Forex Trading Basic

Japanese candlestick Trading Strategy in Forex: Part 1

Japanese candlestick Trading Strategy in Forex

Japanese candlestick Trading Strategy: Learning about Japanese candlestick Trading Strategy, we should at first learn some of the history of this strategy and it’s functional areas.

Brief History of Japanese candlestick Trading Strategy

The story of candlesticks dates back to 18th Century Japan. In early 18th Century Japan, when rice represented the medium of exchange as opposed to currency, feudal lords traded coupon receipts of rice stored in warehouses in Osaka, and eventually these exchanges evolved to became the first modern organized futures exchange (Dojima Rice Exchange), 150 years before the birth of the Chicago Board of Trade (CBOT). In the 1700s legendary Japanese rice trader Homma Munehisa ((1724 – 1803) studied all aspects of rice trading from the fundamentals to market psychology, and subsequently dominated the Japanese rice markets and built a huge fortune. He became the rice king of his day, racking up the present-day equivalent of over $100 billion in trading profits over his illustrious trading career, even making as much as $10 billion over a year’s time, in some cases.

Homm’a trading techniques and principles eventually evolved into the candlestick methodology, later used by Japanese technical analysts when the Japanese stock market began in the 1870s. This method was later picked up by the famed market technician Charles Dow around 1900, who brought its awareness to Western Traders. More recently, Steve Nilson in the 1990s researched and studied candlesticks, writing about them and in turn popularizing them via his classic book on the subject, Japanese Candlestick Charting Techniques. Since their introduction in the West, candlestick charting techniques have become increasingly popular among technical analysts and they remain in wide use today among Forex traders.

The Advantages of Japanese candlestick Trading Strategy

Candlestick charts show the same Open, High, Low, and Close (OHLC) information as bar charts but they have a number of important advantages:

  1. They visually display who is winning the mini battles between the Bulls and the Bears.
  2. We get to see in picture form the force (or lack of force) behind each price bar’s movement.
  3. We can more easily spot the single bar and multi-bar patterns
  4. We see an easy-to-decipher picture of price action, comparing the relationship between open and close as well as high and low.
  5. They are more visually appealing.

Note: While there is much we can see from the candlesticks, there is also much we cannot see. Candlesticks do not depict the sequence of events between the open and close, only the relationship between the open and close. We can easily see the high and low, but we cannot tell which came first. Candlesticks can offer valuable information on the relative positions of the open, high, low, and close, but the trading activity that forms a particular candlestick can vary.

Japanese candlestick Trading Strategy: Bodies and Shadows

Candlesticks are formed using the open, high, low and close of the bar. The principle difference between candlestick patterns and bar patterns lies in the emphasis on the open and close. Bar charts do not treat the open and close with any special weighting. Candlestick charts highlight the “real body” as the wider area between the open and close. If the market closed higher than it opened (bullish), the real body is white or unfilled, with the opening price at the bottom of the real body and the closing price at the top. If the market closed lower than it opened (bearish), the real body is black, with the opening price at the top and the closing price at the bottom. The longer the body, the more trend strength, and the shorter the body, more indecision. The “shadow” is the vertical line running from the real body up to price high (top of upper shadow), or running from real body down to price low (bottom of shadow). The shadow thus measures of high/low range. A long shadow indicates failure for price to maintain its high or low and thus can signal trouble.

  • If close is above open, a white candlestick is formed
  • If close is below open, a black candlestick is formed
  • White or black are between open and close is called the “real body”
  • The thin lines above and below the body show the high/low range and are called “shadows”
  • The top of the upper shadow is the “high and the bottom of the lower shadow is the “low

Long and Short Bodies

Traders also prefer to trade in the direction of longer candlestick bodies. Long bodies indicate strong buying or selling pressure. The longer the body, the stronger the buying or selling pressure. The buyers or sellers were stronger in mass and took control, forming the longer body. In contrast, short bodies suggest little buying or selling pressure and imply more indecision.

Japanese candlestick Trading Strategy

Long white candlesticks represent bullish strength. When the close is a long way up from open, the long white candlestick is formed, indicating that bullish buyers have aggressively pushed the price up from open to close. White candlesticks are generally bullish, but you have to consider them in relation to the big picture. If the market had declined, and is reaching a support level, a long white candlestick bouncing from support can mark a potential turning point. If the market had advanced, and is reaching a resistance level and traders are eager for a break, a long white candlestick breaking the resistance level is a potential message that the level has been clearly broken.

Long black candlesticks represent bearish strength. When the close is a long way down from open, the long black candlestick is formed, indicating that sellers aggressively pushed the price down from open to close. After a long advance to a critical resistance level, a long black candlestick can represent a turning point, where the sellers have launched a counter-attack. Or, if the market had declined to a significant support, a long black candlestick breaking the support level signals that the Bears have breached this level.

Bodies without Shadows (“Marubosu”)

Sometimes a candlestick is all body and no shadow. It has no shadows extending from the top or bottom of the candle. The Japanese call them Marubozu, and they are difficult to find in a real market, but I am no purest, and so I cut and pasted their closest resemblance below (which are bodies with extremely short shadows):

Japanese candlestick Trading Strategy

white marubozu candle has a long white body and is formed when the open equals the low and the close equals the high. The white marubozu candle indicates that buyers controlled the price of the stock from the open to the close, and is considered very bullish.

black marubozu candle has a long black body and is formed when the open equals the high and the close equals the low. A black marubozu indicates that sellers controlled the price from the open to close, and is considered very bearish.

Small Bodies with Long Shadows (“Spinning Tops”)

Candlesticks with a long upper shadow, long lower shadow and small real bodies are called “Spinning Tops”.

Japanese candlestick Trading Strategy

The pattern indicates indecision between buyers and sellers. The small real body (whether white or black) shows little movement from open to close, while the shadows indicate that both the bulls and bears were very active during the session. The session might have opened and closed with little change, but prices moved significantly higher or lower during the same period. Neither buyers nor sellers could gain the upper hand and the result is a deadlock.

Long And Short Shadows

The upper and lower shadows of candlesticks are the thin lines poking above and below the body, and they represent price distance between the open and the high/low period. The price distance between the open and high is called the upper shadow. The price distance between the open and the low is called the lower shadow.

Japanese candlestick Trading Strategy

Candlesticks with long upper shadow and short lower shadow indicate that the buyers initially dominated the session, but then sellers later counterattacked and forced prices down from their highs, with the weak close creating the long upper shadow.

Conversely, candlesticks with long lower shadows and short upper shadows indicate that sellers initially dominated the bar session, but then buyers later counterattacked and forced prices higher by the end.

Indecision: Shadows without Bodies (Doji)

Sometimes candlesticks lack a body, or retain only a very small one, and they are called doji. It is seen to lack a body because the opening and closing price are virtually equal. The lengths of the upper and lower shadows can vary and the resulting candlestick looks like a cross, inverted cross, or plus sign. The doji represents indecision in the market.

Types Of Doji:

Japanese candlestick Trading Strategy

If the market is non-trending, the doji is not as significant, for non-trending or sideways markets are inherently indecisive. If the doji forms on a trend, it is more significant, as it is a signal that the buyers (of upward trend) or sellers (of downward trend) are becoming exhausted, weak and losing conviction. The buyers or sellers have been tapped out. The Doji witnessed in such a context can signal a ripe opportunity to enter early on in a potential trend reversal or trend correction, taking a trade in the opposite direction of the prior trend.

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Please note that: Successful Technical Analysis largely depends on the functionalities of the MT4 Platform provided by your broker. If you are new in forex trading, you might consider reading the article on what is the best trading platform, Introduction to MT4 Platform and MT4 Platform functions. We have used a fully functional MT4 platform provided by HYCM Broker. Read why their MT4 platform has better trading conditions from the HYCM Broker review.

READ MORE

Chapter 5

Technical Analysis in Forex Trading

Lesson 1Types of Technical Analysis Indicators
Lesson 2Forex Trading Trendline Analysis
Lesson 3Forex trading Chart Patterns
Lesson 3.2Double Tops and Double Bottoms
Lesson 3.3Head and Shoulders Pattern
Lesson 3.4Rectangle Chart Patterns
Lesson 3.5Triangle Chart Patterns
Lesson 4Japanese candlestick Trading Strategy
Lesson 4.2Japanese candlestick Trading Strategy Part 2
Lesson 5Support and Resistance Levels
Lesson 6Types of Technical Analysis Indicators
Lesson 6.2moving averages Technical Analysis
Lesson 6.3MACD Indicator Technical Analysis
Lesson 6.4RSI Indicator Technical Analysis
Lesson 6.5Stochastics Indicator Technical Analysis
Lesson 6.6Technical Analysis with Bollinger bands Indicator
Lesson 7Fibonacci Retracement Forex Strategy
Lesson 8Forex Trading Pivot Strategies

Go back to Main Page: Forex Trading for Beginners

About the author

Syed Nazim

Syed Nazim is the Marketing Manager of RedMaroon, a Digital Marketing Agency for Financial Institutions. He is also involved with Forexing24.com as a writer and financial Analyst. He is a brilliant marketing geek with vast experience in every sector of Digital Marketing. He likes sharing strategies, tactics and proven methods to help you build a business and live the life of your dreams.

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