Understand and use Japanese candlesticks, for informed crypto trading

Japanese candlesticks, a concept that is often little or not discussed by speakers specializing in cryptocurrency trading, because it seems intuitive. However, they are full of information essential to our good reading of the graphs. Let’s discover their secrets together through this new guide for Wall Street Cubs!

Munehisa Honma, the god of markets

Muneshisa Honma, the god of markets

Japanese candlesticks were born in the 18th century, long before the creation of trading and therefore digital tools! They were invented by the Munehisa Honma, rice merchant. At the time, he sought to anticipate the price of rice, which was the first futures market to have existed. He even ends up working as a financial consultant for the Japanese government! Rumor has it that he won the equivalent of $10 billion in rice markets. He died in 1803 leaving two books on Japanese candlesticks: “Sakata senho” and “Soba sani no den”.

But it was only much later that the Western world discovered this methodology ! It was in 1991, following the release of the book “Japanese Candlestick charting technique” that Steve Nison reaches democratize this way of representing graphics.

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The Anatomy of a Japanese Candlestick in Trading

Diagram explaining how to read a Japanese candlestick in trading by distinguishing between a bearish candle and a bullish candle.
Reading a Japanese candlestick in trading (source: Wikipedia)

This diagram explains how to read a Japanese candlestick.

  • the body of the candle is therefore its variation in price during a given period (according to the timeframe you have selected. It is generally colored in red if the closing price is lower than the opening price, and in green if the closing price is higher than the opening price.
  • The wick of the candle is the maximum reached by the price during this period. If the wick is above, anything above that price level has been soldif the wick is below, everything that has been below that price level has been bought.

The Importance of the Time Frame for Analyzing Japanese Candlesticks

If you don’t know how to use TradingViewI redirect you to this excellent article which should orient you correctly.

The Time Frame is the unit of time represented by a candle. You can change it here on TradingView:

Weekly chart (of the week) on TradingView
Weekly chart on TradingView

This chart is a Weekly chart, probably the largest unit of time usable in crypto-asset trading.

Example of a 4-hour TradingView chart: it is immediately more difficult to read than a one-week chart.
Example of a TradingView 4 hour chart.

Here is now exactly the same graph, but in 4H, you immediately see that the graph is much less clear.

It is important to use a consistent graph with the trade you want to take. An investor aiming for the very long term will probably look at a Weekly chart, while a swing trader, wanting to take a position for a few weeks, will also look at the Daily and the Weekly.

Technical analysis is not intended to be used only for short term speculation, it can also be quite relevant for a long term investor.

However, when you start an analysis, I strongly advise you to start from the largest possible unit of time. The weekly or daily candlesticks are observed by many, and therefore particularly relevant.

In short, a fairly simple rule at the level of the TimeFrame: the larger the unit, the more important the candle is to take into account.

A Japanese candlestick pattern in Weekly (1 week) will have much more impact than a 4 hour candle, which will have more impact than a 15 minute candle.

Read what the graphs tell us

And yes, the graphics tell us a story that you have to know how to decipher. I will give you concrete examples.

Example of Bitcoin's ATH in December 2020: price explosion from $20,000 to $40,000.
“The price literally explodes and goes from $20,000 to $40,000 in a few days”.

Let’s go back to December 2020, the ATH (all time high) is crossed on Bitcoin. This crossing is done in a clear way, the price explodes literally and goes from $20,000 to $40,000 in a matter of days. Buyers are very clearly present and push the price relentlessly.

Counterexample: End of the bullish rally and crash of -50% for the price of Bitcoin.  The candles of this moment are significant on the chart.
Bitcoin suffers a -50% crash

We are now in April 2021, the new ATH is marked, it is around $65,000. The bullish rally ends, and the Bitcoin suffers a crash -50%.

So far I’m not telling you anything, all this is just an observation of past events.

Return of Bitcoin to its ATH, and after having crossed it a violent bearish candle destroyed the last 3 weeks.
A violent bearish candle annihilating the last 3 weeks.

After a new bull rally from July to November, Bitcoin reverts to its former ATH. He crossed it, but after several weeks of battle between buyer and seller, a violent bearish candle wiping out the last 3 weeks of trading.

Ok, but what lesson draw ?

As said before, a breakout of ATH must be done from neat way. This large bearish candle, engulfing the last 3 weeks of buying effort close to an ATH, should put you on alert for the rest of the events.

Without going into learning Japanese candlestick figures, market structure, or other extremely complex indicators, Japanese candlesticks can give you very valuable information.

This example is very pertinent because it is in Weekly. I want to show you here that even by taking a quick look at a graph, without annotations or special techniques, you can to draw conclusions.

Japanese candlestick patterns

I would not list all Japanese candlestick patterns here, as there are hundreds of them. I am simply going to present to you here the ones that serve me the most on a daily basis. In order to maximize their relevanceI would primarily use the weekly chart.

The use of Japanese candlestick pattern should correlate with the context. Support, resistance, wyckoff… We’ll talk about all this in our next parts of this column, so don’t hesitate to follow us on our networks to be kept up to date!

I mainly use two Japanese candlestick patterns that we will see together here. There are hundreds of them, but I will give you here the ones that seem to me the most relevant.

Encompassing

Theory

Diagram of a bullish and bearish engulfing candle
Bullish engulfing / Bearish engulfing (source: Wikipedia)

Lencompassing is probably my favorite candlestick pattern in trading. As said before, Japanese candlesticks tell things.

In the case of a bullish engulfingit tells us that everything that was sold the previous week was bought back the following week.

Conversely, in the case of a bearish engulfingit tells us that everything bought last week was sold the following week.

Example of a relevant bullish engulfing which announces the takeoff of the price.
Once the closing of the engulfing done, immediate takeoff of the price !

Here, in 1H chart, the encompassing also shows us its relevance. Once the closing of the engulfing done, immediate takeoff of the price!

Concrete case

Some examples of bounding box on a weekly chart.
Some examples of bounding box on a weekly chart.

We are here on the Bitcoin Weekly chart as expected. We can also spot other encompassers easily, but they turned out to be tricky because they weren’t put into context. Have fun spotting them on other charts (preferably in Weekly to maximize relevance).

Zoom on a chart in Daily.  Several wicks are present and the last wick makes feverish buyers lose all hope.
Zoom in Daily

By zooming a little in Daily, we can see several things. Several wicks have been in this area, systematically redeemed. The Daily close on this threshold made the buyer lose all hope, the weak hands sold in favor of the large portfolios. Buyer explosion afterwards!

The doji in trading

Theory

Diagram of the different Dojis (types of candlesticks) in trading.
The Doji, example of a Japanese candlestick (source: Wikipedia)

the Doji, in most cases trading is a candle of indecision, or reversal. In the case of a star Doji, the volatility is low, in the case of a cross Doji, the volatility is high.

The Dragon Doji will be bullish, while the Tombstone Doji will be bearish.

Concrete case

Chart of the Ethereum price in weekly, 3 candles are framed.
Ethereum weekly price, analysis of the 3 candles in the rectangle

We are here on Ethereum in Weekly. Surrounded in the red rectangle, 3 candles:

The first, buyers had their hands on most of the week.

The secondthe Doji appears, with more selling above than buying below, this is a first signal that should alert you.

The thirda candle that retraces the entire penultimate buying candle, this is a big warning signal, the market then tumbles.

I insist here on the fact that the graph used is in Weekly! It is therefore really important to watch it because it givesexcellent signals.

Example of a Volatile and Indecisive Doji on a Bitcoin Price Chart
Example of a volatile and undecided Doji.

Here on Bitcoin on a daily basis, an undecided and volatile doji appears after a candle where the buyers had full control. The price corrects thereafter.

Example of a Dragon Doji
Example of a Dragon Doji

Still on Bitcoin on a daily basis, the end of this Bitcoin retracement was marked by a Dragon Doji.

Its meaning here is quite strong, because we have already had a reaction before on this level. The uptrend can therefore continue.

Japanese candlesticks give us a large amount of information that is very often underestimated by market participants. Still, they are only a building block that will lead to your decision, they do not alone constitute a signal to buy or sell. If you are a long-term trading investor, looking at a chart with weekly candlesticks can be very helpful.

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