Our world is full of signs and symbols. In everyday life, we ​​meet them almost everywhere. Examples of various forms of graphic signs and pictograms are any font, road signs, smileys, gestures, etc. Also, the financial world is rich in multiple visual symbols and representations. For example, bulls and bears are symbols of price growth and fall. Candlelight charts are a visual representation of price movements in the stock market. We will discuss Candle charts and formations in this article.

Basics and history of Candle charts

Candle charts and formations have a long history. Why is it still one of the most popular graphical methods of technical analysis today? Mainly because they capture in a clear, simple, and readable format the four key prices (opening, closing, highest, lowest) of the business period. In other words, candles have substantially increased the depth of information that we can read from the market map – graphs. It’s like drawing a heart. Everyone knows right away that it’s a sign of ‘love’. And when someone draws a heart pierced by an arrow, everyone immediately realizes that the author of the drawing tells us, “I’m in love.”

Introduction

In short, everyone on the market speaks the same language (as other pictograms use colors to convey information), and can scan graphs and figures. Another reason for the popularity of candles is that they reflect the psychology of the market in a given trading period. When analyzing the market, we should pay close attention to the movement of the market itself rather than monitoring external issues that may or may not affect the market. The Japanese call it “consult the market about the market.” And by studying the market (candlestick charts), we can identify the path that a given commodity, currency, or stock has taken in the past, and to predict its future course.

Candle chart roots go back to Japan to rice traders in the 17th and 18th centuries when trading moved from physical trading to the Dojima futures exchange, in Osaka. Pioneering technical analysis is generally attributed to a trader named Munehisa Homm (1724-1803), also known as Sokyu Homma or Sokyu Honma. He was a wealthy rice trader, and is the father of Japanese candlelight charts. In 1755 he wrote a work focusing on market psychology. Steve Nison have the credit for bringing candles from the east to the western world. He was an analyst at Merrill Lynch, who introduced candle techniques in his 1989 article. He later wrote two books about it.

Formations

Candle formations contain about 40 reverse (i.e., indicative of price reversal) and ongoing patterns. However, the 12 main candlelight patterns are among the fundamentals that every good trader should know by heart. In this article, we will describe this dozen in more detail. Some have Japanese names, and some have English names. Both are in the list. Candle charts and formations generally illustrate price movements in the market. Therefore, they are a visual tool for technical analysis for trading. In this article, will introduce candle formations. They belong both in the forex and the stock, commodity, derivative, and other markets. Ultimately, their history comes similarly from rice trading.

However, there are some differences in the case of forex. Some candle formations (eg, Morning Star) sometimes have a gap in their rules. The opening value of one candle will be different from the close value of the previous candle. Since the forex is traded 24 hours a day, gaps are virtually non-existent (of course, except for possible weekend gaps on Sunday evenings). Consequently, we can use such candle formations on the forex without the gap rule in the given candle formation. The beauty of candle market analysis is that we do not need to know any intricate patterns or indicators, and so it does not require a vast amount of knowledge to use business signals. Everything is easy to see in the form of candle formations.

We all know that the key to make money in trading is to recognize the change in trend. And we also know that trafficking is influenced by people’s psychology and their recurring emotions. Candle formations are conducive to being able to warn us that change is coming. We can help analogy to a steam locomotive as a trend. When the train has to change direction, logical indications first occur. For example, the engine starts to whistle, and you can hear the slow rhythm of the wheels. As soon as the brakes are applied, steam begins to roll from the sides. The motors on the tracks start to squeak. All these indications show us that the train is approaching to a stop.

Candle formations offer similar signs. Candles are a powerful technical analysis tool for trading in the forex market that simply, clearly, and relatively accurately, identifies changes in market sentiment. But, as with all analytics tools, the effectiveness of their use will depend on your trader experience and skills. For over 200 to maybe 300 years, merchants have been using candles and their formations to their advantage. There is no reason why, as merchants, you cannot do the same.

Below, the ‘anatomy of a candle’ is one of the first vital terms in this article. There are also a lot of English names that we don’t need to translate, and are commonly used as standard terms: bullish, bearish, downtrend, or uptrend.

You can follow the candlestick charts right here.

DOJI (Doji Bike)

The basic doji consists of one candle. The Japanese say, when a doji appears, we should always notice. It is one of the most critical candle signals. A formation is formed when the opening and closing prices are identical or nearly identical, and this creates a horizontal line. This is because bulls and bears are in a state of indecision. Doji is an urgent alarm, both in the uptrend and downtrend.

How to recognize it?

1. Opening and closing prices are identical or almost identical,

2. The length of the shadows should not be too long (for the base dojo).

Structure from psychology point of view

Doji expresses the indecision of the market. This means that after an uptrend or a downtrend, there is an equalization of forces between bulls and bears, and neither group can take dominant control. (or generally at the end of the period – in this sense, it is meant throughout the article) prices will close at or near the level where they opened at the beginning. Doji indicates indecision, weakening, or potential trend reversal. Depending on where the Doji appears on the graph, this may be a bullish or bearish reversal of the trend, or it may be continued in the direction of the trend after breaking the Doji.

Japanese rice traders realized that price movement was not based on the fundamentals themselves. But above all, how investors perceive these fundamentals. The doji signal is beneficial at all timeframes, both M5, M15, H1, etc. for intraday trading, and at H4, D1, W1 for swing, and long-term traders (the same applies to all candle formations). There are several specific variations of doji candles (and thus with other names): Doji Star, Long-Legged Doji, Gravestone Doji, and Dragonfly Doji.

Bullish Engulfing and Bearish Engulfing (Tsutsumi)

Engulfing Pattern is another critical reverse pattern that consists of two candles of opposite colors. It can be bullish or bearish. Bullish Engulfing is created after a downtrend, opens lower than the closing price of the previous day, and closes higher than began the last day. Bearish Engulfing is created after an uptrend, opens more elevated than the closing price of the previous day, and closes lower than opened the previous day. Thus, at Bullish Engulfing, a green candle completely absorbs the red candle of the last day. And at Bearish Engulfing, the red candle completely absorbs the green candle of the previous day.

How to recognize it?

1. The body of the candle on the second day completely absorbs the body of the previous first day. We don’t pay much attention to the shadows.

2. Prices follow a definite trend (downtrend for bullish, the uptrend for bearish), although they did not last for a long time.

3. The second candle body has the opposite color to the first candle, the color of the first candle being the trend color. An exception to this rule is when the absorbed candle is doji or has a tiny body.

Structure from psychology point of view

Bullish Engulfing means that the bulls have taken control were able to drive the price up to and closed the opening price of the previous bear candle. The more a bull candle absorbs a previous bear candle, the stronger the trend reversal signal. Similarly, in the case of Bearish Engulfing, bears take control, and the uptrend loses power, etc.

Hammer and Hanging Man – Paper Umbrella (Karakasa)

Hammer

One of the visually most impressive candle patterns is the hammer (hammer). This signal consists of a single candle and is easily recognizable by the lower shadow, also known as the tail, that protrudes downward after a more extended downtrend. The Japanese name for the Hammer pattern is takuri, which means water depth testing. Hammer is very similar in appearance to the Hanging Man pattern, but occurs in a downtrend and is a bullish signal that points to a possible trend change. The candle is called Hammer in English because it “kills” the base at the bottom of the downtrend. Regardless of the color of the candle body, the long lower shadow of the hammer is a bullish signal. The green frame of the candle is slightly more bullish than the red one. To confirm this signal, the next day (period) must be positive.

How to recognize it?

1. The lower shadow should be at least twice as long as the body (the longer the shadow, the better).

2. The actual body is at the upper end of the trading range. Body-color is not essential, although the green body should have a little more bullish consequences.

3. There should be no upper shadow or a tiny shadow.

4. The next day the Hammer signal must be confirmed by another intense bullish day.

Structure from psychology point of view

The bullish hammer appears in a downtrend, and after the market opening, there is a sharp sale when the atmosphere is extremely bearish. Then the decline stops (the bears reject further low prices), and the market returns almost to the maximum of the day. The market may not be able to continue the sale. This new situation reduces the previously bearish sentiment. If the Hammer candle body is green, then the case looks even better for the bulls.

Hanging Man

Hanging Man is a bearish signal that appears in an uptrend and warns against a possible change in trend. The name of the Hanging Man pattern comes from the fact that the candle looks like a head with legs hanging down. Hanging Man is also composed of one candle. It is easily identified by the presence of a small body with a shadow at least twice that of the body. Located at the top of the uptrend.

How to recognize it?

1. The lower shadow should be at least twice as long as the body.

2. The actual body is at the upper end of the trading range. Body-color is not essential, although the red body should have slightly more bearish consequences.

3. It should have no upper shadow or tiny shadow.

4. The following day must be confirmed by the Hanging Man with a red candle or a gap between the bodies down with a lower closing price.

Structure from psychology point of view

After a strong uptrend, the atmosphere is hugely optimistic, ie, bullish. The price opens higher, but it starts to fall. Bears take control. But before the day is over, the bulls come to take control and push the price back towards the upper end of the business range, creating a small body during the day. From the intraday chart, this could indicate that the bulls still have control. However, the long lower shadow suggests that bears at these levels have entered the market. Even though the bulls were able to keep the price higher at the end of the day, the evident evidence of budding bear talc is apparent. The red candle the next day reinforces the fact that there are pressures to sell.

Piercing Pattern & Dark Cloud Cover

Piercing Pattern is a composite formation of two candles in a downtrend. The first candle is red and is a continuation of the current downtrend. The second candle is formed by opening below the previous day’s minimum. It then closes more than half the red candle, near or at the maximum of the day.

How to recognize it?

1. The body of the first candle is red; the body of the second candle is green.

2. The market is in a downtrend. At the end of the trend, a long red candle is visible.

3. The second day opens lower than the previous day.

4. The green candle closes more than half the red candle.

Structure from psychology point of view

After a strong downtrend, the atmosphere is bearish. Fear is becoming more prevalent. The price gap is downwards. Bears can even push prices even further down. But before the day is over, the bulls enter the market and turn the price dramatically. The day ends at the daily maximum and above half the previous red candle. This almost negated the fall in prices of the last day. Another green candle on the third day confirms this movement.

What to take from it

In today’s first session, we answered why candle charts and formations are so important in trading. We focused on single-candle Doji, Hammer, Hanging Man, and two-candle Engulfing and Piercing Patterns. In the next second section, we’ll talk more about Dark Cloud Cover (opposite of Piercing), two-candle Harami patterns, one-candle Inverted Hammer, Shooting Star, and three-candle Morning Star and Evening Star. Finally, we will show the use of candle formations in practice