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Common Candlestick Patterns and History of Japanese Candlesticks

It's not too often that tools of financial analysis have a near-mythical origin.  In the forex market, however, the most common graphs are referred to as “candlestick” charts.  The type of candlestick charts that are used by forex traders was developed in Japan over 500 years ago.  There, a merchant used these visual representation for the movements of prices in a rice market.  He became, we are told,  very, very rich. 

This history has given some of the candlestick chart patterns very funny names.  Fortunately, these colorful name make it easier to remember what is what.  Before we get into the patterns and what they mean, a quick tutorial on the anatomy of a candlestick chart is necessary. A candlestick can represent a day, week, hour, fifteen minutes or any other time frame of your choosing.  The thick part of the stick is called the body.  The two lines that are usually on either side of the body are called the shadows.  The edges of the body represent the price at the open and close of each time period.  If the time increment had a higher close than it did opening, it will have a certain color, and if the session ended lower, it will be a different color.  The color choice varies from graph to graph, but usually the lighter color mean the session saw growth in value.  For our purposes, let's assume that the chart is just in black and white, though red and blue are equally common. The lines on either end of the body represent the intra-period high and low. 

One common pattern is the Marabuzo.  In it, there is no shadow on either end of the candlestick.  This suggests a very bullish or bearish session, depending on the color.  A White Marabuzo, for instance, would mean that the value of the currency pair started the session at the bottom of the body, and, never dipping below that point, finished at its high for the time period. A “spinning tops” candlestick is essentially the reverse.  In it, the shadow is longer than the body.  It means that the market closed much closer to its opening than the periods highs or lows. Short and long days mean, respectively, that the market moved little and moved a lot.

Now, let's move on to some of the patterns made up of multiple candlesticks.  The dark cloud pattern consists of a white long body candlestick followed by a larger black long body where the end of the black body surpasses the midpoint of the white candlestick.  It means there was a good session, and then an especially bad one.  Usually, this means the negative movement will carry over to the next session, and the shorts will do well. 

Bullish Engulfing patterns are when there is a short black body followed by a longer white body.  Often, it is the sign that a trend has played itself out, and average prices will start moving in the opposite direction.  A bullish engulfing pattern is usually found at the valley of a price swing. A bearish engulfing pattern is just the opposite, and is usually found at the top of a peak in value. 

Three Black Crows is three long body negative periods in a row, found in the middle of an otherwise upwards trend.  It is a very bearish sign.  It usually means the market has decided it is over-valued. Three White Soldiers is the opposite, three white candlesticks in a row in the midst of an otherwise downward trend.  Likewise, it means that the market considers the currency in question undervalued and is a sign of an opening for the bulls. 

Lastly, there is the Falling and Rising Three Methods, which are the bullish and bearish equivalents of each other.  In the former, there is a long black body, followed by three days that stay within the body of the first long body.  That is a relatively strong sign that the next, fifth day will be similar to the first day.

There are other, less common patterns with equally enjoyable names.  But now you've learned the most important patterns that are found most frequently.