What Are Japanese Candlesticks?
One of the oldest and most popular forms of technical analysis is known as Japanese candlestick charting. Dating back to 18th century Japan, candlestick charting techniques were first developed as a method of analysing price movements in domestic rice markets. A prominent rice trader of the period, Muneshi Homma, is credited with inventing the guiding principles for modern Japanese candlestick charting techniques.
For over 300 years, candlesticks have remained a respected and viable technical analysis approach. In contrast to line, point and figure, and open-high-low-close (OHLC) charts, candlesticks record pertinent market data points as well as provide a visual illustration of buying and selling activity.
A candlestick records five important pieces of market information that define price action for a specified period:
- High: The highest traded price, or the top of the trading range
- Low: The lowest traded price, or the bottom of the trading range
- Open: The first price traded at the beginning of a candlestick formation
- Close: The last price traded at the end of a candlestick formation
- Market Direction: The distance between the high and low of a candlestick, as well as the relation of the closing price to the open. A candlestick is bullish if it closes above its open, and is bearish if it closes below its open.
A candlestick consists of a body and tails (also known as wicks). The body of the candlestick is the range between the open and close. The tails of the candlestick represent the distance between the upper and lower extremes in relation to the body.
What Is A Doji?
A doji is a candlestick that has a closing price that is very near to its opening price. The anatomy of the doji is unique to other candlesticks, in that the range of its body is very small or nonexistent. Often, the entire body of a doji can be represented by a single horizontal line, closely resembling a cross or an addition sign. The length of its tails, or the vertical range of the candlestick varies depending upon the magnitude of price action outside of the open and closing price.
The doji is one of the most readily identified chart patterns among technical traders. It is seen to be a neutral pattern, in that neither buyers nor sellers could win the battle to move the prospective market substantially higher or lower during the specified period. A doji is often an indicator of a pending breakout, as the formation itself signals a compression of price action and consolidating market conditions.
Technical traders and chartists interpret the doji in a number of different ways. On a stand alone basis, the doji can be seen as a momentary pause in a longer term trend, or possibly an exhaustion point in price action. When used as part of a more complex chart pattern, the doji can function as a signal of market reversal, or pending breakout. Morning stars and evening stars are examples of the doji candlestick being used within a larger chart pattern.
Types Of Doji
There are five distinct types of doji, each with specific characteristics. Each variety of doji is interpreted by technical traders to be a sign of unique market conditions, and potentially different price actions.
The five types of doji are:
- Standard Doji: The standard doji is a basic cross formation with equal length tails. As stated earlier, a standard doji is a neutral pattern, and when used within the context of a larger pattern, is a useful tool in predicting market reversal.
- Long-Legged Doji: The long-legged doji consists of extended tails above and below the opening and closing price, signaling the presence of an active market and potential directional move. The elongated tails represent a large trading range for a specified period, and when coupled with extreme volume, the long-legged doji can serve as a market entry point for technical traders looking to capitalise on market breakout, reversal, or continuation.
- Dragonfly Doji: The dragonfly doji has an elongated lower tail with no upper tail. The open and close of the candlestick represent the extreme top of the doji. A dragonfly doji occurring during a strong downtrend is seen to be an indicator that selling has been exhausted and that buyers have taken over the market. Typically, a reversal in the trend is predicted, coupled with a bullish move in price.
- Gravestone Doji: The gravestone doji is the reverse of the dragonfly doji, exhibiting an elongated upper tail and lack of a lower tail. The open and close of the candlestick act as the extreme low of the doji. The gravestone doji is most valid when occurring during an uptrend. The long upper tail represents a failure in buying action, as buyers could not sustain the rally above the opening price, signaling an end to the uptrend.
- 4-Price Doji: The 4-price doji is unique in that the high, low, open and close share the same price. No tails are present, and the visual similarity is to that of a subtraction symbol. The 4-price doji is a sign that markets are in extreme consolidation and can serve as an indication of a coming breakout or period of market stagnation.
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Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…