8.1 Important Candlestick Types – part 1

Important candlestick types part 1 - text version

In previous lessons, we talked about moving averages and some other technical indicators that can be used as building blocks for simple trading strategies.

What these indicators all have in common is that they are derived from calculations based upon historical prices.

In this lesson, we are going to talk about the price itself. The Japanese candlesticks that you see on your trading screen can act as more powerfully predictive raw materials, helping you to anticipate what is likely to happen next. If you like, you can see a Japanese candlestick as a kind of Forex candlestick indicator, or candlestick signals. Even a single candlestick can be a kind of single candlstick pattern if it falls in a strategically important position.

In course 2, we explained how Japanese candlesticks are formed. The area between the open and close is the “real body”, and when the price high and/or low is beyond the real body, that area is shown by a vertical line called the “shadow”.

Hundreds of years ago, the Japanese rice traders who used candlestick charting noticed that some types of candlesticks, which could be identified by their real body and wick patterns, had some predictive power. They also noticed that certain groups of candlesticks had predictive power.

This is not surprising when we consider that a higher time frame candle is just a combination of several consecutive candles from a lower time frame.

The old Japanese analysts put a name to just about every type of candle you could possibly imagine. For now though, we are going to concentrate on identifying the five most important types of candlesticks that every trader needs to be able to recognise.

The pin bar

Number one. The pin bar, also known as a “hammer”. The pin bar has a very small real body that is close to either its high or low, and a long shadow that sticks out on one side. It is formed whenever the price opens, moves away in one direction, then returns quickly to the level it started at. The pin bar traditionally signifies an immediate move in the direction opposite to the way the shadow is pointing, especially where the shadow pokes out beyond the highs or lows of preceding candles. This is because the long shadow is believed to show a sharp rejection of the price from SR, which should usually continue for a while.

The inside bar

Number two. The inside bar. This is a bar that is contained within the range of the candle just before it. This means that its high is lower than the previous candle's high, and its low is higher than the previous candle's low. The inside bar is not defined by its real body or shadows. It traditionally signifies a period of market indecision, i.e. consolidation, the breakout of which can be profitably bought or sold. This belief is because the price was not able to move beyond the confines of the previous candle's high and low, so when it finally makes its move, it should be strong.

The outside bar

Number Three. The outside bar. This is a bar that exceeds both the high and low of the range of the candle just before it. This means that its high is higher than the previous candle's high, and its low is lower than the previous candle's low. The outside bar is not defined by its real body or shadow. Traditionally, the significance of the outside bar depends upon where the bar closes: if close to its high, then it's bullish; if close to its low, then it's bearish.

If it closes close to the middle of its range, then it signifies a combination of increasing volatility and indecision, showing traders that it is probably wise to stay out of the market right now.

We'll end this lesson here, but don't worry: in the next lesson we will talk about the other two types of candles that you need to be able to recognize, and some useful information about how candle locations and wider contexts can help you to predict price movements.