Japanese Candlesticks: The art of chart reading for profitable trading

It's worth starting with the fact that Japanese candlesticks are one of the most powerful technical analysis tools that allow traders to visually interpret market movements. They are used in Forex, stock market, cryptocurrencies and other financial spheres, helping traders to identify trends, find entry and exit points, analyse the behaviour of market participants. This method of price display appeared in the XVIII century, but now it has been transformed and remains one of the key tools of professional traders. This article will discuss the history of Japanese candlesticks, their structure, the influence of timeframes, methods of analysing candlestick patterns and key patterns used in trading.

History of Japanese candlesticks and their influence on trading

Japanese candlesticks appeared in the 18th century, long before the advent of trading and digital tools. They were invented by Munehisa Honma, who was an ordinary rice trader. At the time, he was trying to predict the price of rice, which became an analogue to today's futures markets. Eventually he even became a financial advisor to the Japanese government and it is rumoured that he made the equivalent of $10 billion dollars from the rice markets. He died in 1803, leaving behind two books about Japanese candles: ‘Sakata senho’ and ‘Soba sani no den’.

But the Western world learnt about this technique only much later, namely in 1991, after the publication of the book ‘Technique of Japanese candlestick charts’. Steve Neeson, a member of the Board of Directors of the Association of Technical Analysts, managed to democratise this method of charting. And even today, Japanese candlesticks are widely used in Forex, cryptocurrencies and stock market, allowing traders to analyse market sentiment, identify key support and resistance levels and predict further price movements.

Anatomy of the Japanese candlestick in trading: What is it?

A Japanese candle consists of a body and wicks (shadows). The longer the body of the candle, the stronger the price movement was in that period. If a candle has a small body and long shadows, it indicates market uncertainty. Large bodies without shadows indicate a strong trend, while candles with long shadows and a small body indicate a possible reversal. Here is a more accurate description of the components: 

• Candlestick body: This is the change in price over a certain period (depending on the timeframe selected). It is usually coloured red if the closing price is below the opening price, and green if the closing price is above the opening price;
• Candlestick Wick: The element that shows the extreme points for this period. If the wick is long, it means that the price reached these levels but then retreated.

Trader's Assistant: How Japanese candlesticks help to analyse the market

Japanese candlesticks give traders the ability to read the market and identify patterns that precede a rise or fall in price, but it is important to consider timeframes in order to properly analyse. Timeframes are the time frame over which a single candlestick is formed. Here is the main classification of traders who use this method of analysis: 

• Long-term investors: They use weekly and daily candles as they give a clear picture of trends and key levels;
• Swing traders: Focus on daily and 4-hour charts, which allow them to see medium-term trends;
• Scalpers and Intraday Traders: Use 1-hour, 15-minute and 5-minute candles to catch short market fluctuations.

The larger the timeframe, the more significant the signal the candle gives. For example, if a strong bullish candle appears on a weekly chart, it is a strong signal for a continuation of the trend, while a similar candle on a minute chart may not have much significance. As an example, we can consider the case when bitcoin broke through its all-time high of $20,000 in December 2020. The price literally exploded to $40,000 in just a few days, indicating buyer dominance. But in April 2021, ATH was upgraded to $65,000, but bitcoin then collapsed by 50%, an indicator of weakening demand and profit taking by big players.

Key candlestick patterns: What every trader should know

Japanese candlestick patterns are powerful tools that allow traders to recognise market sentiment and find price reversal points that are formed by buyers and sellers, reflecting the struggle between supply and demand. Some patterns signal a trend reversal, while others confirm its continuation. Let's take a closer look at these patterns:

• Takeover pattern: Bullish and Bearish. A bullish coverage indicates that all the selling of the previous candle has been bought out. This is a strong signal for a potential upward reversal. And bearish coverage indicates that all the buying of the previous candle has been absorbed by the sellers. This is a strong signal for a price decline;
• Dodgy: This is a candle with a small body and long wicks. It signals uncertainty in the market. The Dragon Doji is a bullish signal indicating possible upside. The Tombstone Doji - is a bearish signal, warning of a possible decline. And the classic doji indicates the expectation of a strong movement in either direction.

Conclusion: Mastering Chart Reading for Profitable Trading

Japanese candlesticks are not just a charting tool, but a powerful analytical method that allows you to accurately assess market sentiment and find key pivot points. Using Japanese candlestick patterns in combination with support, resistance and volume levels can increase the accuracy of forecasts and minimise risks. Understanding how to analyse Japanese candlesticks allows traders to better navigate market trends, find the optimal moments for entry and exit and avoid mistakes made by beginners. Mastering Japanese candlesticks is one of the most important steps towards profitable trading!