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The Anatomy of a Candlestick Pattern
by Steve Crooks

August 19, 2005

Around 100 years after Leonardo de Vinci had designed his myriad mechanical devices and painted the world famous “Mona Lisa”, a young Japanese Rice Trader realised the intricate relationships between the Open, High, Low, and Close market prices of the day and represented them graphically using symbols. These symbols are known today as Candlesticks.

Look at the above diagram and you will see that a close that is lower than the open produces a black candle (a bearish candle) and a close higher than the open produces a white candle (a bullish candle). The combination of these black and white candles together with their size and position are what form the basis of Candlestick Analysis. The longer the body of the candle in either direction, the stronger it's bearish or bullish attributes are.

Once believed to be far too complicated for the average western mind, Candlestick Analysis is now enjoying a massive following, thanks in no small measure to the efforts of two very high profile Candlestick Analysts; Stephen W. Bigalow and Steve Nisson, who between them have distilled the 1000’s of Japanese Candlestick patterns down to a few Major Signals that can be used by any trader who takes the time to learn them.

The Japanese Rice Trader mentioned earlier, used and developed them to amass a quite incredible fortune by using them in his daily trading on the Rice Exchanges. His family quickly became the forerunners of today’s billionaire elite and the stuff of legends. A point to remember here is that computers did not exist in those days and so all charts and calculations were done by hand; a quite formidable task for most of us these days!

By studying the interaction of these candlestick symbols and by applying selected western indicators to the charts; an astute and disciplined analyst can predict, with incredible accuracy, the movements of any chosen market.

What I am trying to do in this article is to give you an example of how a signal can pre-empt a reversal of a trend. If you are able to foresee such occurrences then you are in a very strong position to execute consistently profitable trades. The candlesticks in unison with selected western indicators will ensure your accuracy exceeds 75% to 85%. That’s one heck of a hit rate.

An example of a Candlestick Signal.

To give you an example of how a Candlestick Pattern can trigger a signal to trade; look at the chart below:

Look at the three candles that are arrowed. This pattern forms what is known as a "morning star" pattern. So called because it is formed at the bottom of a trough. Its sister pattern, is called an "evening star" and is formed at a peak.

The first candle must be the colour of the present trend which for a morning star is a bearish trend. Therefore the candle will be black (or in this case brown). The second candle will be a Doji or Spinning Top, the colour of the body does not matter. In the case of a Doji, the open and close are the same very nearly and the spinning top has a very small body. Both of these candles show indecision, or a battle for control between the bears and the bulls. The third candle will be a white candle (bullish candle) and should really close at least halfway up the body of the first candle.

I can hear you saying "But it doesn't!!". True, in this case it does'nt. However, the overall trend of this market was bullish and by understanding the principles of reading charts you would have realised that this pattern was signalling an end to a retracement and a continuation of the original trend.

I would emphasise that this is in no way meant to be an exhaustive study of Candlestick Analysis. I am only trying to give you an understanding of how the signal patterns can help you when making a trading decision. They work for me, which is why they form the major part of the trading strategy I teach and use in my own trading.

Steve Crooks is the webmaster of CTWorkshops and of
The Candlestick Trading Workshops. He is also the author
of two books on Japanese Candlesticks and Online Digital
Options. Steve runs various workshops on the subject of
Trading including 1-2-1 sessions and group workshops of
15 persons or less. He is also an active Trader himself.

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