3.13 Candlestick charts and patterns

As a beginner, you may be wondering if you need to study economics to read Japanese candlestick charts. The answer is no. In this lesson we will teach you what a candlestick price chart is.

In this lesson we will focus on understanding candlestick charts and formations.

Content

• Understanding candles

• Japanese candlestick construction

• Using candlestick charts
   

Understanding candles

This method originated in Japan. Its inventor was Munehisa Homma, a rice merchant who lived in the 18th century. After gaining popularity in Japan, the technique began to be used more widely in Europe and America in the 1990s as well. Candlestick charts are now widely used in many financial markets, including the cryptocurrency market.

The inventor of candles discovered how strongly traders' emotions affect markets. Candles decoded these emotions, depicting price movements in graphical form.

Let's look at a chart of BTC/EUR - one of the most popular cryptocurrency pairs on zondacrypto. The figure shows a chart consisting of candles. Depending on the interval, one candle corresponds to one time interval. For example, on a daily chart, one candle represents one day. If it were a weekly chart - one candle would correspond to one week.

 

Japanese candle design

A single candle contains four pieces of information:

• Opening Price

• Maximum Price

• Minimum Price

• Closing Price

You may have come across the term OHLC while studying candles. They reflect the above points as follows.

O - Open(Opening), H - High(Maximum), L - Low(Minimum), C - Close(Closing).

Candles rise when the closing price is higher than the opening price. Or, conversely, they fall when the closing price is lower than the opening price.

In addition to these four elements, the fifth source of information that a candle contains is color. The color indicates whether a candle is rising or falling.

You can choose the color according to your preference. The default setting is a white background, where green candles (with black borders to make them visible on a white background) are rising candles. Red candles, on the other hand, are declining candles, that is, indicating bearish market behavior.
 

Body and wick

Another feature to know about candles is that each one has a body and wick:

 

As you can see in the illustration, the opening price for a falling candle is at the top, and the closing price is at the bottom. The opening and closing prices determine the boundaries of the body of the candle and its color.

If the price has risen since the beginning of the analyzed period, the body of the candle is green with the opening price at the bottom and the closing price at the top. Similarly, the red color of the candle tells us that the price has fallen since the beginning of the analyzed period.

In turn, the length of the upper and lower wicks is determined by the lowest and highest price values in the analyzed period.
 

Using candlestick charts

Traders use candlestick charts, to find specific formations. Let's take a look at the most popular candlestick formations listed below:

Doji

A formation is called a Doji candle when the opening and closing prices are virtually the same. However, as you can see in the picture, these candles can differ from each other. The length of the wick (shadow)in different situations can take on different sizes.

Doji tells us that there is a battle between buyers and sellers in the market, in which neither side can tip the scales to its side. As a result, uncertainty and indecision are on the rise. At such a time, it's best to wait and take a coffee break - market forces will solve the problem on their own.

 

Bessy or bullish engulfing formations

Absorbing formations are two-light trend reversal formations. Traders use it to open a trade while anticipating a possible change in the trend. An Embrace candle can be either uptrend or downtrend, depending on its location in the current trend.

A Bullish Embrace is formed at the bottom of a downtrend, and a Bullish Embrace begins at the top of an uptrend. This formation is classified as a double formation, because as the name indicates: it is formed by two candles.

The bullish embrace  formation indicates a possible change in the trend from a downtrend to an uptrend, and consists of the first red candle and the second green candle, the body of which completely covers the body of the first candle. The opening of the second candle is below the close (not the minimum) of the previous candle, and the close is above the opening of the first candle.

In the Bessy Cover Formation, the situation is similar, i.e.: the body of the second candle completely covers the body of the first candle, with the first candle being 'demand' and the second candle being 'supply'. In these formations, the shadows are of little significance. An embracing situation is also encountered in which the candle bodies will be equal, but the formation is much more reliable and credible when the body of the first candle is much smaller than the body of the second candle.

 

Hammer

In the Hammer formation, we see a small body close to the top wick with no bottom wick or with a very short bottom wick. This formation is considered an upward signal in a downtrend. It indicates to us when the sellers had control and at what point they lost it to the buyers - as a result, the price rose again near the opening level or higher.

It is worth noting that the hammer does not indicate a complete takeover by buyers, but suggests an increase in their strength and a likely increase in the number of buying transactions.

 

Falling Star

The falling star formation is the most popular and characteristic formation of a single candle illustrating the reversal of an uptrend (foreshadowing declines). The structure of this candle is identical to that of the hammer, except that it appears after the uptrend. A shooting star has a long upper shadow, a small body (red or green) and a small or completely absent lower shadow. The upper shadow, on the other hand, should be 2 to 3 times larger than the body. On the other hand, as it might seem, the lower shadow cannot be larger than the body (or cannot occupy more than 20% of the entire candle). This formation signals a decline after an uptrend.

 

Candlestick charts and formations are an effective way to visualize market trends as reflected by traders' behavior. Reading candles can help you better understand and track market movements. This will be helpful in making investment or trading decisions in the cryptocurrency markets.