One of the things that investors most desire is to get as close as we can to predicting the future results of our operations. Over time, different indicators to facilitate the reading of prices, methodologies to understand market cycles and much more. But it is true that the first practices of technical analysis go back many centuries. In today's trading training, we are going to dust off this ancient practice and learn about it; the analysis of Japanese candles.
What are Japanese candles?
Japanese candles, as their name indicates, date back to their origin in Japan during the first decade of the 17th century. The Japanese were the first to use this analysis technique to speculate in rice futures markets. One of the best rice traders of that time was Homma; today it is unknown if he was the creator of Japanese candles. Likewise, Japanese candles as we know them today are based on the theories of Business just as he raised them some time ago. We could consider it the first trading training in history. This analysis technique has allowed different generations of investors the possibility of using these techniques to visualize levels of support, resistance, reversal or indecision.
How do Japanese candles work?
In order to understand candlestick analysis techniques, we must first understand what they rely on when formulating hypotheses. The Japanese candles represent the movements that the asset that we are viewing has made in the chosen time frame. If, for example, we are observing a 1-hour time chart, each candle will represent the movements of each hour. Japanese candlesticks can be distinguished in two colors, which represent both purchases and sales. Next, we can see the body of the candle, which represents the opening and closing range of the candle. Finally, we can see that a wick can appear above, below or on both sides of the candle. These wicks represent the rises and falls that have occurred in the price of the asset.
Analysis structure of Japanese candles. Source: Created from Empires.
What does this analysis contribute to our trading training?
Candlestick analysis has sometimes been questioned since they are not accurate analysis techniques. But it has also been proven that over time, it continues to be one of the techniques most used by traders to detect possible trend reversals or to provide entry or exit signals within their operations. There are several types of Japanese candlesticks that can support our analysis to determine if an asset is entering a trend, when it can reverse, or when a movement is brewing. Let's see which are the best Japanese candlestick patterns:
Hammer/shooting star candle
This pattern is made up of a small body (like a square) and a long strand. It helps us to determine trend changes in the price. If we find the hammer at the end of a downtrend, it could be the beginning of an uptrend. On the other hand, if the hammer is at the end of an uptrend and reversed, a downtrend could begin. This pattern shows us that throughout a day there may have been buying/selling pressure that has finally been absorbed and redirected.
Example of a shooting star candle that reverses the bullish trend. Source: Tradingview.
Wraparound candle
This Japanese candlestick pattern is made up of two candles. The first is a candle with a small body and the next candle wraps around the entire path of the previous candle. This candlestick pattern represents a weakness of interest in the current trend and, therefore, a reversal of it. It can be applied in both bullish and bearish trends, identifying itself at the end of the trends.
Enveloping candle starting a trend reversal. Source: Tradingview.
Candle of the three white soldiers/three black crows
This pattern is based on three candles of the same color succeeding each other consecutively with increasingly larger bodies. This candlestick pattern gives us a fairly important signal of an entry into a trend and shows a growth in interest in it. They can indicate both an upward movement (white) and a downward movement (red). This pattern along with the hammer is one of the easiest to identify on a chart.
Candle of the three white soldiers. Source: Tradingview.
Sunrise/sunset star candle
This candlestick pattern symbolizes hope for a reversal within a trend, whether bullish (dawn star) or bearish (evening star). It is made up of three candles, a first with a small body between a large candle of each type on the sides. This pattern is somewhat difficult to identify but it also gives us a good signal to take advantage of.
Dawn star pattern. Source: Tradingview.
Doji Candle
This candlestick pattern is one of the easiest to identify of all. The Doji candle represents a fight between buyers and sellers, which results in periods of indecision. This is a continuation pattern, although it can also appear in other patterns such as the dawn star. It is composed of a very fine body followed by a wick above and another below the body at the same distance. We can also find two variables of this Doji, the dragonfly Doji at the end of downtrends and the tombstone Doji at the end of uptrends.
Doji candlestick pattern. Source: Tradingview.
Conclusions from this trading training
For this trading training we are not going to show you any investment strategy since we strongly recommend that this type of analysis serves as a support rather than a reference, since the analysis of Japanese candlesticks can shed light on the possible direction of the price but not with due precision. We also found that the analysis of Japanese candlestick patterns is more effective over longer periods of time, given that they collect more data and the signals are more reliable.