Online Trading : Japanese Candlesticks

Japanese Candlesticks: OK - so now we understand a little of how the markets work and the tricks that are played by the professional online players - the market makers, we are going to look at trading using Japanese Candlesticks in a little more detail, and please remember we can use candlesticks for trading stocks, options and currency -they can be applied to any financial instrument. We saw on the previous page, how by comparing the actual volume with the associated price spread, we can start to draw some meaningful and common sense conclusions for our trading.

Now please don't run away with the idea that your conclusions will always be right, they won't, but they will give you a guide and stop to make you think about what you are seeing on the screen, and asking yourself very simple questions, such as: "is this a valid move that the professional money is joining in with?"  or " is this a false move and we must wait and see?" We must now look more closely at the stock charts, and I would now like to introduce you to the wonderful world of Japanese candlesticks.

Japanese Candlesticks: Introduction

It's hard to believe that Japanese candlestick charts were almost completely unknown in the West, before being introduced in 1989 by a man called Steve Nison in his book called Japanese Candle Charting Techniques. These candlestick techniques are now so widely used throughout the financial industry, it is hard to imagine a world without them. What is unique is that a simple candle shape can hold so much information, and because it is graphically and colourfully displayed, it allows the mind to absorb the information very quickly. Combined with our knowledge of volume, they provide the two elements that will form the basis of your online trading. As you will have guessed they are called candles or candlesticks because that is what they look like! So, lets look at the basic elements of a candlestick. Each candlestick is defined by the four price points, namely the opening, closing, highest and lowest prices in the time frame.

Lets look at the UP candle first which is shown above. The price has opened and at some point during the time the price has fallen to  the lowest price , but it has not remained there, and has subsequently risen to  the highest price. Again it did not remain at this point but fell back to close the time period at the closing price. Overall, the price has risen during the time period from,  and therefore this is an UP bar. Generally these bars are coloured blue but most charting packages allow you to choose a variety of colours. Now imagine if this information were contained in data format it would take you some time to establish exactly what had happened in the time period. With a candlestick you can see instantly. As you will learn later, all aspects of the candle are important, but particularly the size of the body, the length of the wicks ( upper and lower ) and of course whether it is an up or down candle.

Now look at the DOWN candle, the price opened and at some point during the period it went down to form the lowest price, and then at some point to the highest price. It eventually closed below the opening price, and is therefore a DOWN bar. These are normally coloured red but again this is just convention - you can have them any colour you like. Some candles have no body at all, with the opening and closing prices being the same, or very close. These are an extremely important group of candles, as they represent indecision in market prices, and therefore represent a possible turning point, and an opportunity for you to make money!!

Japanese Candlesticks: Trading Timeframes

Now that you understand the basic formation of a candlestick I am going to discuss timescales in a little more detail. It may surprise you to know that on my online currency trading charts I have the following timescales : 5 seconds, 10 seconds, 30 seconds, 1 minute, 5 min, 10 min, 15 min,30 minutes and onwards to the monthly. The reason I mention it now is firstly to make you aware that you can have candlestick charts in virtually any timeframe you like ( all charting packages are slightly different ), and secondly if you are not careful, you will spend your time like some lost soul endless flicking between timeframes to try to look for confirmation of something you have seen in another timeframe!. Don't worry, everyone has the same problem when they start, it is part of human nature! Every form of trading has different requirements and in addition this also depends on the length of time you are going to be holding positions open. Let me try to give a silly example, which I hope will make the point.

As I mentioned it above, take the 5 second charts as an example. Imagine you were buying shares as part of your investment portfolio for the next few years. You would not base your decision on a 5 second chart would you! ( no you wouldn't!! - really you wouldn't) The timescale of your holding and the timescale of the chart you are looking at are completely out of balance with one another. You would look at a daily, weekly or even monthly chart going back several years. The timescales are relevant to one another, and you must base your decision on a relevant chart for the time you are likely to be holding the trade.

Now let's look at another trade using the 5 second chart. In currency trading you have people who trade by what's called scalping. In the currency markets the prices move around constantly and sometimes very fast indeed. In a few seconds a price may have moved several points. A scalper will trade large amounts of money on small movements, trading in and out of the markets several hundred times a day. There would be little point looking at an hourly or daily chart. Trading would be over by the time you pushed the button. A silly example I know, but I hope you get the point. Scalpers would use anything between 10 second and 5 minutes, and in case you're wondering, no I am not a scalper nor do I ever look at these timescales. My trades are longer term hours, days and sometimes weeks and months, so I use hourly and daily charts 95% of the time ( much less stressful)

OK, before we move on to look at some more candlestick types and what they mean, one last point on time and data ( I'll cover this later in more detail so don't worry ). There are two types of data, real-time and historic. When you start trading you do not need real time, and don't let anyone tell you otherwise.( real-time is where the data comes in real time - i.e. as it happens live on the market) If you follow the steps I have outlined in getting started, all you need is what is called end of day data ( historic). Real time is expensive and unnecessary. The charting package I use for share trading is simple and cheap, and you just update your charts by a download in the evening, which takes 2-3 minutes. Right - back to candlesticks. I am going to give you four generalizations for the candles themselves ( I'll call them candles from now on as it it less typing!) which I hope will give you some very basic guidance. Remember there are whole books and websites dedicated to the study and analysis of candle charts and you will have to do lots of reading, study and practice to become expert.

• The longer the body of the candle, then the more meaningful the move, and the more volume ( effort ) is required.
• It takes effort to go down as well as up, so the above applies whichever the direction of the bar.
• The longer the wick ( whether top or bottom), then the more one can interpret from the analysis.
• When the open and close are close together, this is indecision in the market, and could represent a turning point.
• The same candle can mean different things depending on where it appears in the chart.
• You never act on one candle alone, but wait for a confirmation in the next few bars.
• Candle patterns and groups are more meaningful than single candles.

Now, all the above points are  important and we are going to look at one group of candles in particular. These are where the body is small or does not exist at all and because they represent possible turning points in the market. They are the point where the bears and the bulls are fighting in the market - in effect it is a drawn contest. At some point one or the other will win. Now prices could continue in the direction they were already going, but they may not and you must wait for confirmation from the next few candles to confirm the move.

In the study of candles and candle charts, one is always looking at groups of candles in a move, which may be up or down. Therefore depending where the candle appears in the move can mean very different things. This can be confusing for beginners, but don't worry all will become clear in a minute. Finally as in the last point, you never act on one candle alone, always wait for confirmation.

Right, lets look at the most important group of candles. You will find that many still have the original Japanese name, whilst others have been labelled descriptively and colourfully. This group which is the most important is called DOJI. The reason they are so important is in fact twofold. Firstly as I said earlier, they can represent turning points in the market, and secondly they provide great information in their own right. The volume merely acts as confirmation of what we are seeing in the candle.

Japanese Candlesticks - Doji Candle Formations

One thing this group all have in common, is that the opening and closing price are either identical or very close together. I have shown them in a neutral colour as these can be up or down bars, it does not matter. The important point is that the opening and closing prices have closed in the same ( or very closely the same ) place. This indicates indecision in prices and either a battle between bulls and bears or a lack of interest by the professional money. Either way something may happen and we need to pay attention!! Now lets consider one of these candles  which is often called the Dragon Fly, but is also referred to as a Hanging Man, and also a Down Thrust. After a long uptrend, if you see one of these forming, it could represent a turning point and a change from bullish sentiment to bearish, so you may expect prices to fall from here. In essence what has happened is that prices have reached a peak, and the professional money makes one last effort to push prices higher but fails. Remember you must always wait for the next few candles to confirm the move.

After a long down trend if you see this forming, again it could represent a turning point, but this time from bearish sentiment to bullish. In this case after a long fall in prices, the professional money has moved in and is now starting to buy the market, with prices bouncing off the low closing at the opening price. IN other words, buying is entering the market so we should consider buying as well. This is also known as hammering out a bottom, so this candle is often referred to as a hammer. In the candle itself the bears have driven prices down, but the bulls have won and pushed them back up again.

This is one of the most important doji candles, and is called the Upthrust. If you just traded using this one candle, then you would make money. It appears in all markets, and is most relevant when it appears at the top of a long up move. The candle signals that the move has run out of steam and that the professional money is selling into the rise, but that sellers are coming onto the market and knocking prices back down again - so prices fall back. It is the first sign of market weakness and a change in market sentiment. It is one of my personal favourites, as it can signal an absolute top ( and in the reverse case at the bottom of a fall ) an absolute bottom, so either way is significant in signalling a major change in market sentiment, and a possible opportunity to profit. But as always, you must wait for confirming signals from the next few bars.

Finally , one more doji candle, what I call the Daddy Long Legs! - the wicks are generally long, and when this appears, it suggests a change in direction. So if prices had been falling, expect a rise, and if they had bee rising, expect a fall. The longer the wicks or 'legs', then the better and the more weight you can add to the move. Now, whatever time frame you are trading, you must wait for confirmation. If you are trading shares and are using a daily chart, wait for 2-3 days and see what happens. If you see confirmation then you can open your trade, depending on whether you are trading long or short. ( remember short would be in spread betting - and NOT until you have been trading for some time - PLEASE!! ) Now I'm going to move on to look at some examples combining Japanese candlestick, charts and volume which starts to put it all together! - don't worry it may seem very confusing but with a little reading and study it will be worthwhile. Chart reading and analysis is vital to your online trading success. Trust me - I know! If you would like to discover more about Japanese candlesticks have a look at the site on advanced Japanese candlesticks. The new site explains some of the more important patterns which can signal a reversal so please follow the link here for more details  Japanese candlesticks 2 and 3 bar patterns.

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