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Candle Charting Basics 1
“ A good beginning is the most important of
things.” (Japanese proverb)
This
section discusses only a few of the scores of candle chart patterns.
There are many important candle patterns and trading tactics not
discussed in this basic introduction. As such, do not trade based on the
limited information. The goal of this section is to illustrate how
candles can open new and unique analytical doors, not to provide a
trading methodology. For example, there are many times candle signals
should be ignored. This is where experience with candle charts comes in.
WHAT ARE
CANDLESTICKS?
Japanese candle chart analysis, so called
because the lines resemble candles, have been refined by generations of
use in the Far East. These charts are
now used internationally by traders, investors and premier financial
institutions. Candle charts:
Are
easy to understand: Anyone, from the first-time chartist to
the seasoned professional can easily harness the power of candle charts.
This is because, as will be shown later, the same data required to draw a
bar chart (high, low, open and close) is used for a candle chart.
Provide
earlier indications of market turns: Candle charts can
send out reversal signals in a few sessions, rather than the weeks often
needed for a bar chart reversal signal. Thus, market turns with candle
charts will frequently be in advance of traditional indicators. This will
help you to enter and exit the market with better timing.
Furnish
unique market insights: Candle charts not only show
the trend of the move, as does a bar chart, but, unlike bar charts,
candle charts also show the force underpinning the move.
Enhance
Western charting analysis: Any Western technical tool
you now use can also be used on a candle chart. Candle charts, however,
will give you timing and trading benefits not available with bar charts.
This merging of Eastern and Western analysis will give you a jump on
those who use only traditional Western charting techniques.
CONSTRUCTING THE CANDLESTICK
LINE
 The broadest part of the candlestick
line is the real body. It represents the range between the session's open
and close.
If the close is lower than the open the real body is black. The real body
is white if the close is higher than the open. The real body is white if
the close is higher than the open.
The thin lines above and below the real body
are called the shadows. The peak of the upper shadow is the high of the
session and the bottom of the lower shadow is the low of the session.
The color and length of the real body reveals
whether the bulls or the bears are in charge. Note that the candle lines
use the same data as a bar chart (the open, high, low and close). Thus,
all Western-charting techniques can be integrated with candle chart
analysis.
At Candlecharts.com, we have found the
candles are most potent when merged with Western technical analysis.
Accordingly, we harness the best charting techniques of the East and West
to provide you with uniquely effective trading tools.
USING
INDIVIDUAL CANDLE LINES
A critical and powerful advantage of candle charts is that the size and
color of the real body can send out volumes of information.
For example:
a long white real body visually displays
the bulls are in charge
a long black real body signifies the
bears are in control.
a small real body (white or black)
indicates a period in which the bulls and bears are in a "tug of
war" and warns the market's trend may be losing momentum.
While the real body is often
considered the most important segment of the candle, there is also
substantial information from the length and position of the shadows. For
instance, a tall upper shadow shows the market rejected higher prices
while a long lower shadow typifies a market that has tested and rejected
lower prices.
The slogan of our firm is "Helping
Clients Spot Market Turns Before the Competition."
This is based on the powerful fact that candle charts will often provide
reversal signals earlier, or not even available with traditional bar
charting techniques.
Even more valuably, candle charts are an
excellent method to help you preserve your trading capital. This benefit
alone is incredibly important in today's volatile environment.
Candle Charting Basics 2
L
et's look at an example of how a candle chart can help you avoid a
potentially losing trade.
Exhibit
1 (below) is a bar chart. In the circled area of Exhibit
1, the stock looks strong since it is making consecutively higher closes.
Based on this aspect, it looks like a stock to buy.
Exhibit 1
The candle chart, uses the same data as Exhibit 1 (above),( remember, a candle
chart uses the same data as a bar chart; open, high, low and close.)
Let's now look at the circled area on the candle chart in Exhibit 2
(below). Note the different perspective we get with the candle chart than
with the bar chart. On the candle chart, in the same circled area, there
are a series of small real bodies which the Japanese nickname spinning
tops. Small real bodies hint that the prior trend (i.e. the rally) could
be losing its breath.
Exhibit 2
As such, while the bar chart makes it look attractive to buy, the candle
chart proves there is indeed a reason for caution about going long. The
small real bodies illustrate the bulls are losing force. Thus, by using
the candle chart, a trader or investor would likely not buy in the
circled area. The result -- avoiding a losing trade.
This is but one example of how candles will
help you preserve capital.
When investing his own money, Warren Buffet
has two simple rules that he follows:
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RULE #1
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Don't lose money.
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RULE #2
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Don't forget Rule #1.
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Candles truly shine at helping you preserve
capital!
Let’s now look at a specific type of candle
line that has a very long lower shadow called a hammer (shown in Exhibit 3
below). So called because the Japanese will say the market is trying to
hammer out a base. The criteria for the hammer are:
1. The real body is at the upper end of the
trading range.
2. The color of the real body can be black or white.
3. A bullish long lower shadow that is at least twice the height of the
real body.
4. It should have no, or a very short, upper shadow.
Exhibit 3
The hammer reflects the visual insights obtained from a candle
chart—specifically the hammer’s extended lower shadow shows that the
market rejected lower price levels to close at, or near, the highs of the
session.
In the intra-day chart shown at Exhibit 4
(below), I show two hammers at the same area (denoted by the arrow).
These areas took on extra significance since there were two hammers at
the same level and these dual hammers confirmed a support level shown by
the dashed line. This illustrates how easy and powerful it is to combine
the insights of candle charts (the hammers) with classic western trading
signals (the support line) to signal the likelihood of a market turn.
Exhibit 4
Most of the candle signals are made with
candle patterns in which we have more than one candle line. An example of
a candle pattern is a bullish engulfing pattern as shown in Exhibit 5
(below). The market falls, and a black candle forms. Next session a
candle line develops with a white real body that wraps around the prior
session's black body. The name for this pattern is based on the fact the
white candle “engulfs” the black candle. As the white real body opens
under the prior black real body’s close, and closes above that session’s
open, it shows buying pressure has overpowered selling pressure, i.e.,
the bulls have taken charge! If the market is solid, the lows of the
bullish engulfing pattern should be support.
Exhibit 5
Exhibit 6
(below) illustrates a classic bullish engulfing pattern in IBM in which
the bullish engulfing pattern confirmed a support area set by a hammer.
Exhibit 6
CONCLUDING COMMENTS
With candle charts, one can use candle
charting techniques, or Western techniques, or a combination of both. This
union of Eastern and Western techniques provides our clients with
uniquely effective tools to help enhance profits and decrease market risk
exposure.
A Japanese proverb says, "His potential
is that of the fully drawn bow- - - his timing the release of the
trigger." The timing of the "release of the trigger"
depends on many factors not addressed in this pamphlet. However, while
this pamphlet provides only a basic introduction to candle charts we hope
you have discovered how candle-charting techniques open new and unique
doors of analysis.
As a final note, there have recently been
books, articles, and seminars from so-called "candlestick
experts" who make no reference to where they found their information
about candlesticks. Even more worrying for you as a trader is that they
are making up their own candlestick signals without any historical basis.
Conversely, all of the candlestick patterns
and signals I've revealed have been confirmed by more than one Japanese
source (Japanese traders, Japanese books, etc.). From my vast array of
candlestick resources, there is absolutely no mention of many of these
"new" patterns I see tossed around by other writers and
speakers.
This is not to say some of other authors
ideas may not be useful. But you must be careful about the information
they give – especially when they teach "home-made" candlestick
patterns. True candlestick patterns have been refined by generations of
use, and not by someone who has only been using candlesticks for a few
years and decided to "invent" a candlestick signal.
As the Japanese proverb says, "If you
wish to know the road, inquire of those who have traveled it."
©2005
Nison Research International Inc./Candlecharts.com All rights reserved.
No part of this publication may be reproduced, stored in a retrieval
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written permission of Nison Research International Inc. Brief excerpts my
be made with due acknowledgment.
This
publication is designed to provide accurate and authoritative information
in regard to the subject matter covered. It is distributed with the
understanding that the publisher and author is not engaged in rendering
legal accounting or other professional service. If legal advice or other
expert assistance is required, the services of a competent professional
person should be sought. From a Declaration of Principles jointly adopted
by a Committee of the American Bar Association and a Committee of Publishers
Associations.
Nison Research International, Inc. does not
guarantee or warrant that readers who use the strategies herein will
achieve favorable results. Nison Research international Inc. disclaims
responsibility for any adverse consequences that might arise directly or
indirectly from the use of strategies discussed in this publication.
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