Ever wanted to know how technical analysis anticipates and capitalizes on market movements? It is a whole set of techniques that, when put together, allow us to detect the moves with the highest probability of success.
Today, we will start from the beginning with Japanese candlesticks and particularly, their bullish configuration.
What is a Japanese candlestick?
Before we go into details about the different patterns, let’s start at the beginning! Japanese candlesticks first appeared in Japan in the 18th century. Before any other form of a candlestick surfaced, Japanese investors were already using this technique to trade rice in the market! This technique was only discovered by the Americans in the 1980s.
A Japanese candlestick has four elements—an opening price, a closing price, a high price, and a low price. Graphically, it looks like this:
The importance of timeframe in trading
Each candle represents a quotation period. Does it already sound confusing? Do not worry—we will explain. On charting software such as TradingView or ProRealTime, you can change what is called the timeframe. This can be anything from less than a minute, to a month or more. Specifically, if you choose a timeframe of 15 minutes, each candlestick at its close will represent the history of the last 15 minutes of trading.
The choice of timeframe is a very important element in the analysis of candlesticks and more globally, in all technical analyses. The longer the timeframe, the more relevant your analysis will be. Indeed, a shorter timeframe tends to provide more false signals. The patterns we will analyze below are valid on all timeframes.
Continuation or Reversal?
Today, we will separate candlestick patterns into two main categories: reversal patterns and continuation patterns. This distinction is important because it will help you avoid many costly mistakes.
Indeed, a reversal pattern will have a much better chance of being valid if it occurs on the support zone; rather than if the same structure appears under resistance. If it is the latter, it will not have the same value and will be a source of false signals, hence the importance of knowing which pattern to look for at which point.
A bullish gap is defined as a Japanese candlestick whose opening price is higher than the closing price of the previous candlestick. It usually occurs in an uptrend and is often formed after being characterized by several large green Japanese candlesticks.
It can happen that the gap is filled, that is to say, that the prices come down, not necessarily at the close but at least to the closing price of the previous candlestick. The best way to analyze candlesticks is to couple them with volume analysis.
In the case of a continuation gap, we prefer to look for a strong buying volume, in order to determine and confirm the continuation of a bullish trend.
This candlestick pattern is a typical case of continuation. It is equivalent to a consolidation composed of 3 candlesticks of indecision between 2 directional green candles to allow prices to catch their breath before resuming the rise.
For this to be confirmed, the close of the last candle must be higher than the close of the first bullish candle. Of course, neither the consolidation candle nor the confirming candle must have a low below the first green candle.
Now, let’s look at reversal candles. As for the continuation candles, it will generally be preferable to see a rise in volume at the same time for these patterns to be valid.
This pattern is one of the most relevant to remember. The opening price of the second candle must be at least lower than the closing price of the previous bearish candle. If it is lower than the low of the bearish candle, it is even better!
The closing price of the bullish candle should be at least higher than the opening price of the bearish candle; even better if it is higher than the high point of the latter.
If the green candle is a Marabozu, ie. Its low and high points are also openings and closing points while encompassing the entire previous candle, this is the most powerful form of Bullish Engulfment. We tend to see this kind of pattern in a support zone.
The hammer is also one of the most important turning configurations. It also appears very often towards support and is just as, if not more powerful, than engulfing. Indeed, the hammer consists of a small body and long wick, indicating a low point.
The psychology inherent in this pattern is a strong buy on the support level which completely negates the previous bearish move and sometimes even closes higher. It is very common to see a huge increase in volume on this type of pattern.
We have seen that there are different types of Japanese candlestick patterns, reversal, and continuation. As always in technical analysis, a single method should not be applied blindly but rather used in conjunction with other tools. One of the important tools to use in combination is volume.
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