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Spotting early reversal signals by using candle charts
A prudent man has more than one string to his bow." — Japanese proverb
Japanese candlestick chart analysis, so-called because the lines resemble candles, has been refined by generations of use in East Asia. Such charts have been used longer than bar charts and point-and-figure charts but were unknown to the Western world until I introduced them in 1990. These charting techniques are now used internationally by traders, investors, and premier financial institutions here and abroad. Most technical analysis Web sites, real-time trading systems, and technical analysis software have candlestick charts, attesting to their popularity and usefulness.
Some of the reasons for the explosive interest in these heretofore secret techniques are:
•Candlestick chart techniques are easy to understand. Anyone, from the first-time chartist to the seasoned professional, can easily harness the power of candlestick charts. This is because, as will be shown later, the data required to draw the candlestick chart is the same needed to draw the bar chart (the high, low, open, and close).
•Candle charts provide earlier indications of market turns. Candlestick 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 ascertained with the aid of candle charts will frequently be in advance of traditional indicators. This should help you enter and exit the market with better timing.
•Candle-charting signals furnish unique market insights. Candlestick charts not only show the trend of the move, as does a bar chart, but, unlike bar charts, candlestick charts also show the force underpinning the move.
•Candle-charting tools enhance Western charting analysis. As noted earlier, candlestick charts use the same data as bar charts: open, high, low, and close. This means that any Western technical tools you now use can also be used on a candlestick chart. However, candlestick charts can also give you timing and trading benefits not available with bar charts.
Candle-charting strategies are a tool, not a system, and they are best used in conjunction with those Western technical techniques you are most comfortable with.
As the Oriental proverb states, "A journey of a thousand miles begins with the first step." This chapter is a first step, albeit an important one, on the road to candlestick chart analysis. You will see how the candles can help make your market analysis more efficient, improve entry and exit timing, and open new, effective, and unique avenues of analysis.
Charts 1 and 2 show samples of candle lines. The broad part of the candle line, called the real body, is the range between the session's open and close. If the close is higher than that session's open, the real body is empty (see a in chart 1). A black real body (see b in chart 1) occurs when the close is lower than the open.
The thin lines over and under the real bodies are, respectively, the upper and lower shadows. The top of the upper shadow is the high of the session; the bottom of the lower shadow is the session's low.
FIGURE 2
Notice how the candle lines in chart 2 do not have a real body. Instead, they have a horizontal line. These lines that look like crosses are called doji. A doji indicates that the open and close are the same (or almost the same). The doji signifies that the market is in balance between the forces of supply and demand. The emergence of a doji in a trending market could be an indication that it is losing its momentum. Doji are discussed in more depth later.
FIGURE 3
Step 1: Type INDU <Index> GPC <Go)>.
Step 2: Tab in to the RANGE fields, and enter 04/14/99 and 07/30/99 as the start and end dates, respectively, for the analysis. Press <Go>. Note the doji on July 6.
Candle-charting techniques can be applied to whatever time frame you now use, from intraday to weekly. Thus, on a 60-minute chart, the real body is the range of the open and close of that 60-minute Japanese, such a session — especially after a sharp advance — indicates that the stock is, as the Japanese ay, "separating from its trend."
As previously mentioned, candlestick charts can be used in any time frame, including small intraday segments. For example, type NDX <Index> IGPC1 5 <Go> for a chart of the Nasdaq 100 Stock Index in which each candle line represents the open, high, low, and close of a five-minute period.
Whether intraday or over several days, the presence of a doji after a forceful rally should hoist a warning flag. The doji can be a valuable warning that as an index or security reaches a peak, it meets enough supply to checkmate all of the demand. If there is a doji after a long white candle, you can use the highest high of the tall white candle or the doji — including their shadows — as signals of resistance.
An example of this technique can be seen in figure 3. Observe how the high of the doji became resistance. This chart shows how resistance can be penetrated intraday, as it was on July 17. But if the bulls cannot maintain enough force to hold the market above resistance into the close, then the resistance area is still valid. A close over that resistance level would mean a bullish breakout. Just as the market is "tired" with a doji after a tall white candle, so it is said to be "refreshed" with a close over the resistance area.
A Japanese proverb states, "His potential is that of the fully drawn bow; his timing is the release of the trigger." The timing of the "release of the trigger" depends on many things beyond those addressed here. For example, there are times when candle signals should be ignored. This is when experience with candlestick charts comes in. Candlecharts.com analyzes and evaluates candle-charting signals with many other considerations, including the risk/reward of potential trades, candle patterns in relation to current market conditions, and a market's action after a trade is initiated. These and other trading aspects allow for the most fully enhanced power of the candles, and such an integrated approach is recommended for their use. May the candles help enlighten your trading.
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means: electronic, mechanical, photocopying, recording, or otherwise without the prior written permission of Candlecharts.com. 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.
Candlecharts.com does not guarantee or warrant that readers who use the strategies herein will achieve favorable results. Candlecharts.com 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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