Introduction
In the world of trading, technical analysis is an invaluable tool for investors who want to make good decisions and maximize their profits. Within this analysis, japanese candlesticks play a key role in providing visual information about the price movements of financial assets such as cryptocurrencies, stocks or Forex. In this article, we will explore in detail what japanese candlesticks are and how they are used in technical analysis for cryptocurrency trading.
What are Japanese Candlesticks?
The Japanese candlesticks are a graphical representation of the price movement of an asset in a specific period of time, each candlestick can be the movement of an asset during 1 whole day, 1 minute, 4 hours, etc.
Each candlestick is composed of a body and generally two wicks, one that appears visually above the body and another below (although they do not always have to appear in the same candlestick) also known as shadows or tails. These candles provide visual information about:
- Opening price
- Let’s say that each candlestick represents the movement of an asset during 1 full day (24 hours). In this case the opening price is the first price at which the financial asset trades in the reference period.
- Closing price
- It is the last price at which the financial asset traded in the reference period and represents the highest or lowest point of the body of a candlestick. If the candlestick is red or black, it means that the closing price was lower than the opening price, and vice versa.
- Maximum price
- The maximum price of a Japanese candlestick is the highest price reached by that asset in a given time interval. This high is represented by the upper wick of the candlestick.
- Minimum price
- Conversely, the minimum price of a Japanese candlestick is the lowest price reached by that asset during a given period of time. This low is represented by the lower wick of the candlestick.
Candlestick charts offer more information than traditional bar or line charts. Being aware of this is a good starting point to better understand and use candlestick charts during your trading.
Each candlestick has a color that indicates whether the price of the asset has risen or fallen during the period under analysis. If the closing price is higher than the opening price, the candlestick is typically represented in green or white. On the other hand, if the closing price is lower than the opening price, the candlestick is represented in red or black.
This is how the candlesticks look in isolation, let’s see how they look on a chart:
In this Bitcoin ($BTC) chart each candlestick represents the price of the asset during a full day (24h). You can see candles of all types and shapes.
And you may wonder: Is the shape of each candlestick relevant? That’s right, let’s see how to interpret Japanese candlesticks.
How to interpret Japanese Candlesticks
Japanese candlesticks show very well the price movement in the market, and to interpret them, three characteristics of these candlesticks must be taken into account:
- The length of the wick
- The color of the candle
- The different Japanese candlestick patterns.
The length of the wick of a Japanese candlestick can give us signals of the future behavior of the asset.
- If we see long wicks at the top of the green candles during an uptrend, this may indicate that the market is running out of steam and that a trend reversal may soon follow.
- On the other hand, if we see long wicks at the bottom of the red candles during a downtrend, it may be a sign that the asset is ready for a trend reversal.
Common Japanese Candlesticks Patterns
Japanese candlestick analysis is based on the identification of patterns that can help predict future price movements. These patterns have developed over the years and have become valuable tools for traders who use them. Some of the most common Japanese candlestick patterns include:
Hammer candlestick.
This pattern is characterized by a long downward wick and a small or non-existent body. It indicates a possible upward reversal after a downtrend.
Shooting star candlestick
This pattern is similar to the hammer, many know it as an inverted hammer, but it appears at the top of an uptrend. It has a long upward wick and a small or non-existent body. It indicates a possible bearish reversal.
Doji candle
The Doji candlestick is the only Japanese candlestick that has no body. The opening and closing price of the candlestick are equal or very close to each other, so a symbol resembling a cross appears. Doji candlesticks represent indecision as to the direction of the asset.
In this chart we see many Doji candles in a row one after the other, as it means indecision, we see that the price during a long period of time does not make up its mind and keeps sideways.
Bullish engulfing candlestick
This pattern is formed by a red candlestick followed by a green candlestick larger than the previous one, whose closing price is higher. It suggests a possible uptrend.
Bearish engulfing candlestick
This pattern is the opposite of the bullish engulfing candlestick, it is a green candlestick followed by a red candlestick, where the closing price of the second candlestick is lower than the previous one, indicating a possible reversal or the beginning of a downtrend.
Before concluding, we would like to highlight two points.
- Japanese candlestick analysis is not the holy grail, it is not infallible. You must combine this analysis with other indicators or tools in order to draw a better conclusion for your trading.
- Patterns are never perfect or repeat symmetrically, sometimes they are difficult to identify on the chart. Mastering candlestick analysis requires time and experience.