Munehisa Homma, a Japanese rice trader of financial instruments, developed candlestick charts in the 18th century. People used it to trade rice. A western author named Steve Nison introduced it to the western world through his book ‘Japanese Candlestick Charting Techniques’. He did deep research on candlesticks before publishing the book. Traders all over the world use Japanese candlesticks to analyze the charts along with other analytical tools like Fibonacci. It gained popularity in the ’90s.
Japanese Candlesticks Explained
Each candlestick describes the price action during the given time frame. A candlestick explains open, close, high and low (OHLC) prices for a period of time. If you are working on a one hour chart, then each candlestick represents one hour. You can use the candlesticks in any time frame.
A hollow or white candlestick is formed when the close is above the open. Similarly, a filled or black candlestick forms when the close is below the open. The hollow or filled part in the center is the actual body of the candlestick. The thin lines that you see above and below the body show the high and low range. They are called shadows.
A long white candle indicates that there is a very strong buying pressure. Similarly, a long black or filled candle shows that the selling pressure is too high. A short body means that there is very little buying or selling activity.
Basic Candlestick patterns
A spinning top is a candlestick that has a long upper shadow, long lower shadow and a very short body. It can be a white or a black candle. This pattern shows indecision between the buyers and sellers.
As you can see, the price shows little movement from open to close. That is why the body is too small. The longer shadows indicate that neither sellers nor buyers gained the upper hand. If there is a spinning top in an uptrend, it means that a very few buyers are left and that the trend may change direction. If there is a spinning top in a downtrend, it means that a very few sellers are left. This also indicates a reversal in the direction of the price.
Marubozu candles have no shadows. A marubozu candlestick has just a body without any shadows. If it is white, then the open price equals the low price and the close price equals the high price. The white marubozu shows that the buyers are in control during the entire session. It is a bullish pattern.
If the candle is black, then the open equals the high and the close equals the low. It is a bearish candle and shows that sellers are in control.
In a Doji candlestick, the open and the close price are the same. Because of this, its body is extremely short. The body just looks like a thin line. A doji indicates indecision between buyers and sellers. Based on the length of the upper and lower shadows, we can classify Doji into four types.
If a doji forms after a series of long white candles, it indicates that buyers are weak. This means that a reversal could occur. Similarly, if a doji forms after a series of long filled candles, it shows that the sellers are weak. This also signals a reversal.
Hammer and Hanging man
Hammer and Hanging man look similar but have different meanings based on the context. They have very little bodies and long lower shadows. The upper shadows are too short or absent. The lower shadow of the hammer is about two to three times of the real body. The color of the body is not important. The candle is called either a hammer or a hanging man based on past price action.
A hammer is a bullish reversal pattern and it forms during a downtrend. It signals that the price will rise again. The hanging man is a bearish reversal pattern that forms during an uptrend. It signals that the price may come down.
Inverted Hammer and Shooting Star
Inverted Hammer and Shooting Star look similar too. An inverted hammer is a bullish reversal candlestick and a shooting star is a bearish reversal candlestick. They have little bodies, long upper shadows and small or absent lower shadows.
An inverted hammer forms at the end of a downtrend and signals that the price will rise again. Similarly, shooting star occurs at the end of the uptrend and signals that the price will come down again.