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Candlesticks with a Japanese flavor

Seven traditional Japanese candlestick patterns that can help you identify price moves.

  • Fidelity Active Trader News
  • – 06/25/2014
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From sushi and anime art to advanced automobiles and electronics, the Japanese have had a significant influence on global culture and the modern world. These contributions extend into the world of trading as well: Users of candlestick charts and patterns have Japanese rice traders from the 18th century to thank.

The origins of all candlestick charts and patterns derive from these Japanese rice traders’ candlestick charting methods. Over the years, Western practitioners of candlestick charts have created their own names for many of the same Japanese candlestick patterns, along with some new patterns.

Here are seven distinctly Japanese candlesticks patterns and how you can implement these trading signals in your strategy.

Yorikiri: Bullish and bearish

Yorikiri is a sumo term meaning to hold on to an opponent’s belt while attempting to push him out of the ring. The Western equivalent of the Yorikiri pattern is the more commonly termed—and appropriately named—belt-hold pattern.

There are two types of yorikiri patterns: bullish and bearish. A bullish yorikiri is a single reversal candlestick pattern that occurs in a downtrend. It is recognizable as a long bullish, or white, candle that opens near or at its low and closes at or near its high after a downtrend (see the chart below). Note that when referencing individual candlesticks, bullish candles are white or not colored in; these represent days when the stock closed above the open. Conversely, bearish candles are colored in, typically in black, red, green, or some other "dark" color; these represent days when the stock closed below the open.

A bullish yorikiri would be a potential signal of a reversal of the downtrend into an uptrend. Consequently, you may choose to enter into long positions or close short positions after confirmation of the pattern. Confirmation can occur soon after a given candlestick pattern if the price action moves in the direction suggested by the pattern. For example, in the case of a bullish yorikiri, if subsequent candlesticks were bullish after the yorikiri, this could be considered confirmation of a reversal of the downtrend and you may want to consider entering bullish positions or closing bearish positions.

The opposite of a bullish yorikiri pattern is a bearish yorikiri. This is a single reversal candlestick pattern that occurs at the end of an uptrend. The bearish yorikiri is recognizable as a long, dark candle that opens near or at its high and closes at or near its low after an uptrend. The pattern would be a potential signal of a reversal of an uptrend into a downtrend. Consequently, you might consider closing long positions or entering short positions upon confirmation.

Harami: Bullish and bearish

Translated loosely as a pregnant woman, a harami pattern exists when a candle is completely engulfed by the previous day’s candle. A bullish harami candlestick pattern may occur when the trading range on an up day lies completely within the previous day’s loss (see the chart below). Traders might consider this a positive signal, because the bullish harami could suggest that a downtrend is reversing.

In the chart above, a bullish harami formed on December 19, when the stock opened at $20.12, rose to $20.23, and then fell to $19.00 intraday before finally closing at $19.05. The next day, the stock opened at $19.42, fell to $19.35, and rose to $19.90 intraday, before finally closing at $19.69. Day 2’s entire trading range lies completely within Day 1’s loss.

Alternatively, a bearish harami exists when the trading range on a day when there is a loss is completely engulfed by a previous day’s gains (see the chart below). Traders would most likely interpret this as a sign that an uptrend is losing momentum and that a reversal into a downtrend might take place.

A bearish harami formed on April 12, when the stock opened at $66.52, fell to $66.32, and rose to $68.57 before closing at $68.33. Then, on April 13, the stock opened at $68.00, rose to $68.13, and fell to $66.59 before closing at $66.67. Day 2’s entire trading range lies completely within Day 1’s gain.

Doji

A doji is a unique candlestick. It looks like a cross or a plus sign. It occurs when a stock closes at or very near to where it opened (see the chart below).

In the chart above, you can see that a doji formed when the stock opened at $33.87 on February 7, rose to $34.30, and fell to $33.41 in the session before closing near $33.86 by the end of the session.

Indecision is the key interpretation of a doji; the market isn’t sure in which direction to go. After a long uptrend, a doji might indicate that buying activity could weaken. Similarly, after a long downtrend, a doji might suggest that selling pressure is weakening. Typically, further confirmation is needed, as a doji by itself is not enough to determine whether a reversal is taking place.

It’s worth noting that there are several variations of the doji pattern—although they are not nearly as common as the traditional doji—including a dragonfly doji (where the price drops during the trading session, but the open and close price are the same at the high of the day) and a gravestone doji (where the price rises during the trading session, but the open and close price are the same at the low of the day).

Tasuki gap

You may already be familiar with gaps; they frequently occur around an earnings announcement or major event when the price jumps up or down as a result.

Suppose XYZ stock is trading at $20 at the close on a particular day when the company is scheduled to report earnings after the closing bell. If the actual earnings report is significantly better (or worse) than consensus expectations, the following day the price may gap up (or down) by opening at $22 (or $18 for a down gap).

Tasuki gaps are interesting patterns in that they involve big prices moves and they are made up of three separate candlesticks. An upside tasuki gap is a continuation pattern, where there is a large white candle within a defined uptrend, followed by a second white candlestick that has gapped up, and, finally, a third dark candle that closes within the gap between the first two candles. This type of gapping pattern suggests the existing uptrend may continue.

A downside tasuki gap is a continuation pattern, where there is a large dark candle within a defined downtrend, followed by a second dark candlestick that has gapped down, and, finally, a third white candle that closes within the gap between the first two candles. This type of gapping pattern suggests the existing downtrend may continue.

Putting candlesticks into action

There are many more Japanese candlestick patterns that can help you identify price moves. When conducting this type of analysis, it’s important to consider candlestick patterns within the context of the broader pattern. Understanding how these patterns fit within the longer-term trend may help you avoid head fakes—where the price doesn't move in the direction suggested by the candlestick pattern.

Of course, candlestick patterns—and technical analysis in general—can be highly subjective; what one trader perceives as a valid pattern may not be confirmed by another. Moreover, the existence of such a pattern does not guarantee that an expected trading action will occur. Investors must recognize that candlestick charting techniques do not incorporate fundamentals that may influence how a particular stock or other security performs.

However, candlestick trading is a widely recognized method. It can be a compelling technical tool in your trading arsenal, and Japanese candlesticks are the foundation from which all candlestick patterns derive.

Learn more

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Technical analysis focuses on market action—specifically, volume and price. Technical analysis is only one approach to analyzing stocks. When considering which stocks to buy or sell, you should use the approach that you’re most comfortable with. As with all your investments, you must make your own determination as to whether an investment in any particular security or securities is right for you based on your investment objectives, risk tolerance, and financial situation.
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