Japanese price action candlesticks

Candlesticks are the purest known form of price action.

 They provide visual picture of what is happening on the market, because they can visually align your thoughts with the market. They also hold more reliability than any other known form of the bar chart. That of course doesn't mean that you should consider the candles as indicators to buy or sell, but they should be used with other strategies which you have developed.

Candlestick pattern recognition is an arrangement of price bars which are used to anticipate the next move of the market. These patterns should help you to confirm your expectations and your continuous collective thoughts that determine your future bias of the market. The bars ( also called candles) depict how the buyers/sellers have acted on the market and how strong they have been in comparison with opposite site (buyers or sellers).

It is important to note that attempting to define the movements of the market just with candles, not knowing trend, support/resistance or wave theory is useless!

The candles are used for confirmation, not for defining the trend.

The important question you should ask every time you have encountered candle stick pattern is:

Has this pattern helped me to confirm my trend? Has it weaken my expectations or has it negated them? 

I use this question a lot and I strongly encourage you to do the same.

The basic knowledge of candlesticks

Every candle has its low, high, open and close. The hollow or fulfilled part of the candle is called the body. It represents the opening price and closing price in particular time frame. The long thin lines above and below the body represent the maximum high and maximum low of the candle which the price action has reached . If the stock closes higher than its opening price, a fulfilled candlestick is drawn with the bottom of the body representing opening price and the top of the body representing closing price(also works reversed).  If the stock closes lower than its opening price, a filled candlestick is drawn with the of the body representing the opening price and the bottom of the body representing the closing one. The longer the body of the candle is, the more intense was the price movement. On the other hand the shadow represents how far the price has come. After reaching certain point  the body of the candle has retraced back before enclosing of the candle, while leaving the thin line(called shadow) behind.

There are about 50 patterns. I will define in my opinion the most important ones:

Doji candlesticks

This type of candlesticks shows the indecisiveness of the market or a struggle for positioning between the buyers and sellers. They should have same closing and opening price or their bodies are extremely short. They indicate equilibrium between supply and demand, it is a clear reversal signal. You should also pay attention to the preceding candle. If the Doji appears after an uptrend, it should indicate that a price action is at its peak or is close to the peak. It is one of the most important patterns you should know so it's therefore essential to recognize it. 

Long-legged Doji

The shadows have to be almost equal in length to be legit. It is important to observe candle's relation to the midpoint. The closer the candle to the midpoint is, the more equal strength between buyers and sellers was. It shows that the price traded well from both sides, but the ending result didn't change a lot.

Dragonfly and Gravestone Doji

In this case the open and close are almost or are equal. It indicates that sellers or buyers have pushed the price down or up, but the opposite site has pushed at the end of the session prices back to the open.

Neutral Doji and Four- Price Doji

This formation is valid if the length of the candlestick and its shadows are almost equal or are very short in the price. These formations clearly indicate total hesitancy of the market, in which the buyers and sellers were not active that much.

The spinning tops

The candlesticks with a small bodies and big shadows, which come in series are called spinning tops. This pattern indicates indecision between sellers and buyers. The small body represents the small price movement and the long shadows show that the sellers and buyers were "fighting", but none of them has won, even though the prices have changed a lot before the candle has enclosed. They are mostly represented by the Doji candles. This pattern indicates possible reversal in price action.

The Hanging Man and Hammer

These candlesticks show at the end of the uptrend or downtrend and indicate possible significant price reversal. if the Hanging Man appears after uptrend, it should indicate sell. If on the other hand the Hammer appears at the end of the downtrend, it should indicate possible buy positions. The Hanging Man and Hammer have longer bodies than Dojis and longer lower shadows. The longer shadow determines selling or buying pressure. This is how they should look like:

Remember that Hammer is bullish reversal pattern and Hanging Man is a bearish one. The shadows should be at least 3 times as big as the body of the candle and that the color of the body is not that important.

Inverted Hammer and Shooting star

These patterns are exact opposites of the Hanging Man and Hammer.  Even though they also determine the possible price action reversal, but  on the other hand have longer upper shadow instead of lower one, which is at least twice as big as the body. The longer upper shadows imply selling or buying pressure. If the Inverted Hammer appears, it should mark possible reversal after significant  downtrend and exactly contrarily the Shooting star possible reversal after significant uptrend. This is how they look like: 

Tweezer tops and bottoms

These are dual candlestick reversal patterns. They can be spotted after significant downtrend or uptrend, indicating a reversal is soon to happen.  They express a clear resistance by first or by the second site because the trend was rejected twice after trying to reach higher or lower point.

The strongest tweezers have following characteristics:

• The first Tweezer has the same body color as the overall downtrend/uptrend. So if the price was moving up, then the candle should be bullish(green)
• The second Tweezer is the opposite of the trend. So if the price was moving up, then the second candle should be bearish(red) 
• The shadows of both candles should be of equal or similar length

The Marubozu

These candles have no shadows attached to the closing price of their bodies. It means that high and low is in fact the same as its open and close price. The green candle has no or small upper and bottom shadows (top) and big green body. It is very bullish candle which indicates that the buyers were in control over the course of time. It usually becomes the first part of a bullish continuation move or a confirmation of a bullish reversal pattern (the second candle after doji or indecisive candle - considered as confirmation). The red candle is the opposite, it has no lower or upper shadow  and a big red body. It is very bearish candle which indicates that the sellers were in control over the course of time. It usually becomes the first part of a bearish continuation move or a confirmation of a bearish reversal pattern. In both cases as mentioned, it  is considered as confirmation candle after indecision.

Bearish Engulfing and Bullish Engulfing Formation:

These patterns occur at the bottom or at the top of the trend. This formation is confirmed if the candle which is in the color of the trend is followed by a bigger candle which is in the color of the opposite trend. The body of the bigger candle has to be bigger than the body and shadows of the first candle alongs. This pattern indicates a reversal of a great significance. So for example the Bullish Engulfing Formation indicates a change in sentiment from bearish downtrend, to a large green body candle which closes higher than the high of the previous candle. Buyers have stepped in after the open and have taken control of the market after that. Greater the engulfing is, greater the reversal should be.

The Morning Star and the Evening Star Formation

These kind of formations consist of 3 candles. They look like engulfing formations, but have a Spinning Top, a Doji or a Hammer/Pin bar in between. They indicate indecision and a sudden acceleration/halt  to the opposite trend (reversal). The only rule that this formation has is that the third candle has to close within the upper 40 % part of the first candle. After the third candle is closed, the reversal is confirmed and we can think about getting into the trade. 

Note! a buy/sell trade should be executed upon the opening of the next (4th) candle

The Inside Bar Formation:

This pattern consists of 2 candles and the second candle has to be completely contained within the range of the first candle. This setup can also occur at turning points in the market or at support and resistance points. They also indicate a moment of indecision or consolidation after making a big directional move. At first you should establish and highlight  the high and low of the first candle. Then the  market should break the high or low of the first candle and continue in the same direction. it means that the trend can proceed in both directions.

Candlesticks wrapped up 

In this article I have tried to boil down the basics of the candle stick patterns. Of course there are more setups and informations which can be useful, but these setups have the highest probability to occur. You should be able hopefully to use them now and have a slight advantage on the market.

It is important to note that the candlestick patterns should be used along with other tools and be applied  as confirmation!

Learn, learn and learn you can't remember these patterns in a single run. It will get easier over time as you proceed. These are all the patterns mentioned in the post:

1.  Doji candlesticks
2. The spinning tops
3. The Hanging Man and Hammer
4. Inverted Hammer and Shooting star
5. Tweezer tops and bottoms
6. The Marubozu
7. Bearish Engulfing and Bullish Engulfing Formation
8. The Morning Star and the Evening Star Formation
9. The Inside Bar Formation