CANDLESTICKS, JAPANESE

Overview

In the 1600s, the Japanese developed a method of technical analysis to analyze the price of rice contracts.
This technique is called candlestick charting. Steven Nison is credited with popularizing candlestick charting
and has become recognized as the leading expert on their interpretation.

Candlestick charts display the open, high, low, and closing prices in a format similar to a modern-day bar-
chart, but in a manner that extenuates the relationship between the opening and closing prices. Candlestick
charts are simply a new way of looking at prices, they don't involve any calculations.

Each candlestick represents one period (e.g., day) of data. Figure 45 displays the elements of a candle.

Figure 45

Interpretation

I have met investors who are attracted to candlestick charts by their mystique--maybe they are the "long
forgotten Asian secret" to investment analysis. Other investors are turned-off by this mystique--they are only
charts, right? Regardless of your feelings about the heritage of candlestick charting, I strongly encourage
you to explore their use. Candlestick charts dramatically illustrate changes in the underlying supply/demand
lines.

Because candlesticks display the relationship between the open, high, low, and closing prices, they cannot
be displayed on securities that only have closing prices, nor were they intended to be displayed on securities
that lack opening prices. If you want to display a candlestick chart on a security that does not have opening
prices, I suggest that you use the previous day's closing prices in place of opening prices. This technique can
create candlestick lines and patterns that are unusual, but valid.

The interpretation of candlestick charts is based primarily on patterns. The most popular patterns are
explained below.

Bullish Patterns
 Long white (empty) line. This is a bullish line. It occurs when prices open near the low and close
significantly higher near the period's high.

Hammer. This is a bullish line if it occurs after a significant downtrend. If the line occurs after a
significant up-trend, it is called a Hanging Man. A Hammer is identified by a small real body (i.e., a small
range between the open and closing prices) and a long lower shadow (i.e., the low is significantly lower
than the open, high, and close). The body can be empty or filled-in.

Piercing line. This is a bullish pattern and the opposite of a dark cloud cover. The first line is a long black
line and the second line is a long white line. The second line opens lower than the first line's low, but it
closes more than halfway above the first line's real body.

Bullish engulfing lines. This pattern is strongly bullish if it occurs after a significant downtrend (i.e., it
acts as a reversal pattern). It occurs when a small bearish (filled-in) line is engulfed by a large bullish
(empty) line.

Morning star. This is a bullish pattern signifying a potential bottom. The "star" indicates a possible
reversal and the bullish (empty) line confirms this. The star can be empty or filled-in.

Bullish doji star. A "star" indicates a reversal and a doji indicates indecision. Thus, this pattern usually
indicates a reversal following an indecisive period. You should wait for a confirmation (e.g., as in the
morning star, above) before trading a doji star. The first line can be empty or filled in.

Bearish Patterns
Long black (filled-in) line. This is a bearish line. It occurs when prices open near the high and close
significantly lower near the period's low.

Hanging Man. These lines are bearish if they occur after a significant uptrend. If this pattern occurs
after a significant downtrend, it is called a Hammer. They are identified by small real bodies (i.e., a small
range between the open and closing prices) and a long lower shadow (i.e., the low was significantly
lower than the open, high, and close). The bodies can be empty or filled-in.

Dark cloud cover. This is a bearish pattern. The pattern is more significant if the second line's body is
below the center of the previous line's body (as illustrated).

Bearish engulfing lines. This pattern is strongly bearish if it occurs after a significant up-trend (i.e., it
acts as a reversal pattern). It occurs when a small bullish (empty) line is engulfed by a large bearish
(filled-in) line.

Evening star. This is a bearish pattern signifying a potential top. The "star" indicates a possible
reversal and the bearish (filled-in) line confirms this. The star can be empty or filled-in.

Doji star. A star indicates a reversal and a doji indicates indecision. Thus, this pattern usually indicates
a reversal following an indecisive period. You should wait for a confirmation (e.g., as in the evening star
illustration) before trading a doji star.
 Shooting star. This pattern suggests a minor reversal when it appears after a rally. The star's body
must appear near the low price and the line should have a long upper shadow.

Reversal Patterns

Long-legged doji. This line often signifies a turning point. It occurs when the open and close are the
same, and the range between the high and low is relatively large.

Dragon-fly doji. This line also signifies a turning point. It occurs when the open and close are the
same, and the low is significantly lower than the open, high, and closing prices.

Gravestone doji. This line also signifies a turning point. It occurs when the open, close, and low are
the same, and the high is significantly higher than the open, low, and closing prices.

Star. Stars indicate reversals. A star is a line with a small real body that occurs after a line with a much
larger real body, where the real bodies do not overlap. The shadows may overlap.

Doji star. A star indicates a reversal and a doji indicates indecision. Thus, this pattern usually indicates
a reversal following an indecisive period. You should wait for a confirmation (e.g., as in the evening star
illustration) before trading a doji star.

Neutral Patterns
 Spinning tops. These are neutral lines. They occur when the distance between the high and low, and
the distance between the open and close, are relatively small.

Doji. This line implies indecision. The security opened and closed at the same price. These lines can
appear in several different patterns.

Double doji lines (two adjacent doji lines) imply that a forceful move will follow a breakout
from the current indecision.

Harami ("pregnant" in English). This pattern indicates a decrease in momentum. It occurs when a
line with a small body falls within the area of a larger body.

In this example, a bullish (empty) line with a long body is followed by a weak bearish (filled-
in) line. This implies a decrease in the bullish momentum.

Harami cross. This pattern also indicates a decrease in momentum. The pattern is similar to a harami,
except the second line is a doji (signifying indecision).

Example

The following chart of Corn illustrates several Japanese candlestick patterns and principles.
You can see that advancing prices are usually accompanied with empty lines (prices opened low and closed
higher) and that declines are accompanied with filled-in lines (prices opened high and closed lower).

Bearish engulfing lines occurred at points "A" and "B" (and prices subsequently moved lower). Bullish
white lines occurred at points "1," "2," and "3" (as prices moved higher).

CandleStick Shapes

In and of themselves, candlestick shapes can tell you a great deal about the stock or market in
general, although it is these shapes that combine to make patterns -- and THAT is the real art.

Note that these are just the basic shapes, and just like bar charts, may represent varying time periods.
One stick could equate to the movement in a week, a day, or within minutes.

Starting simple (remembering the upper shadow, real body and lower shadows) we present a doji.

Doji

A doji is a shape wherein the opening and closing prices are the
same and the shape has no noticable "real body."

It signals market indecision except when it appears as a

Gravestone Doji, below.

Gravestone Doji

This particular type of doji, in which the opening and closing prices
are at the low of the price range, signals a top in a bull run and a
bottom in a bear phase.

Hammer
 The same format as the Hanging Man. It warns of a potential
bottom reversal in a falling market.

As with any single candlestick, confirmation is required. The

Bullish Hammer formation shows the price goes much lower than
the open then closes near the opening price. This fact reduces the
confidence of the bears. Ideally, a white real body Hammer with a
higher open the following day could be a bullish signal for the
days ahead.

Inverted Hammer

A small real body at the lower end of a long upper shadow. It

warns of a potential bottom reversal in a falling market.

Hanging Man

A small real body at the top of a long lower shadow. It warns of a

potential top reversal in a rising market.

The Hanging Man formation indicates that the price goes much
lower than the open then closes near the opening price. This
might mean that many longs have positions that they are
attempting to sell. Ideally, a red real body Hanging Man with a
lower open the following day could be a bearish signal for the
days ahead.

Marubozus

Marubozus do not have upper or lower shadows and the high

and low are equal to the open or close. A White Marubozu
indicates that buyers controlled the price action from the first
trade to the last trade. A red Marubozu indicates that sellers
controlled the price action from the first trade to the last trade.
Shaven Head

A real body, white or red, and no upper shadow. 

Shaven Bottoms

A real body, white or red, and no lower shadow

Shooting Stars

A small real body at the lower end of a long upper shadow. It

warns of a potential top reversal in a rising market.

Spinning Tops
A small real body and long shadows. They imply equilibrium
between buyers and sellers. They can be red or white.

Pattern Recognition

Now comes the harder part, identifying patterns in the charts.

These simple patterns provide crucial glimpses into potential
moves, trends, reversals, support and resistance levels that can
make or break the trade.
To start with, we'll provide smaller samples, and later some larger
scale, more in-depth patterns.

Bearish Engulfing Pattern

The 2nd day opens above

the close of the 1st day,
but quickly sells off to
finally close below the
open of the 1st day. This
dampens the spirits of
the longs and brings into
question the bull trend
which prompts selling in
the coming days. A
bearish trend reversal.

Bullish Engulfing Pattern

A long white body that

engulfs a small black real
body in a down trend.
The white body's opening
price is below the closing
price of the previous
black body. A bullish
trend reversal which
Prompts more buying in
the coming days.

Dark Cloud Cover

 In an uptrend a long
white body is followed by
a black body that opens
higher than the previous
days upper shadow, but
then closes more than
half way down the white
body. A bearish trend
reversal, making
longs quickly question
their strategy.

Piercing Pattern

This is considered to be
the opposite of the Dark
Cloud Cover. In a down
trend a long black body is
followed by a white body
that opens lower than the
past days lower shadow,
it then closes more than
half way up the black
body. A bullish trend
reversal.

Top Star

A Spinning Top of any

colour that gaps away
from a long real body in
an uptrend. Gaps on
candles are different to
bar charts. Candle gaps
work on the opening and
closing price. Stars
indicate a slowing of the
current trend.

Bottom Star

A Hammer of either
colour that gaps away
from a long real body in a
down trend. Gaps on
candles are different than
bar charts, as candle
gaps work on the opening
and closing price. Stars
indicate a slowing of the
current trend.

Doji Star Top (bearish)

 In an up trend a Doji
gaps away from a long
real white body. An
important reversal signal
that is usually confirmed
by a black downwards
body in the next session.
The uptrend is in full
force with a strong 1st
day. All confidence built
up

by the bulls from the 1st day is crushed when the 2nd day's
gap up closes near its open.

Doji Star Bottom (bullish)

A Doji gaps away from a

long real black body in a
down trend. Generally
regarded as an important
reversal signal that is
usually confirmed by a
white upward body in the
next session. The down-
trend is in full force with
a strong 1st day.

Confidence built up by the bears from the 1st day is

crushed when the 2nd day's gap down closes near its open.
Short covering will quickly appear if the next day opens
higher.

Evening Star (Bearish pattern)

A major top reversal
formed by three candles.
A Star top is followed by
a black body that closes
well below the first white
bars closing price. The
2nd day gaps higher, but
trades in a small range.
The bearishness of this
indecision is confirmed by
the lower close of the 3rd
day. Look for lower
prices.

Morning Star
A major bottom reversal
formed by three candles.
A Star bottom is followed
by a white body that
closes well above the first
black bars closing price.
The 2nd day gaps lower,
but trades in a small
range. The bullishness of
this indecision is
confirmed by the higher
close of the 3rd day. Look
for higher prices.
Evening Doji Star (bearish)

The same pattern as the

Evening Star but the
middle candle is a Doji.
This pattern is considered
to be even more bearish
than the Evening Star.
The bearishness of the
doji star created on the
1st two days is confirmed
with the 3rd day. If the
penetration of

the 3rd day is more than 50 % then this formation has a

much better chance to work well for the trader.

Morning Doji Star (bullish)

A similar pattern as the

Morning Star, but the
middle candle is a Doji.
This pattern is considered
to be even more bullish
than the Morning Star.
The bullishness of the doji
star created on the 1st
two days is confirmed
with the 3rd day. If the
penetration of

the 3rd day is more than 50%  this formation has a much
better chance to work well for the trader.

Bullish Belt-Hold

A bullish Belt-Hold is a tall

white candlestick which
opens at the lowest price
of the session. It is also
called a Shaven Bottom. A
significant gap down
occurs. The remaining
price action for the day
occurs to the upside. This
triggers a buying

spree. Shorts cover their positions due to concern over this

price action.

Bearish Belt-Hold
 A bearish Belt- Hold is a
long red candlestick which
opens on its high. Also
called a "Shaven Head." A
significant gap up occurs.
The remaining price action
for the day occurs to the
downside. This triggers
shorts to cover and
positions to be sold.
Concern over this price
action reinforces the
selling.

Bearish Harami
Harami, meaning
"pregnant." A long 1st
candle with high volume in
the existing uptrend brings
complacency to the bulls.
The next day trades in a
small range within the
previous day's real body.
Light volume on the 2nd
day should give rise to
concern by the bulls of an

impending change of trend. Look for lower prices over the

coming days, especially if the next day provides
confirmation of a trend change by closing lower.

Bearish Harami Cross

The 2nd day's price range
does not pierce the
previous day's range and
closes about where it
opened. Volume on the
2nd day is low which
indicates that traders are
lacking enough information
to decide whether to go
long or short.

Bullish Harami
A long 1st day with high
volume in the existing
downtrend brings
complacency to the bears.
The next day trades in a
small range within the
previous day's real body.
Light volume on the 2nd
day should give rise to
concern by the bears of an
impending change of trend.
Look for
higher prices over the coming days, especially if the next
day provides confirmation of a trend change by closing
higher.
Bullish Harami Cross

The 2nd day's price range

does not pierce the previous
day's range and closes
about where it opened.
Volume on the 2nd day is
low which indicates that
traders are lacking enough
information to decide
whether to go long or short.

Bearish 3 Black Crows

Pervasive profit taking takes

its toll on those who remain
long. This enduces a
snowball selling effect in the
coming days.

Bullish 3 white soldiers

Three consecutive long white

days with higher closes each
day. Each day opens within
the previous body. This
formation represent
powerful unabated buying.
Longs should be prepared
for a rest before proceeding
on to higher prices.

Bearish Tri-star
All three days are doji days.
2nd day gaps above the 1st
and 3rd days. This formation
is very rare. The huge
amount of indecision created
by these three dojis must
not be ignored. This level of
indecision strongly suggests
that the trend is about to
change.

Bullish Tri-star
 All three days are doji days.
2nd day gaps below the 1st
and 3rd days. Again, this is
rare. Massive indecision
created by these three dojis
must not be ignored. This
level of indecision strongly
suggests that the trend is
about to change.

Bullish Tasuki Gap

1st two days are white days
with an up gap between the
1st and 2nd day. 3rd day is
a black day which opens
within the body of the 2nd
day and closes within the
gap between the 1st and
2nd days.
The gap up on the 2nd day
does not get filled by the 3rd
day. This suggests that the
uptrend will continue.

Bearish Abandoned Baby

The gap up on the second
day encourages the bulls,but
the close on the second day
is nearly the same as the
open on the second day
showing indecision.  Watch
for additional downside price
action in the next few days.

Bullish Abandoned Baby

The gap down on the second
day encourages the bears,
however the close on the
second day is nearly the
same as the open on the
second day. Watch for
upside price action in the
next few days.

 
This list is in no way intended to represent ALL of the
Japanese Candlestick charting patterns,  the number
of which is incredible. There are many books
available with a more extensive look into pattern
recognition.