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Candlesticks light new path for western chartists
By Simon Denyer
The west has never been quick to unravel the mysteries of the Orient. Yet, after more than a century, the investment community is finally learning to watch markets by Japanese candlelight.
They are using candlestick charts, a method which predates all occidental charting techniques. Some candlestick enthusiasts say that one day they could even supercede bar charts.
Soon many more westerners will learn to recognise 'evening stars' even after Christmas, or take note of other exotically named formations like 'three-winged crows' and 'hanging men'.
Steve Nison, the west's leading exponent of the method, says there has been an explosion of interest in North America and Europe in the past two years.
"Candlestick trading techniques have become one of the most discussed forms of technical analysis in the trading community, both (in the U.S.) and abroad," he says.
"They're definitely used more and more in England," says Bronwyn Wood, education director for the Society of Technical Analysts in London. "I think they are going to eventually eliminate bar charts for most people."
The principles of the technique are simple. A candlestick chart uses the same open/high/low/close data as a conventional bar chart, yet in a way which reveals more to the eye.
The broad 'body' of the candlestick is drawn between the market's opening and closing prices, like the line on a bar chart only thicker. Thin 'shadows', or lines, at either end extend to the session's highs and lows.
The body is then coloured to show market direction - black if the close is below the open, white (or red) if prices close above the opening level.
Their similarity to conventional bar charts makes candlesticks compatible with traditional western technical analyses. Anything from simple moving averages to Elliott Wave can be incorporated.
" You do get an extra dimension ... but you have to put them together with trendlines, other indicators and moving averages," says the STA's Wood.
Nison agrees, descibing candlesticks as a tool rather than a system in themselves. Yet their advantage, and their complexity, lies in the patterns which these charts throw up - an array of poetically named formations which make head-and-shoulders tops and saucer bottoms sound positively mundane.
" Part of the reason it caught on so quickly (in the past few years) is that the terminology catches your attention," says Nison. "But their staying power reflects the value they offer in analysing the markets," he adds.
The formations can be split into those which suggest a reversal in market direction, and those which suggest a continuation of the trend.
A 'three-winged crow', consisting of three consecutive daily declines drawn as black candles, is a typical bearish continuation pattern. 'Evening stars' and 'hanging men' are bearish reversal patterns.
"They do tell you much more than average bar charts," says Amir Anvarzadeh, technical analyst at Towa International in London. Perhaps the most significant single-day reversal pattern of all is the 'doji' (pronounced doh-gee), a candle with no body. where the market opens and closes at the same price.
Anvarzadeh says he spotted one on December 6 when the dollar closed in Tokyo at its opening price of 124.90 yen, suggesting an end to dollar strength when conventional bar charts gave no clue. This was followed the next day by a one-yen fall, mapping out a 'bearish engulfment' pattern to confirm a change in trend.
At 1526 GMT Monday the dollar stood at 123.03/08, roughly two yen below its 'doji' top.
"Candles give you an early warning system," says Refco's Nison. "Whereas bar charts can take weeks to break a trend, candles can give you a reversal pattern in just a couple of days "
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