Japanese Candlesticks

Two Candle Patterns: Those of you who have come from the Making Bread site will know that I have already provided an introduction to what I feel is the most important group of Japanese candles, the doji candlestick family. The reason these candles are so important is simply that they represent indecision in the market, and therefore a possible turning point. As traders we are always looking for these signals, either to close out a profitable position, or to open a new position as a trend reverses. In general terms the longer the shadow on a doji, the greater the significance, but as always we have to wait for a confirming signal, either from other technical indicators or from further candlesticks. We looked at several single candles as an introduction to Japanese Candlesticks, so let's take a look at some two bar candlestick patterns.

Japanese Candlesticks : Dark Cloud Over

I love the name of this particular candlestick formation as it describes the price action in the description exactly. A dark cloud has appeared on the horizon and we need to take notice. So what has actually happened here? We have a significant up bar which has closed at a price. The following candlestick has opened higher due to the continued buying pressure but then falls to close as a significant down bar.

The two bar candlestick pattern reflects a change in buying with prices being forced down as selling enters the market. For the two bar pair to be significant the down bar must finish at least below the mid-point of the previous candle. If it falls above the mid-point traders consider this to be an incomplete dark cloud over. The other point to note about this Japanese candlestick pattern is that if you join the two candles together they from an upthrust, so in effect what you are looking at here is a 'deconstructed' doji. If the two candlesticks are side by side then I call this pattern a two bar upthrust and in effect becomes a gravestone. Mentally adding two bars together will often provide another type of candlestick formation which is more familiar!

Japanese Candlesticks : Bullish Engulfing

As the name implies one candlestick has been engulfed by another, implying that market conditions have changed. In this case the first bar to form is a down bar, which should have no or very short shadows. The bar opens and then closes lower with a strong body.

The following bar then opens with a gapped down opening price, but prices subsequently rise in the timeframe and the candlestick closes well above the opening price of the previous candle. As we can see the down bar has been engulfed by the following up bar. Strong buying has entered the market and pushed prices higher following the previous down bar. This is an excellent candlestick pair to watch for, as the gap down in price, followed by the strong up move indicates a change in sentiment and therefore a possible change in direction.

Japanese Candlesticks : Bearish Engulfing

This is the reverse of the bullish engulfing candlestick pair that we looked at above. In this case the the first bar is an up candle, again with no or very small shadows.

The candle closes and prices are then gapped up, as though the move is going to continue. Instead, the market falls and a down bar is formed with a well formed body. The down bar engulfs the up bar and a reversal in market conditions is signalled. Now as with all candlestick analysis we have to wait for a confirmation, either from the following candles, or from another technical indicator such as volume, but in essence, both these two candlestick patterns should raise an alarm signal for us as traders as they represent a strong signal that the market may change direction in the near future. Now finally, let's look at one last pair of candlesticks, the tweezer family!

Japanese Candlesticks: Tweezer Tops and Bottoms

There are two members of this family, the tweezer top and the tweezer bottom. The tweezer top indicates a change from bullish to bearish, and the tweezer bottom a change from bearish to bullish. The key elements of the patter are as follows. Firstly the initial candlestick must have a large real body with a top that has no shadow ( or very little ).  The second candlestick should have a small real body. Finally the tweezer top or bottom occurs when the same highs or lows are tested in subsequent candles. In other words a price has been tested twice and the price move has failed. The image on the left is for a tweezer top. The tweezer bottom occurs where prices on the first candlestick have fallen and been tested again on the second candle, but have failed to fall further. This is a candle pattern that I use myself a great deal in currency trading.

OK, that's it on two bar candlestick patterns - let's have a look at some of the more common three bar candle formation. Japanese candlestick analysis and chart reading is a huge topic and I can only cover the basics here. You will need to do lots of reading and practice, and in the resource section I recommend an excellent and simple guide, along with some interesting books which I think will help you learn more quickly. It can be quite daunting when you first start, but with the right books and lots of practice you will soon start to read the markets as begin to predict changes in direction, before they happen!!

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