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Candlestick charts have been used for
over a century in Japan, and are as common there are bar charts
are in the West. And since candle charting techniques offer
so many important advantages, they are now one of the most
discussed forms of technical analysis. Steve Nison tells how
he saw the light.
 Since
candlesticks are Japan's most popular form of technical analysis,
understanding them may provide insights into how the Japanese
view the markets. This may help
to answer the question: "What are the Japanese going to do next?" Candle-
stick charting tools can be fused with any Western technical tool, and can send
signals not available from bar charts. This may provide a way to get the timely
jump on those who use traditional Western charting techniques. The Japanese are
very knowledge- able about the technical tools used in the West. Now that Western
traders have access to technical tools refined by generations of use in the Far
East, it is their turn to learn from the Japanese. Exhibits 1 and 2 show the
construction of the basic candle line. The thick part of the candle is called
the "real body", and illustrates the relationship between the session's
open and close. When it is black (filled in), it means that the session's close
was lower than open.
If the real body is white (empty), it means that the close was higher than the
open.
The thin lines above and below the real body are the "shadows". The
top of the upper shadow is the session's high; the bottom of the lower shadow
is the low of the session. This is why these charts came to be called candle
charts — - the chart lines look like candles with their wicks. Candles
can be used across all time frames — from intraday to monthly charts. For
example, on a weekly chart an individual candle line would be composed of Monday's
open, Friday's close and the high and low of the week.
A major advantage of the candle chart compared to a bar chart is that a candle
chart shows visually whether it is the bulls or bears in charge of the market.
For example, a long white candle reflects a session in which the bulls are in
control; a long black real body, as in exhibit 1, reflects a market with the
bears are in charge.
Example 3 shows a doji (pronounced do-jee). Note that this type of candle session
does not have a real body. A doji is when the market has the same open and close,
and reflects a time when the bulls and bears are in equilibrium.
A doji that emerges after a tall white candle should be viewed as a warning that
the market trend may be changing. The reason for the doji's negative implications
in up trends is because it rep- resents indecision. Indecision, uncertainty,
or vacillation by the buyers will not maintain an uptrend. It takes the conviction
of buyers to sustain a rally, and if a doji surfaces after an extended rally
it could mean
the scaffolding of buyers' support will collapse.
Chart I (British Pound Weekly)
shows two doji near the $1.60 area — both of which emerged after long white
candles. A doji after a long white candle is a warning that, as the Japanese
would say, the market is "tired".
The long white candles before these doji showed that the bulls were in control.
But the appearance of the doji hinted that the bulls had lost control. These
doji confirmed a resistance area near $1.60. This resistance is based on the
fact that there was a major support area throughout 1991 near $1.60. Based on
the technical axiom that old support becomes resistance, the prior $1.60 sup-
port area became resistance in late 1992 and throughout 1993. That the doji near
$1.60 confirmed this resistance level shows how easily the candles can be melded
with Western technical tools.
Exhibit 4 shows a candlestick session with a long lower shadow and a small real
body (which can be black or white) near the top of the range. This line is bullish
if it appears during a down- trend. Such a candle line is called a hammer since,
supposedly, the market becomes so strong that a hammer can- not break it. A hammer
pictorially displays that the market opened near its high, sold off during the
session, then rallied
sharply to close at, or near, the highs of the session.
Chart 2 (December Comex Gold) shows how a bullish hammer formed at the June lows.
Also of interest was the August 2 doji (see the arrow) that came after a tall
white candle. This doji session in itself was a warning, but of extra concern
was that it was a "long
legged" doji with a long upper and lower shadow. Such a candle reflects,
the Japanese say, "a market that has
lost its sense of direction".
 Exhibit
5 is called a bullish engulfing pattern. The market is in a downtrend, then a
white real body engulfs the prior period's black real body. The engulfing pattern
illustrates how the candles can help provide greater understanding of who is
winning in the battle between the bulls and the bears.
For example, if the market is in a downtrend it means that the bears are in control.
Then, if a long white candle wraps around a black candle after a downtrend (i.e.,
forms a bullish engulfing pattern) it tells us that the bulls have wrested control
from the bears. In Chart 1 (British Pound) a bullish engulfing pattern is highlighted.
There are many more patterns, concepts and trading techniques than those shown
above, but even with the basics covered here, the powerful and unique insights
the candles
provide can be seen.
Candle charting techniques are now used by professional money managers and traders
worldwide. In a recent Lon- don article about the explosive interest in the candles,
a member of the English Society of Technical Analysts said she believed that
candle charts will for most people eliminate bar charts. Since candles offer
insights into the markets not available anywhere
else, this is no wild
prediction.
Candle charts reveal not only the trend of the market, but the force behind the
move. In addition, most candle signals will take only a few sessions to reveal
a market turn, whereas traditional pattern recognition with bar charts may take
weeks. With candle charts, traders can use candlestick techniques, Western techniques,
or a combination of both. Experienced technicians will find the union of the
techniques of East and West to be a powerful combination.
Those who can make use of the candle's tremendous potential will discover that
candles provide important trading and timing advantages. As you become familiar
with candle charts you will see why candle charts have been called the most powerful
method of charting
in the world. May the candles enlighten your trading!
from Futures and Options World
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