Whether you are a professional trader in the stock market or just a retail investor that likes to dabble in cryptocurrency, you need an accurate and reliable chart analysis strategy to help you plan entry and exit points. One of the best methods uses the Japanese candlestick chart as a powerful tool to identify the emotional state of buyers and sellers to determine when trend reversals will take place.
Trying to read candles can seem overwhelming for a beginner, but it's actually a rather simple tactic once you learn the basics. After you know the different parts to a candlestick and what they mean, you can then identify patterns in a chart that can signal an impending reversal. I've created this extremely in-depth guide to teach you everything I know about trading candlesticks and analyzing candle charts.
Japanese Candlestick History
Munehisa Homma is the godfather of candlestick chart analysis. He created this trading strategy as a rice trader in Japan in the 1700s, but the exact same techniques still work today for any securities or commodities that trade on an open market. The candle chart itself is also a Japanese creation from the late 1600s. Despite the power of this system, it was mostly unknown to the United States until it became widely adopted in the 1980s by large institutions.
It doesn't matter what kinds of assets you trade with this strategy. Even though it was originally created for commodities like rice, the same principles apply to securities like stocks and even cryptocurrency. The only difference between the creation of this tactic in the 1700s and now is speed. In the 1700s there were paper price charts, but now computers run charts and provide real-time data.
A candlestick chart can show different time intervals, so each candle could represent a single minute or even a full day. Each candle shows you four price points for the time period it represents: the open, close, high and low. The solid body indicates the opening and closing price. For bearish candles, the open price is at the top of the body, but with a bullish candle it will be at the bottom of the body. The lines that extend above and/or below the candle body are the shadows, sometimes also called tails or wicks. The upper and lower shadow tell you the high and low price.
The shapes, sizes and locations of these candles can tell you information about the emotional state of traders. This knowledge can then be used to determine future price action. Even though candlestick analysis is very powerful and considered to be a pretty accurate trading strategy, you should never depend only on reading candles. Always use other indicators along with candles to determine the future price direction. I will be teaching you some of these indicators and guiding you through the proper usage of this strategy in this post.
To be able to accurately read a candlestick chart to quickly figure out the overall sentiment of the market and emotional state of traders, you're going to need to learn the meanings behind the different potential candle formations.
The sizes of the candle bodies can tell you about the strength of buyers and sellers. Short bodies indicate low activity and relative indecision. Longer bodies show stronger trading power and more activity.
Bullish and bearish candles in combination with the body size can tell you whether buyers or sellers have the upper hand. For example, a bullish candle with a long body tells you that there's strong buying activity and the buyers have a foothold over the sellers.
The size of the real bodies can tell you a lot about the current emotional state of the market by quickly glancing at them. Many specific candle patterns that will be discussed later in this guide will make use of short or long body sizes to indicate different kinds of reversals in emotional state.
Solid & Hollow Bodies
It's worth noting that some charting programs will show both solid and hollow bodies on candles. Personally, I don't like this particular chart setting and have it disabled anywhere that offers the option, but some traders may like the slight bit of extra information that a hollow candlestick body will tell you.
In general, a hollow body indicates that the trading price moved higher after opening. This means hollow bodies can be interpreted as bullish and solid bodies are bearing. Again, this only applies to a chart that is using both solid and hollow candle bodies. This seems to be a much less common format though, so I'm not familiar with any software that uses this setting by default.
The look of the chart just doesn't seem right when this setting is being used. I don't feel like the information visually flows as well as it does with standard solid bodies, so I will personally have to spend a lot more time analyzing a hollow bodied chart.
Shadows & Tails
Any price action outside of the open and close prices for each candle will be registered as a shadow. Shadows are also sometimes referred to as tails or wicks. The shadow above the body is called the upper shadow and the highest point of the upper shadow is the high price. Below the body is the lower shadow, and the low price sits at the bottom of it.
Both the presence and size of shadows can be strong indicators and even signs of trend reversals. Long shadows will often indicate resistance and will sometimes foretell a trend reversal. Consider a short candle (bullish or bearish) with a long lower shadow. The opening and closing prices stay relatively close to another. However, the long shadow tells you that sellers drove the price down, but the buyers were able to hold them off and drive the price back up before the session close. By themselves, these long shadows do not necessarily mean anything, but when they're combined with other indicators, they can signify strong resistance and even the potential to change the trend direction.
Short shadows tell you that there was not much price action on that side of the body, so it can indicate weaker activity in that direction. You can also have shadows that are so short that they simply don't exist, leaving you with just a candle body. This is an even stronger indicator of zero activity trading in that direction.
White / Black & Red / Green Candles
Different stock chart software can show candlesticks with some minor variations. One of the most obvious of these is the color. Some programs will use a black and white color configuration, while others will use red and green.
Ultimately, it doesn't really matter what colors you use. If your software gives you a choice to change this setting, you can simply pick the one you like the best. I personally prefer red and green colors, since I feel like it gives me a faster visual indication of the trading direction.
White and green colors are used to indicate a bullish candle. Open prices will be on the bottom of the body, and closing prices will be at the top since the price has moved higher since it opened.
Black and red signify bearish candles. Open and close prices will be opposite - open on the top and close on the bottom. The price point has declined during the session of a bearish candle, which is why the open price is on top and the close price is on the bottom.
How to Trade Candlesticks
The information that you gain from reading candlesticks only tells you part of the whole story. Other indicators are often necessary to use in combination with candle analysis to accurate gauge the future direction of the market.
Overall, candle analysis will work best at longer timeframes on charts. Daily and 4 hour candles work the best, while trading on really short timeframes like 1 minute or 5 minutes is an almost guaranteed way to lose money. You'll also find patterns to be more accurate and reliable indicators when trading volume is higher.
Since there are a lot of different patterns and types of trend reversals you can identify in candles, there is not a single, clearly defined rule that you can use to trade this strategy for all situations. However, there are a lot of specific scenarios that you can learn about that you can use to plan trade entries and exits.
I'll be updating this post numerous times over the month of June and possibly even July to provide in-depth knowledge you can use to initiate trades using a candlestick analysis strategy. You'll find this information at the bottom of each pattern page listed below.
Practice Candlestick Analysis
I highly recommend that you open charts through your trading platform and simply spend some time practicing. First try to identify different patterns in the candlesticks. Then figure out what the candles are trying to tell you. Do you think the price will move up or down next? Make an educated decision and then wait to see what happens. Do this over and over again for a while until it feels natural to do it quickly and until your accuracy increases.
Also try to practice some simulated trades. Identify a pattern in the chart that you believe is a trend reversal indicator. Match this information with the overall trending direction and other trading indicators to try to plan an entry price. Then wait to spot another trend reversal pattern that you believe will bring an end to your trade. Declare your trade over when you spot this second pattern. Try to simulate multiple successful trades using this approach.
After you have practiced enough to feel comfortable with this strategy and your accuracy rate, then you can move on to making some trades in real life with your portfolio. DO NOT simply scan through this guide, look at a pattern or two, and then immediate start to make trades based on that info. You need all of the candlestick analysis knowledge that I provide combined with other indicators to truly be able to make educated trades with this strategy, so be patient to do so until you are confident with your chart reading skills.
There are a lot of different candle patterns to learn if you want to be able to truly understand candlestick charts. Munehisa Homma originally saw these patterns as a way to gauge market emotions. Fear and greed play a big role in the emotions of traders, as does hope. These emotions control their trading behaviors, so Homma sought a way to identify these emotions by simply looking at a price chart made from candlesticks.
Homma created an original set of these patterns, but more modern traders have added to and expanded on those original techniques. You'll be able to find all of that information in one place on this blog so you can master the art of candlestick trading.
This section of this guide is a work in progress, but it should be complete before the end of July 2022. Each of the candlestick patterns below will have its own page on this website to show a picture of the pattern and explain it in detail so you can learn all of them.
- Bear Engulfing Bar
- Bull Engulfing Bar
- Doji (neutral)
- Dragonfly Doji (bullish)
- Gravestone Doji (bearish)
- Morning Star (bullish)
- Evening Star (bearish)
- Hammer (bullish pin bar)
- Shooting Star (bearish pin bar)
- Hanging Man (bearish pin bar)
- Harami Pattern
- -Bullish Inside Bar
- -Bearish Inside Bar
- Tweezer Tops and Bottoms
- Double Top (bearish)
- Double Bottom (bullish)
- Harami Cross
- Three Black Crows (bearish)
- Three White Soldiers (bullish)
- White / Green Marubozu
- Black / Red Marubozu
- Spinning Top
The Candlestick Bible
I want to at least provide a shoutout to the Candlestick Bible. This was a resource that I used in the beginning to learn a lot about reading candlesticks. It's based on the original trading system by Homma.
There are a few negatives about this trading bible. It seems like English may not be the primary language of the writer, so it can be a tough read at times. You'll also notice that it lacks quite a few of the candlestick patterns that are covered on this site, so it's not exactly a complete knowledge resource anymore.
There is rather extensive information about trading candlestick patterns in the bible, and I find those the most useful lessons in the book. By using both my website and the candlestick bible, you'll be able to teach yourself one of the most powerful trading strategies that exists.