The other day Ken left a comment with some good questions about Japanese candlesticks. I thought I should answer them in a new post in case others had similar questions. Here’s Ken’s comment:

I notice there are some black candles on your charts. Why are they in black? On the WIRE chart, why do you consider that candle a reversal candle? Do you consider it a hammer? And lastly, you mentioned that a doji or hamari cross at gap support is a sign of strength. Is this your own observation? or it’s a pattern from a book? Thanks!

The colors on the charts are simply an option that StockCharts.com offers on their charts. Red means the stock closed below the previous close and black candles closed higher than the previous close. These colors have nothing to do with candlestick analysis — plain old bar charts would have the same coloring if that option was checked. Here’s an example using the Nasdaq chart:

Here’s the chart of WIRE for the next two questions:

I don’t consider that candle to be a hammer because the upper shadow is too long. It’s more of a star / spinning top. (Note that the pattern morphed into a morning star, one of my favorite bullish reversal patterns, on the next session.) The reason that those type of candles are considered (potential) reversal candles are because the small size of the real body shows a stalemate (tug of war) between buyers and sellers. The signal is more (only) important after a downtrend or an uptrend.

In this case, WIRE had just fallen about 16% in 2 days. The bears were having a party. Then all of a sudden the buyers started to hold them off — that’s the action that printed the spinning top. From the ‘Stars’ chapter in Steve Nison’s ‘Japanese Candlestick Charting Techniques’ (emphasis is mine):

The same is true, but in reverse, for a star in a downtrend. That is, if a star follows a long black (closed or solid colored) candlestick in a downtrend, it reflects a change in the market environment. For example, during the downtrend the bears were in command but a change is seen in the advent of the star, which signals an environment in which the bulls and bears are more in equilibrium. The downward energy has thus been cooled. This is not a favorable scenario for a continuation of the bear market.

To answer the question about gap support — Nison writes extensively about this type of support. The book refers to them as windows:

A window is a gap between the prior and the current session’s price extremes…

Windows also become support and resistance areas. Thus a window in a rally implies further price rise. This window should also be a floor for pullbacks. If the pullback closes the window and selling pressure continues after the closing of the window, the uptrend is voided….

Tradition Japanese technical analysis (that is, candlesticks) asserts that corrections go back to the window. In other words, a test of an open window is likely. Thus, in an uptrend one can use pullbacks to the window as a buying zone…

Nison gives many examples of reversal candles at gap/window support/resistance in the book.

P.S. As a slight aside, I’m starting to frequently see people referring to hanging men as hammers. There’s a HUGE difference between the two. It’s important to recognize whether the candle’s printing after an uptrend or a downtrend.