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Tuesday, December 4, 2007

Japanese Candlesticks

Japanese candlestick charts and patterns

The candlestick analysis we use today originated in Japan over 300 years ago. This was at least 100 years before the West developed the bar and point-and-figure analysis systems. In the 1700s a Japanese futures trader named Homma, discovered that, although there was a link between price and the supply and demand of rice, the markets were strongly influenced by the emotions of the traders. He understood that when emotions came into the equation there were vast difference between the value and the price of rice. This perceived difference between value and the price is as applicable to financial markets today as it was to rice market in Japan centuries ago.

Technical analysts found that there are recurring patterns on the candlestick charts. These patterns tend to occur when a trend is about to end or reverse its direction. Candlestick bodies vary in sizes length and formation. Long solid bodies indicate strong buying or selling. The longer the body is, the more intense the buying or selling pressure. Short bodies imply very little buying or selling activity. By observing the candlestick patterns, traders can spot potential reversals of trends and enter or exit trades.
Unlike other indicators like moving averages or stochastics candle patterns can be regarded as leading indicators rather than lagging indicators. They warn in advance that a reversal is about to occur.

Basic candlestick patterns.

Doji candles
Doji candles normally open and close at almost the same price. They vary in length and have different trading interpretations. They can be bullish , bearish indecision or exhaustion candles.
Short doji candles that open and close at the same price signify indecision between the buyers and sellers. Prices move above and below the opening price and the candle closed at or near the opening price. Neither the bulls nor the bears could gain any advantage and the session ended in a draw.

Dragonfly Doji's that open at the high of the session have a considerable decline bouncing off support then close at the same high as the open of the session. Dragonfly doji's are seen as bullish reversal patterns after moderate declines in the market.

The long shadow should be about 2 to 3 times longer than the real body.
There should be little or no upper shadow.
The real body should be at the top of the candle.
The colour of the real body is not important.
Best traded when followed by a bullish engulfing candle.

Gravestone Doji's are the opposite of dragonfly doji's opening at the low of the session and rising considerably only to bounce off resistance then close at the low of the session.
Gravestone doji's are seen as bearish reversal candles and are best traded short when followed by a bearish engulfing candle and coming off resistance.
The long upper shadow should be 2 to 3 times the length of the real body.
There should be little or no lower shadow.
The real body is at the bottom of the trading range.
The colour of the real body is not important.

Piercing Line Bullish Pattern. The first candle is a long bear candle followed by a long bull candle. The bull candle opens lower than the bear candle and closed more than halfway up the bear candle.

This pattern normally occurs at a low in the market. If the bullish candle does not reach at least halfway up the bearish candle then it is not a true piercing line.

The closer the bullish candle is to being a bullish engulfing candle the greater the possibility of a reversal. If the bullish candle comes off support then that improves the possibility of a reversal.

Dark Cloud Cover Bearish pattern. The first candle is a long bullish candle followed by a long bearish candle. The bear candle opens higher than the bull candle and closes more than halfway down the Bull candle
This candle pattern normally occurs at a high in the market.

If the bearish candle comes off a resistance line or is closer to being an engulfing candle then there is more likely hood of a reversal.

A Bullish Engulfing candle occurs after a significant down trend. The engulfing candle must completely engulf the real body of the preceding candle but need not encompass the shadows.

A Bearish Engulfing candle is the opposite of a bullish engulfing candle and occurs after a significant uptrend in the market.

Engulfing candles often signify a trend reversal from Bullish to bearish or bearish to bullish.

The Hanging man candle is Bearish if it appears after a significant up trend. It is identified by the small real body at the top and a long lower shadow with no upper shadow. The lower shadow should be at least twice the length of the real body. The longer the lower shadow the more significant the candle.

The Hammer candle is Bullish if it appears after a significant down trend . It is identified by a small real body with a long upper shadow and no lower shadow.The upper shadow length must be at least twice the length of the real body. The longer the shadow the more significant the candle

Typical Hammer and Hanging man candles.

Evening and Morning Star candle patterns.

The Evening star is a Bearish pattern signalling a possible top to the market. The star indicates a possible bearish reversal and the bearish candle confirms this. The colour of the star is not important it can be green or red. For this to be a valid pattern the star should be higher than the preceding candle and following candle.

The Morning Star is a Bullish pattern signalling a possible bottom to the market. The star followed by a bullish candle signals a possible bullish reversal. Again the star should be lower than its adjacent candles.

Spinning tops are considered neutral candles where the distance between the high and low and open and close are very small. They suggest uncertainty and indecision. Supply and demand are balanced and there is no clear market direction. They tend to highlight the war between the bulls and the bears with neither side emerging as clear winners.

Marbuzu candles are strong bullish or bearish candles recognised by the fact that they have no shadows top or bottom. They can signal continuation of a trend when occurring during an up or down trend.
They can also signal reversal if for instance a bearish Marzubu appears after a significant uptrend or a Bullish marzubu appears after a significant down trend.

There are many more candlestick formations traded but these are the more commonly traded candles and patterns. Every trader should learn to Identify these candles and patterns as they can be early warnings of impending market reversals.
As with all trading candlestick patterns are best traded with confirmation using other indicators.

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