2. Common Candlestick Terminology
Some traders seem put off by the language that surrounds candlestick charts. But it's quite simple actually: the names of the patterns will often tell you what message is inherent to it. Originally, candlestick formations were labeled accordingly, in part, to the military environment of the Japanese feudal system during that time. Therefore you will find terms such as as “piercing”, “thrusting” and “advancing three soldiers” which definitely reflect a military cast. But candles were also given other more mystical names which may sound unusual at first but which are actually very descriptive like the “dragon fly” or “morning star”. Steve Nison, in one of his books about the topic, explains:
A fascinating attribute to candle charts is that the names of the candlestick patterns are a colorful mechanism describing the emotional health of the market at the time these patterns are formed. After hearing the expression “dark-cloud cover”, would you think the market is in an emotionally healthy state? Of course not! […] this is a bearish pattern and the name clearly conveys the unhealthy state of the market. […] The descriptive names employed by the Japanese not only make candle charting fun, but easier to remember if the patterns are bullish or bearish. For example,[...] the “evening star” and the “morning star”. Without knowing what these patterns look like or what they imply for the market, just by hearing their names, which do you think is bullish and which is bearish?
The evening star (the nickname for the planet Venus), which comes out before darkness sets in, sounds like the bearish signal - and so it is! The morning star, then, is bullish since the morning start (the planet Mercury) appears just before sunrise.
Source: “Japanese Candlestick Charting Techniques, A Contemporary Guide To The Ancient Investment Techniques Of The Far East” by Steve Nison, Prentice Hall Press, Second Edition, 2001.
Out of a universe of dozens of candlestick patterns, it has been found that a small group of them provide more trade opportunities than most traders will be able to utilize. In this section, 12 patterns are dissected and studied, with the intention to offer you enough insight into a fascinating way to read price action. The following is a list of the selected candlestick patterns.
2.1. Marubozu candlestick
Although this candle is not one of the most mentioned ones, it's a good starting point to differentiate long candles from short candles. A marubozu is a single candlestick pattern which has a very long body compared to other candles. Although this is considered a confirmation of the market's direction, it suggests to enter the move when the price has already moved a lot. The resulting risk associated with this signal makes the marubozu not so popular compared to other candlesticks.
It signals a strong buying when the close is significantly above the open, and vice versa when the candle is bearish. A short candle is of course just the opposite and usually indicates slowdown and consolidation. It occurs when trading has been confined to a narrow price range during the time span of the candle.
The smaller the real body of the candle is, the less importance is given to its color whether it is bullish or bearish. Notice how the marubozu is represented by a long body candlestick that doesn't contain any shadows.
2.2. Doji candlestick pattern
When confronted with a doji candlestick pattern, the Japanese say the market is “exhausted”. The doji also means the market has gone from a yang or ying quality to neutral state. In western terms it is said that the trend has slowed down - but it doesn't mean an immediate reversal! This is a frequent misinterpretation leading to a wrong use of dojis.
Despite the odds of a market turn increasing with a doji, it still lacks a confirmation to be traded upon. Doji's are formed when the session opens and closes at the same level. This pattern indicates there is a lot of indecision about what should be the value of a currency pair. Depending on the shape of the shadows, dojis can be divided into different formations:
A long legged doji candlestick forms when the open and close prices are equal. The dragonfly doji shows a session with a high opening price, which then experiences a notable decline until a renewed demand brings the price back to finish the session at the same price at which it opened. At the top of a trend, it becomes a variation of the hanging man; and at the bottom of a trend, it becomes a kind of hammer. It is thus seen as a bullish signal rather than neutral. The gravestone doji's are the opposite of the dragonfly doji. Appropriately named, they are supposed to forecast losses for the base currency, because any gain is lost by the session's end, a sure sign of weakness. The Japanese analogy is that it represents those who have died in battle. Dragonfly and gravestone dojis are two general exceptions to the assertion that dojis by themselves are neutral. In most Candle books you will see the dojis with a gap down or up in relation to the previous session. In Forex, nonetheless, the dojis will look a bit different as shown in the picture below.
2.3. Spinning Top candlestick pattern
In Forex, you may consider the doji and the spinning top as having the same potential for reversal. For example, if a market makes a new high as shown in the image below, and does so with a doji or a spinning top — that’s a small real body with a long upper and lower shadow — the signal is the same: the market rejected the higher levels and shows indecision as where to proceed.
How can I deal with the fact that different charting platforms show different candlestick patterns because of their time zone?Forex market, we would suggest to use a GMT chart since most institutional volume is handled in London. This is specially valid if you work with daily charts but intraday charts superior to 1 hour will also show differences in the patterns. In any case, because of the 24 hour nature of the Forex market, the candlestick interpretation demands a certain flexibility and adaptation. You will see how some of the textbook patterns look slightly different in Forex than in other markets.
The following patterns are thought to alert the trained eye of pending reversals offering the chance to the trader to get early on a possible new trend, or to alert the trader who is already in the money that the trend is ending and the position demand to be managed.
