanese candle is the representation of the trade of a product in a specific period of time.
Its parts indicate specific values of the day, as shown in the previous image.
The information provided by a candle is: Maximum and minimum represented as a wick, and opening and closing as a body.
Also known as Japanese candlesticks, they can be used in any color, although green is generally used for bullish candles, and red for bearish candles.
Japanese Candle Reading
These graphic tools are usually the main sources of information for a trader to make decisions. Although it is practically impossible that they are useful if they are not used in conjunction with other techniques, such as supports and resistances, and the correlation of different temporalities.
Japanese candles are often read in groups to identify possible reversals or continuations of a trend. These groups are known as patterns, and are used for both bearish and bullish trends. The theory holds, only the direction of the candles is reversed.
A single candle could also give a buy / sell signal at a certain time, if it is also used with other technical analysis tools, mainly support / resistance zones.
Here are the types of candles most used to predict movements
Remember that all are valid for both bearish and bullish scenarios, only the direction of the candle is reversed.
Envelope
They are full-bodied candles with few wicks, capable of wrapping one or more previous candles, and indicate a reversal of the trend.
Doji:
They indicate indecision during the trading period, and although they no longer support one direction or the other, they are used in conjunction with other candles to try to predict the future.
They generally indicate tiredness from the previous trend or movement, but they may only be a break from those in control, and then continue. Therefore they are almost always used to read patterns, but not a specific day.
Hammer
They are candles with a long wick at one end.
In the bullish case, the longest wick is the one at the bottom, indicating that despite a strong bearish attempt, buyers wrapped up the whole intention, and even made gains during the day.
Hanging man
They are the opposite of hammers, but they also indicate a change of direction.
They are composed of a long wick on one of the two sides, and a smaller body.
In the bullish case, they represent the sellers’ attempt to wipe out the gains of a day (wick), but the buyers manage to maintain control of the body, indicating that the time period was controlled by the bullish force.
Japanese candle reading trading strategy
As discussed, Japanese candles are generally used with supports and resistances to forecast future movements.
The main rule to operate in favor of signals thrown by these graphical tools, is to wait for the closing of the same, since in the middle of the period the sentiment may turn around and totally eliminate the probabilities in your favor.
Some traders use the maximum or minimum of the expected candle or pattern to position their stop loss. While close supports / resistances are used as profit takings.
Here are examples of how you can take advantage of the signals thrown by the candlesticks to make entries:
1st example
In the previous graph we can see a large support area, left by a long wick, part of a bullish hammer.
Later, we see how the price of Bitcoin reacts leaving rejection to a nearby resistance zone, and after a new test of the area, an inverted hammer is presented, a possible sell signal.
However, since the price was in a historical support area, the priority was purchases, so on the new visit to the support area, the bullish engulfing candle could have been used.
2nd example
The price creates a resistance zone, leaving a strong rejection of bullish prices. Soon after, she is visited and rejected again.
On a 3rd attempt, an inverted hammer candle demonstrates buyers’ inability to break through that level. As a bearish 4th signal, after a slight decline, a significant envelope makes presence.
3rd example
In previous paragraphs I mentioned that Japanese candles are also used together to forecast future market movements, and for example the one seen in the image above.
A close resistance can be observed, the buyers try to overcome it, but the break is invalidated by observing how the bears completely return the intention. As a consequence, a pattern known as a sunset star can be observed.
4th example
As a last example of this lesson from the free trading course to learn from scratch, we look at another candle pattern known as Harami.
In the previous image we see the graph of the Euro vs US Dollar in the 4-hour time frame.
A Shoulder Head Shoulder is observed, indicating a possible reversal of the trend.
Indeed, the bears manage to get through the support.
Then, after performing a validation pullback on the same level, the bulls demonstrate the completion of the reverse movement in the form of a Harami pattern, formed by a small candle wrapped by the previous one, indicating loss of the previous momentum.
Did you like this lesson of the trading course?
I hope your answer is yes, and motivates you to stay tuned for our next posts. Remember that the knowledge learned in this lesson can only be really effective if you combine it with what you will learn throughout this course of trading to learn from scratch.
