Tad DeVan is a Senior Forex Analyst for Market Traders Institute and host of the Ignite Trading Room. Ignite Trading Room is FREE to join for active SmartTrader users.
Today, we’ll cover what some traders view as the sign language of the market – Japanese Candlestick Formations.
Candlestick patterns are important tools for conducting technical analysis to better forecast price trends. They can help traders interpret possible market directions and also signal bullish or bearish movements. And these trends and patterns, in turn, help traders to form their trading decisions.
So let’s discuss Japanese candlestick formations and how you can quickly identify them on a trading chart.
First things first, here’s a quick look at how to read candlesticks charts…
Candlesticks and Candlestick Formations
Candlesticks are used to identify chart patterns. These patterns help traders in setting up a trade by giving them insights about the entry, stop loss, and exit levels.
The patterns are formed by grouping two or more candles in a certain sequence, although some powerful trading signals can be identified by just a single candlestick pattern. So, candlesticks can be broken down into single and multiple candlestick patterns.
Strength is represented by a green or bullish candle and weakness by a red or bearish candle.
And a general rule of thumb is to look for a prior period while reading candlesticks. If you are looking at a bullish pattern, the prior trend should be bearish. And likewise, if you’re looking for a bearish pattern, the prior trend should be bullish.
Below is a quick “cheat sheet” showing five types of bullish and bearish candlestick formations. You can also download the PDF version by clicking here.
Source: Market Traders Institute
With that in mind, let’s get talking about Japanese candlestick formations…
Japanese Candlestick Formations
Well, the concept of candlestick charting was developed by Munehisa Homma, a Japanese rice trader, and therefore we get the name Japanese candlestick charts and Japanese candlestick formations. (Source: Wikipedia)
A Japanese candlestick represents the time that each candle takes to form. This is referred to as a time frame. Each candlestick here tells you the open, high, low, and close (or OHLC) price during the time frame for that candle.
Here’s a look…
Source: AdobeStock
The bold part of the candlestick is called the body, which represents the open and close of the period. So, if the chart is a 30-minute chart, each candlestick body will show the opening price for that 1 hour period and the closing price for the 30-minute period.
The wicks on the top and the bottom of the body show the highest and lowest price reached during that 30-minute period.
Moreover, Japanese candlestick formations occur on all candlestick charts and can give us an idea on where the market may go next.
When you spot these patterns on a chart, there’s a good chance that the market is going to react based upon that pattern. After all, the market has always moved in patterns and it always will. And that gives traders the opportunity to potentially profit from it.
Here’s how you can identify these patterns real quick…
Identifying Formations
The best way to go about spotting candlestick formations is to know them by memory. You can do that by reviewing the above “cheat sheet” and practicing how to find those formations on your charts.
Alternatively, if you’re on the SmartTrader trading platform, an easier way to identify these patterns is to click on the ‘Candlestick Tools’ button, which allows you to activate all the bullish / bearish candlestick formations and gives you all the formations that meet the formula on your selected chart.
Just go to Candlestick Tools and select all the formations that you want to be displayed on your chart. For example, if you’re looking for bullish formations, you can select any or all of these formations: Bullish Engulfing, Bullish Shooting Star, Bullish Morning Stars, Bullish Piercing Line, etc.
Here’s how the formations would be highlighted on the chart:
Candlesticks Highlighting Bullish Formations
Source: Market Traders Institute
All the highlighted candles on the chart above show us various bullish candlestick formations. Now, if you want to look up which pattern a particular candle is representing, just click on that candle and it will show you the pattern that’s in play.
Trading Candlesticks
Once this is done, one way to trade these candlesticks is to spot them at the bottom of retracement.
That means identifying the green candlesticks that are at the lowest levels during a given time and setting a trade on them for higher levels. So, once you spot a green candlestick from where the trend on the chart is reversing, you can place a trade for higher levels (as the pattern is indicating an uptrend).
The opposite goes for red candlesticks. Here you will identify the red candlesticks that are at the highest levels and set a trade on them for lower levels.
A simple strategy to trade candlesticks could be to place an order when a candlestick closes so that you know which formation it is representing.
Say you want to place a buy order now. You can do so at the closing price of the body where the stop loss could be 10 PIPS below the previous candlestick’s low. The target price here can be set up in a 1:1 risk-reward ratio. Which means, you can set your target price higher by the same level that you have set your stop loss at from the buy price.
So, that was a simple way in which you can identify Japanese candlestick formations as well as trade them.
Tad Devan, Senior Currency Strategist at Market Traders Institute, has also recorded a short video on this concept, which you can Watch Here.
For more such Forex strategies and trades, you can check out the Analyst On Demand Trading Room.
Every week, within the trading room, Tad will take you through real market conditions and help teach you the keys to being a consistent trader across the board. Just spend a little time in the trading room and we believe you could see great results for yourself. You can access it by clicking here >>
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