Forex traders can utilise Japanese candlesticks to gauge the market sentiment surrounding a particular currency pair or security. In a nutshell, these formations provide detail on how the emotions of market participants are affecting the price movements of financial instruments.
Many traders prefer candlestick charts because they are visually appealing and provide substantial information in a small amount of space. If investors can successfully use them to interpret market sentiment, they will have one more tool they can use to determine whether to enter or exit a trade.
Japanese candlestick charts date back to to 18th century Japan, when a rice trader named Munehisa Homma discovered the key role that emotions played in rice prices. He was able to uncover this relationship by keeping track of the daily price movements of this commodity.
Every day, he recorded the opening, closing, high and low price of rice contracts, and began identifying specific patterns with this information. Because he was able to keep track of price movements, Homma had insight into whether the broader markets believed rice was on the upswing or alternatively, moving lower.
He reasoned that if most were bullish about the commodity, it was a great time to take the exact opposite position. Likewise, if the majority believed that rice would soon fall in price, it was instead a time to take a bullish stance.
Forex traders use these exact same techniques today. If investors want to develop candlestick charts for a security, they can start by keeping track of its opening price, whatever high and low it reaches, and also where it closes.
The open and close form what is known as the real body, and this area is white if the financial instrument closed higher and black if it finished the session lower. Because this area contains the prices a security had when it started and ended a trading day, its length shows how much volatility the asset experienced during that session.
Should a real body be long and white, it points to robust buyer demand. In other words, market sentiment is bullish. However, if a real body is long and black, it generally means that sellers were aggressive, or bearish, about a particular security.
If a real body is short, this points to a modest change in price between the beginning and end of the session, which would not indicate a strong investor desire to either buy or sell.
The high and low points are used to determine the wicks or “shadows” of a candlestick chart. While upper shadows show the session high, lower shadows provide information on the low.
These shadows also provide important information, which vary based around their length and also whether the real body is white or black.
For example, if the upper shadow on a white real body is short, that means the closing value was near the high point for the session. Alternatively, when the upper shadow on a black real body is short, it means the opening price was close to the day’s high.
Once forex traders have learned the basics of Japanese candlesticks, they should start learning some of the more basic patterns. Spinning tops are candlestick patterns that involve small real bodies and long shadows. Because these patterns contain small real bodies, they point to a tight trading range and therefore little volatility.
Spinning tops generally mean that both bulls and bears were active during a trading session, but that they failed to move the security very far in any one particular direction.
Doji candlesticks appear when the opening and closing price of a security are virtually the same. When this happens, the real body is very short. Any time a Doji candlestick appears, forex traders can interpret them as meaning that market sentiment is largely neutral, at least for the time being.
In other words, investors cannot look at these formations alone and take that information to mean that the broader markets are either bullish or bearish. To obtain a better sense of the market, forex traders can look to the most recent candlesticks that appeared before the Doji.
For example, if a Doji shows up immediately after a long white candlestick, this indicates that the bullish sentiment surrounding a financial instrument is beginning to fade somewhat. Alternatively, if a Doji appears right after a long black candlestick, this points to selling pressure that is starting to decline.