The Four Formations of a Japanese Candlestick

There are a lot of tools which are used by traders in order to better and improve their trading, and to sharpen their timings while placing a trade at a particular point of time and within specific conditions. Commonly, such tools are indicators, signals, charts and analyzers. Here, in this article we will discuss about the candlestick chart. Going back centuries, this chart type was first used in Japan for the purpose of calculating profits and price changes in the rice trade. In the 21st century, they are used to track price movements of commodities within a particular period of time (or time-frame).  

Candlesticks get their name from the shape they form. There is a cylindrical ‘body’ in the middle which represents the distance between the ‘opening’ and ‘closing’ price points. There are these ‘wicks’ on either end which represent the high and low trading points. Solid points would be points when the ‘low’ was the open point and the ‘high’ was at the close. However, when prices have been fluctuating a lot and thus could be rightly described as ‘volatile’, the ‘body’ of the candlestick looks much less solid. There are mainly four kinds of candlestick chart positions. Below is a description along with the conditions which lead to the formation of each: (Points collected from CornèrTrader).

  1. The Bullish Engulfing Candlestick: This is seen to form when a stock, share or future’s price moves beyond both the high and low points of the range of a previous day. Hence the name ‘engulfing’. Such a price movement generally indicates that a price has first dipped down below the previous day’s ‘low’ point to find an enhanced buying volume and then surged back up to break the ranks of the ‘high’ point. This chart is often used to describe or signify a sustained upward movement of prices.
  2. Bearish Engulfing Candlestick: This is the polar opposite of the bullish engulfing pattern described in the above point. In here, price levels will first rise above the previous day’s ‘high’ point, and after finding the adequate sales volume will crash down below the ‘low’ point of a recorded previous day’s price movement. And hence, it appropriately signals a sustained drop in prices of a particular volume of shares or stocks.
  3. Hammer Reversal Candlestick: This is formed when the market participants force a price to close around its opening price level after it has moved down to a certain level. Hence the shape is that of a hammer in an upright form. After a while, it can be seen that a strong bullish pattern candlestick has been formed which displays a sustained increase in prices. This helps the traders to find value as a result of which this price begins to trend. Normally the direction of the hammer is in a vertical fashion (with the head up), but it can also be in an up-side down form.
  4. Doji Candlestick: Doji patterns are formed when there is a lot of indecision regarding the final level of pricing for a certain stock. It is a situation where the price cannot close at either the open or close, because the bearish and bullish forces are fighting each other to push the prices in their respective directions. The result is a candle with a very short body and a heightened wick at one of the ends.

These four, in short, are the four main formations of Japanese candlesticks.

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