When it comes to technical Forex trading, it’s all about reading charts and analyzing data, and when it comes to charts, no one can deny the importance of the candlestick graphs.
While they may seem complicated at first glance, candlestick charts are actually quite simple, and understanding them doesn’t require more than using your brain to break down some concepts and voila, all is clear!
So, shall we dive into real matters?
Forex Candlestick Charts: Origins
Although they may seem modern and sophisticated, candlestick charts actually date back to the 18th century, when they were first used by a merchant called Munehisa Homma during his trades in the Ojima rice market in the Osaka region.
Now, one may think that candlestick charts aren’t that big of a deal compared to bar and line charts, but they actually caught the eyes of Western traders because of their predictive features, which allowed these charts to conquer any technical trader’s arsenal in no time.
The introduction of these charts to the west was done by the hands of a Western trader called Steve Nison who learned the Japanese candlesticks technique from a fellow Japanese merchant.
Soon after his discovery, Steve’s secret technique broke out of secrecy and gained significant fame in the ’90s. From the rice market to the Western traders. Talk about a long way from home.
How to Read a Candlestick Chart?
To understand candlestick charts, you need to get a grasp of the elemental structures first, which are candles, obviously.
Each candle represents a specific period of time or timeframe, be it an hour, a day, a month, a year, or even a decade, and it reflects the price action during that period through four different values, which are the opening and closing prices along with the lowest and highest values during the period at hand.
In other words, one look at a candle will allow you to determine whether the session ended in the buyers’ or sellers’ favor. in the Forex trading lingo, you’ll determine whether the session ended bullish or bearish. The primary visual variable that distinguishes the two is the fullness state or the color of the candle.
In case the closing price is higher than the opening price, it’s called a bullish candle, which is visually represented by a hollow or empty candle. Typically, charting platforms use the green color to reflect a bullish candle, although colors may differ from one platform to the other.
On the other hand, if the opening price is higher than the closing price, it’s called a bearish candle, which is generally filled or red-colored. Again, keep in mind that the visual representation may differ, so focus on the difference between the opening and closing prices rather than the coloring schemes.
The last element that we need to cover is the candle’s shadows; the upper shadow presents the timeframe’s high, while the below shadow indicates the timeframe’s low.
Why Should You Use Candlestick Charts?
Professional Forex traders use candlestick charts for two main reasons:
First, they provide a clean and slick interface through which traders can analyze their data and interpret the price action during the time period without having to spend their time decoding every sign and shape.
Second, candlestick charts provide a lot of data that’s easy to understand and analyze, which is something that technical traders dig, as it allows them to identify the character of price action and the movement of the market definitively, a step that’s required for a sound decision-making process.
It ain’t all sunshine and rainbows though, as candlestick charts do have some drawbacks, mainly the lack of smoothness compared to the line chart. Professional traders have ways to surpass that though, by using a moving average for a short timeframe, which gives the feel of a smooth trend or lack of trend in the market.
Forex Candlestick Patterns
Over the years, professional traders have been developing patterns through which they can understand the price action and the market movement, both in the short and long run.
These patterns can be categorized into four categories: basic, single, dual, and triple models, each of which has its own purpose and uses.Basic Japanese Candlestick Patterns
There are three basic patterns that you should know: Spinning top, Marubozu, and Doji.
Spinning tops refer to candlesticks with small bodies and long shadows regardless of the color, which reflects the indecision between the buyers and sellers. Each side was aggressive and tried to pull the price to their end (long shadows) but to no avail (since the opening and closing prices were close).
It is a neutral pattern but if a spinning-top pattern forms during an uptrend or a downtrend, it usually means that the trend and price are most likely to go in the opposite direction.
Don’t let the name frighten you, as Marubpzu is nothing but a candlestick pattern where the candle has no shadows, regardless of whether it is bullish or bearish.
A bullish marbozu indicates that the session was dominated by the buyers who took control of the price. The chances of the buying pressure carrying over the next few candles are high.
A bearish marbozu indicates that the session was dominated by the sellers who took control of the price. The chances of the selling pressure carrying over the next few candles are high.
It’s easy to spot a Doji candlestick as it’s presented by a candle with a tiny body, one that looks like a fine line because the opening price is the same as the closing price.
A Doji pattern reflects indecision that ends in a draw between buyers and sellers. It is also considered a neutral pattern but can act as support and resistance based on the placements
If you spot a Doji pattern on your chart, pay attention to the preceding candlesticks.
Single Candlestick Patterns
Understanding single candlestick patterns can help both professional and beginner Forex traders identify potential market reversals to plan their future moves accordingly.
Hammer candlesticks have long lower shadows, which indicates that the buyers were able to overcome the sellers’ attempt at bringing the price down.
This pattern is a bullish one that forms during a downtrend, and it signals a potential rise in the price. The key word here is “potential,” as you need more bullish signals to make your move and place your order.
Shooting star candlesticks have long upper shadows, which indicates that the sellers were able to overcome the buyers’ attempt at bringing the price up.
This pattern is a bearish one that forms during a uptrend, and it signals a potential fall in the price.
Dual Candlestick Patterns
Although basic and single candlestick patterns give useful information regarding the trend, you need to see the bigger picture to make a decision as to whether you need to buy or sell, which led to the creation of dual and triple patterns.
Tweezer Tops and Bottoms
Tweezer candlestick patterns usually occur after an extended, strong uptrend or downtrend, and they signal a potential reversal. As a general rule of thumb, a tweezer is considered effective when it has the following characteristics:
- The first candlestick follows the same trend that the previous candles are following.
- The second candlestick is the opposite of the overall trend.
- Tweezer tops have the same highs (upper shadows) whereas Tweezer Bottoms have the same lows (lower shadows).
Engulfing Bullish and Bearish Candles
When a large bullish candle follows a smaller bearish candle, the result dual pattern is a called a bullish engulfing pattern, where the buyers are baring their teeth and trying to enforce an uptrend after a downtrend or a consolidation period. This dual pattern usually signals an upcoming uptrend.
A Bearish engulfing pattern forms when a bearish candlestick follows a smaller bullish candle, which reflects that the sellers were the winners and that a downtrend may happen.Triple Candlestick Patterns
What’s better than dual? Triple, of course.
Morning and Evening Stars
The morning and evening stars, just like the Tweezers, are usually found at the end of a trend. They are reversal patterns, and they share a couple of characteristics (or rather a triple of them):
- The first candle is the same as the overall trend.
- The second candle has a small body that reflects indecision in the market.
- The third candle is the opposite of the overall trend, confirming the reversal.
Three White Soldiers/ Black Crows
The three white soldiers’ pattern is a strong bullish formation composed of three bullish candlesticks that follows a downtrend. These candlesticks has following characteristics:
- The first candlestick, or the reversal pattern, follows an extended downtrend, and it signals the end of it.
- The second candlestick is longer than the first, with a small to non-existent upper shadow.
- The third candlestick is either longer or has the same size as the second candle, and it has a small to non-existent upper shadow as well.
The three black crows’ pattern is the opposite of three white soldiers, as it’s a strong bearish formation that follows an extended uptrend, and it’s composed of three bearish candlesticks that have these characteristics:
- The first candlestick, or the reversal pattern, follows a strong or extended uptrend, and it signals the end of it.
- The second candlestick is longer than the first, with a small to non-existent lower shadow.
- The third candlestick is either longer or has the same size as the second candle, and it has a small to non-existent lower shadow as well.
Mastering forex trading takes time and patience, but once you learn the ropes and play your cards right, you can earn your place in the sun as a veteran trader and start raking in money in no time.
To corner the market as a successful forex trader, nip your apprehensions in the bud, go forward by degrees, study every aspect of the candlestick chart – including the patterns, strategies, and indicators – thoroughly, and you may soon discover that forex trading is right up your alley.
Again, remember that a pattern is not to be taken on its own, but with the rest of the indicators and signs on the chart.
If you have any question regarding any of the candlestick patterns mentioned above, do not hesitate to ask in the comments.