How to trade crypto with Japanese candlestick patterns
Japanese candlesticks are arguably the most popular styles of financial charts used to describe price movements. It is used by most crypto traders for any type of trading style whether it’s shorting bitcoin, day trading or using indicators like EMA or CCI.
Developed by Munehisa Homma, a Japanese rice trader, Japanese candlesticks are mostly used to predict possible price changes by analysing past patterns. Their design is based on the input that traders’ emotions have on market and its prices.
In this blog post, we break down the structure of Japanese candlesticks and how to trade crypto by using this style of visualising market movements.
Structure of Japanese candlesticks
Japanese candlesticks visually represent the price changes, using different colours to highlight the differences. By applying this style, crypto charts are extremely useful for traders as they allow them to predict price movements and make decisions based upon historical movements.
One of their greatest strengths is that they provide more information about possible price changes due to a visual representation of supply and demand for every price movement.
Each candle shows four important pieces of information - the asset opening and closing price, as well as a high or low of that particular time frame. The central part of the candlestick is called “body” and it represents the price range between the opening and the closing price.
Almost all charting tools let traders choose colours for the candles. The standard setting is green for bullish candles and red for bearish candles, as shown in the picture above. So, if the body is red, that means the closing price was lower than the opening price and vice versa.
The upper and lower wicks, attached to the body, are also known as the “shadows”. The upper shadow represents the price range between the top of the body the high price of that day’s trading. The lower shadow represents the price range between the bottom of the body and the low price of that day’s trading.
There are many different ways to use candlesticks. Trading a particular asset by using candlestick analysis is a very common trading technique. We take a look here at three popular trading techniques based on the Japanese candlesticks.
1. The hammer pattern
Hammer candlestick pattern is a bullish reversal candlestick pattern that mainly occurs at the bottom of downtrends. It is characterised by a very long lower wick, and a much higher closing price. The body of this candle is short while the lower wick has to be twice the length of the real body.
In a chart above we see a downtrend in Bitcoin as the price moves lower. The reversal happens when the price makes a new low, which is not confirmed with the closing price in the same candlestick. As a result, the price eventually moves higher as bears start exiting their positions.
This pattern implies that that the market tested to find where support and demand was located. Hammer is also often used for confirmation purposes to verify a failed break out.
2. Shooting star pattern
Shooting star is another popular formation that works opposite the hammer. Thus, it is a bearish reversal candlestick pattern that is formed at the top of an uptrend, signalling that a reversal may be on the cards soon.
This pattern is very strong in combination with a failed breakout at an important resistance. As seen in the photo below, the long wick to the upside briefly travels above the resistance line but it ultimately closes below it. In this situation, there is a very high chance that the crypto asset will rotate immediately lower as the shooting star formation confirmed a failed breakout.
3. Doji pattern
Doji is the name of the candlestick pattern where opening and closing prices are virtually the same. There are a few different versions of the doji candlestick, but in general, they can look like a cross, an inverted cross or plus sign. Doji pattern is seen as a reversal pattern as it signals a potential change in the trend as indecision is manifested by both bulls and bears. However, the chance for reversal with doji candlestick is lower than hammer or shooting star, as doji is more connected to the market’s indecision.
As seen in the price chart, Bitcoin had moved higher before the doji pattern occurred at the top of the uptrend. The asset created a fresh multi-week high before doji signals the market’s indecisiveness. As a result, the price action made a correction lower, which was manifested in two bearish daily candles.