To use Japanese Candlesticks chart patterns we must first understand visually the most important candles and the series that form a pattern and what that chart pattern potentially means.
The following are the most common meaningful types of candlesticks created by price movement:
1. Belt-Hold Line – Bullish – The bullish belt-hold line is when the candle opens on its low and closes higher, thereby holding the low.
2. Belt-Hold Line – Bearish – The bearish belt-hold line is when a candle pens on its high and closes lower.
3. Doji – A Doji is when a cross is formed from an unchanged open and close, as discussed in “How a Japanese Candlestick chart is constructed”.
4. Hammer – A hammer is a potential bullish bottom reversal sign when it forms in a downtrend. A hammer is formed when the candle opens on its high (or very close to) and closes close to the high and the price range below the candle box is at least twice as long as the open to close.
5. Hanging Man – A hanging man is a potential top reversal candlestick when it forms in an uptrend. A hanging man is form when the candle closes on its high (or very close to) but opened close to that high and the price range is at least 2 or 3 times the open to close.
6. Inverted Hammer – As with the standard hammer, an inverted hammer is a potential bullish bottom reversal when it forms in a downtrend. An inverted hammer is form when the candle opens on its low (or very close to) and closes slightly higher and the price range extend higher by 2 to 3 times then the open to close price movement.
7. Shooting Star – A shooting star is a potential bearish candlestick in a uptrend. A shooting star is formed when a candlestick opens on its low (or very close to) and closes slightly higher and the price range is primarily above the open to close candle.
We have covered some of the most meaningful Japanese Candlesticks that can form in a chart, now will examine the most meaningful series of candlesticks.
1. Dark Cloud Cover – Dark cloud cover is a potential bearish reversal sign that forms after a large up candlestick in an uptrend, when the next candlestick opens above that large white candlestick and closes well into it.
2. Doji Star – Bullish – The bullish Doji Star is probably one of the most meaningful series of candlesticks that signals a potential bullish bottom reversal. A bullish Doji Star forms in a downtrend after a down candle and the next candle formed is a gapped down Doji (cross). This series is confirmed if the next candle is a white up one.
3. Doji Star – Bearish – The bearish Doji Star is one of the most meaningful series of candlesticks that signals a potential bearish top. A bearish Doji Star is formed in an uptrend after a large up candlestick when the next candle is a gapped up Doji. This series is confirmed if the next candle is a down one.
4. Bullish Engulfing Pattern – A bullish engulfing pattern forms in a downtrend and signals a potential bull bottom reversal. A bullish engulfing pattern forms after a small down candlestick and the next candle is a large white one engulfs the previous down one.
5. Bearish Engulfing Pattern – A bearish engulfing pattern forms in an uptrend and potentially signals a bear top reversal. A bearish engulfing pattern forms after a small up candle and the next one is a large down that engulfs the previous up move.
Although the above are just the basic meaningful shapes and patterns that form in Japanese Candlestick charts, they are some of the most important.
From the above shapes and patterns we can see how they can give us insight into a markets psychology. For example when a Doji is formed this tells us that the market has found a point of reluctance. When a Doji forms in an uptrend it tells us that the bulls are second-guessing their buying decision. When a Doji forms in a downtrend this tells us that the bears are second-guessing their selling decision. The shapes that form in the individual and series of candles gives us a visual queue of what the driving force behind an uptrend or downtrend are thinking.
Munehisa Homma (as discussed in Japanese Candlestick Chart History) figured out that markets trade on emotions and created a method to visualize the psychology of that markets movement by identifying candlestick chart patterns.