Getting Started in Candlestick Charting

Tina Logan

• Publisher: Wiley
• Year: 2011
• Print ISBN: 9780470182000
• eBook ISBN: 9781118045305
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

If you want to gain an edge in today's competitive markets, adding the candlestick methodology to your repertoire of technical analysis skills is essential. Getting Started in Candlestick Charting can help you achieve this goal, whether you're new to chart analysis or looking to enhance your understanding of the approach. This reliable resource covers thirty of the most widely recognized candlestick patterns and includes real-world charting examples backed by informative commentary.

Part 1

Candlestick Charting

Chapter 1

Introduction to Candlestick Charting

When I first began using technical analysis years ago, I used the standard bar chart. Eventually, though, I discovered the candlestick chart with its unique display of price action. Just switching from bar charts to candlestick lines alone helped my chart analysis tremendously. Candlesticks light up the chart’s canvas, making it very quick and easy to see price trends and changes in the sentiment of market participants.

The next step was to learn the candlestick patterns with their unusual yet interesting names. After I understood the psychology behind the various patterns, I never went back to using bar charts. Once you learn to put this powerful charting tool to work, I am confident that you, too, will get hooked on candlesticks.

As valuable as candlesticks are as a chart analysis tool, they are simply that—one tool. They should not be viewed in isolation, but instead in the context of the surrounding chart landscape. Japanese candlestick charting should be blended with classic Western technical analysis methods rather than replacing them. It is the synergy of the two methods—Eastern merged with Western—that provides the means for superior technical analysis.

Getting Started in Candlestick Charting will not only provide you with an introduction to candlesticks, but will show you how to analyze them with the aid of Western techniques. It will guide you down the path toward advancing your charting skills and improving profitability.

Evolution of Candlesticks

Japanese candlestick charting is a centuries old methodology that was a secret of the Far East for generations. Candlestick charting took root in Japan, where the first rice exchange was set up in the 1600s. Eventually the exchange was institutionalized and the Dojima Rice Exchange in Osaka, Japan opened for business. Initially, the merchants dealt only in the exchange of the actual product: rice. In the early 1700s, the exchange shifted to the use of rice coupons. Rice coupons were sold against future rice deliveries resulting in the creation of futures contracts. The Dojima Rice Exchange was Japan’s largest rice exchange, and the world’s first futures market.

The legendary Japanese businessman Munehisa Homma made a considerable contribution to the early development of what we know today as candlestick charting. In 1750, Homma was granted control of his family’s business, which included a large rice farming estate. He began trading at the local rice exchange in Sakata, Japan, a busy port for the collection and distribution of rice, and still an important port city today.

Homma accumulated a great fortune trading in the local and regional rice exchanges. It was said that he set up a network that stretched from Sakata to Osaka (a few hundred miles), which consisted of men using flags to communicate from rooftops. Homma kept records of his observations of the psychology of rice traders, as well as a historical record of weather conditions and rice prices. The trading rules and principles that Homma developed were instrumental to the evolution of candlestick analysis.

It wasn’t until a few centuries later that candlestick charting was introduced in the United States. Candlestick charts have become extremely popular since first being introduced in the West in 1989 by author Steve Nison. The first edition of his groundbreaking book Japanese Candlestick Charting Techniques was released in 1991 (New York Institute of Finance). Before that time, candlesticks were virtually unknown in America. If not for Mr. Nison’s perseverance and passion for the subject matter, the Western hemisphere may have continued to be unaware of this remarkable analysis tool.

Fortunately for us, Mr. Nison spent an immense amount of time and effort researching this charting methodology. This was no easy task. He began his research and study of candlesticks before the advent of mainstream charting programs, and as such, initially had to create the charts by hand. In addition, it also involved the tedious and difficult translation from Japanese to English. Add to that the challenge of interpretation, and some subjectivity that is an inherent part of technical analysis, and you can see the magnitude of this undertaking. As with most great endeavors, he accomplished those tasks with the help of key contacts he developed in the United States and abroad.

Traders who are new to candlestick charting will enjoy the benefits of Nison’s persistent efforts, as well as the contributions by other authors who followed his lead. As candlesticks took hold in America, traders embraced them and helped integrate this technology into the realm of Western technical analysis.

The use of candlestick charts has now become so common that nearly all charting programs include them. With the widespread use of computerized chart analysis, the candlestick chart has become as well known as the bar chart. In fact, almost every trader that I know uses candlesticks; so I’d surmise that the candlestick chart has caught up with the bar chart in popularity, and perhaps even surpassed it.

If a technology is not effective it will not last. Experienced traders will eventually abandon a methodology if it does not prove worthy as an analysis tool, which, directly or indirectly, enhances their profits. The fact that candlestick charting has been around for centuries is a testament to its effectiveness.

Strengths of Candlesticks

Candlestick charts are superior to bar charts. That is only my opinion, of course, but it is one that is shared by many skilled chartists. Compare a bar chart (Figure 1.1) to a candlestick chart (Figure 1.2) and you’ll see that they include the same price data: the open, high, low and closing prices. The candlestick line, however, provides insight into the current psychology of the investing crowd, which is not as easily identified in a bar chart. Once you become comfortable with the candlesticks, and understand their implications, you may find that a standard bar chart looks incomplete.

Since the candlesticks include the same price data as bar charts, you can utilize any of the popular technical analysis tools and techniques that can be used with bar charts, such as moving averages and trendlines.

FIGURE 1.1 Bar chart

Source: TeleChart 2007®

FIGURE 1.2 Candlestick chart

Source: TeleChart 2007®

Candlesticks make analysis quicker and more efficient. Since the area between the opening and closing prices is boxed and colored, it is obvious whether the bar is bearish (black) or bullish (white). In addition, the length of the boxed area tells us how dominant the bears or bulls were during a trading session. You don’t have to stop and “think it through.”

Candlesticks are tremendous for signaling turning points. They help identify the sentiment of investors as price becomes overextended or tests support and resistance levels. Their signals are often received earlier than those from traditio...

Table of contents

• The Getting Started in Series
• Title Page
• Copyright Page
• Preface
• Acknowledgments
• Part 1 - Candlestick Charting
• Part 2 - East Meets West
• Conclusion
• Appendix A
• Appendix B S&P 500 LARGE-CAP INDEX COMPONENTS (AS OF OCTOBER 2007)
• Glossary
• Bibliography
• About the Author
• Index