Steve Neeson, President of Nison Research International, Inc. (NRI), was the first, who discovered the Japanese method of technical analysis, known as "candlestick charts", for the West. He is an internationally recognized authority in the field., revolutionized technical analysis in the USA and Europe using these methods. He is the author of two popular books.: "Japanese candles» and "Beyond Japanese Candlesticks". He advises all over the world, including the Federal Reserve and World Bank. At NRI, Mr. Neeson specializes in webinars and consulting services to organizations.
Detecting Early Reversal Signals with Japanese Candlesticks
The prudent man has more than one string for his bow.. ( Japanese proverb)
Analysis of Japanese candlestick charts has this name, because its lines resemble candles. Used by generations of people in East Asia. Such charts were in use long before columnar histograms or "tic-tac-toe", but were practically unknown to the Western world before, how I introduced them into use in 1990 year. This charting technique is now used internationally by many traders., investors and well-known financial institutions.
Japanese candlestick technique slightly to understand
Anyone, from a novice chartist. The sophisticated pro can easily use the candlestick chart.
Candlestick charts provide earlier indication of market turn
Candlestick charts can give reversal signals over several trading sessions, which is significantly less than weeks, often required to form a reversal signal on the histogram. In this way, centerfold, confirmed with a candlestick chart, will often outperform traditional indicators. It will help you get in and out of the market at the best time..
Candlestick chart signals provide unique insight into the market.
Candles not only show the direction of travel, how bar charts do it, but, in contrast, show strength, supporting this movement.
Japanese candlestick toolkit enriches Western chart analysis.
Candlestick charts use the same data, as histograms - opening, closing, maximum and minimum.
Candlestick charting strategies are a tool, and not a system and therefore, best used in conjunction with that trading technique, which you are most used to.
Plotting Japanese candlesticks
Thick part of the candle, called "body" (real body), there is a distance between the opening price and the closing price of the session. If the close is higher than the open price, the body of the candle remains empty (a). If the close is lower than the open, then the body of the candle turns black ( b).
Thin lines above and below the body of the candle, are named accordingly, "Upper and lower shadow" (upper и lower shadows). the top of the upper shadow is the high of the session price, the bottom of the lower shadow is the low of the price in the same session.
Candle, which has no body, instead of which it has horizontal dashes. Such candles are called "doji" Doji show, that the closing and opening prices of the session were equal (or almost equal to) and means, that the market has found a balance of supply and demand. The appearance of a doji in a trending market could mean, that the market has lost its momentum.
The candlestick technique is suitable for any time frame.
Body size and color are powerful advantages of candlestick charts., because it contains a lot of information about how, who dominates the market - bulls or bears.
– long white candle shows, that bulls dominate.
-a long black candlestick indicates the bears' advantage.
-small candle body (white or black) talks about, that bulls and bears are pulling the rope on top of each other, i.e. market trend ,maybe , lost momentum.
With that in mind, you can use separate candles to scale the supply and demand balance in the market.
Use of individual candles
Doji
The Japanese say, what doji, especially, after a very tall white candle, shows, that the market is "tired" or overbought.
By virtue of that, that doji is very easy to spot, some analysts can use it as a signal to buy immediately (with an upward trend) or sale (with a downtrend). but,, doji point, that the market is in transition. Doji changes the bullish trend to a more neutral direction, but doesn't mean, which will immediately turn into a fall. Chances of it, that doji predicts a reversal, increases if:
– doji confirms other technical clues (for example, the market is near a resistance or support level, near the level 50% corrections, etc.)
-the market is overbought or oversold.
However, these remarks are also true for most other candlestick patterns. Since the toolkit of candlestick charts for the most part, serves as a reversal indicator, market, to which these tools apply, must be sensitive to corrections, and investors strive to increase the chances of catching a turn, even temporary.
DJIA , starting at the end of June 1999 of the year, a series of long white candles, made a big rise to the level 10 550. This pointed out, that the bulls completely control the market. The indicated situation has completely changed with the appearance of one candle - an arrow-shaped doji. Before it appeared, white candles showed strong, busy market, and the doji pointed out, that the rise began to turn.
Doji top becomes resistance, Moreover, this resistance was pierced within the day of July 17th., but since the bulls did not have enough strength to hold the market above resistance, this level remains valid. A close above this resistance would mean a bullish breakout. Figuratively speaking, if the market “Tired” generated dodge, he needs “Freshen up” closing above the resistance level.
A key feature of candlestick charts can be noted here - they generate signals, not available in the Western technical approach. For example, bar chart shows the same open and close prices, it does not give any predictive signals. While such a situation on a candlestick chart may indicate a possible rejection of the original trend.
Candlestick charts can be used on any time frame, including small intraday segments.
Each candle represents a 5 minute period (open-close-high-low). Two tall white candlesticks represent strong rally on December 30th. The warning flag appeared along with the arrow-shaped doji., which testified, that the index has reached its recent peak in 3750, where I met a supply sufficient to meet the demand.
Other uses of the doji can be seen here.. If the doji appeared after a long candle, you can use the tops of the candlestick and doji shadows as a resistance level. Notice how the zone 3745 (the maxim of the white candle, previous doji) becomes resistance.
SHADOWS
Although the body is an important part of the candle (the japanese say, that the body of the candlestick is the "essence of price movement"). It is also possible to extract essential information from the length and position of its shadow..
For example. If a relatively tall white candle had no shadows, then this could be considered a positive indicator. but, examining this candle in full, including shadows, gives us a different idea of market power because, what the long upper shadow indicates. That the lift has been slightly crushed. That is, the long upper shadow indicates that, that during the session the market rose intraday to a high, but to close , the bulls were unable to hold that height..
Usually, two standing next to each other, black-body candles, will be a negative signal, but, the lower shadow of both candles shows, that the bears didn't have enough strength, to keep the market down at the close. Additionally, for both candles , the minimums were equal, which is another warning about bearish sentiment in this market.
"Hammers" and "shooting stars"
Some candles have shadows on one side only.. And that shadow can be very long.. Examples of such single-shadow candles are "hammers" (hammers) and shooting stars (shooting stars).
"Hammer"
If a hammer candlestick appears on a downtrend, then it is a signal of a potential upward reversal.
Hammer signs include
– small candle body (white or black) at the edge of the trading range;
– long bottom shadow, at least, two to three times more. Than body size;
-little or no upper shadow;
-appearance during price reduction, since this is a signal of a reversal upward.
Hammer lines provide visual bullish confirmation. Its long lower shadow indicates that the market sells out and by the close of the session it returned to the top. This indicates, that the market is rejecting lows.
Ideal “hammer” with extended lower shadow, no top and close at the high of the day. This long lower shadow is a positive indicator., since it unambiguously shows, that demand exceeds supply.
but, from a trade perspective, the longer the lower shadow, the further you are from buying at the minimum. And in terms of risk / reward ratio, then buying after the completion of the formation of the "hammer" (at the close of the session) may not be the right deal.
For example, Wal-Mart Stores (WMT) formed a "hammer" with a long lower shadow almost 5$. This would mean a risk of almost 5 Dollars, if you bought at the close. Need to wait for the correction, not exceeding the size of the lower shadow, (if such a correction occurs), before opening a long position. This will reduce the risk of the transaction., because you are buying near a potential support level. In this example,, the paper fell the day after the hammer was formed, but held on to support in the area of the hammer low. If the close was below the low of the hammer, the downtrend would continue.
Another valuable aspect of candlestick charts, which one analyst called "negative selection". This is revealing those papers, which do not need to be touched, neither buy , neither sell, which is useful, as capital preservation can be just as important, like its accumulation.
In the example on the chart, 24-th August, doji, followed by a long white candle, foreshadowed a trend reversal. This reversal has found its bottom., by drawing a "hammer", who supported (closure area) over the next few days. 15-On October 1st, a large black candlestick reflected a strong bearish momentum. Because of this big black candle, the purchase could be very risky, however, the hammer indicated support, near which the paper was. Therefore, I would not sell this stock., despite the long black candle, Demonstrating, thus, negative selection. You can see, how well this hammer worked as a support, since the paper jumped in the next session.
“FALLING STAR”
Candle with extended upper shadow, small body (white or black) and little or no lower shadow. Potentially, is a bearish sign, if it occurs when the price rises. long top shadow “shooting star” speaks of sufficient aggressiveness of bears. which are able to pull the price from the top of the session and close it near the low.
Most candlestick signals are reversal, they work more efficiently when the market is overbought or oversold.( RSI as an indicator of overbought and oversold.)
The RSI indicator adds additional significance to the coincident candlestick. Remember - candlestick charts complement Western technical analysis tools, but do not replace them.
Absorption models.(engulfing pattern)
Engulfing patterns are a two-candlestick formation.
Bullish engulfing pattern - appears on a downtrend, when the white body of a candlestick absorbs the black body of another candle.
Bearish engulfing pattern – appears on an uptrend, the black body absorbs the white body of the candle
Trading technique based on absorption models, is to use the smaller of the two lows of a bullish pattern as a support level. And for a bearish pattern, the larger of the two tops is used., as resistance.
Dell Computer Corp Stock. Formed a bullish engulfing pattern in early August 1999. This model has established a support level of about 37,5$. Doji touched this support in mid-October. More significant was the high volume of this doji.. High volume shows, what was a significant speculation, but small body (ie dodge) visually proves, that the whole proposal was consumed, practically, equal aggressive demand.
Bearish engulfing pattern. Moment to sell ( in terms of the risk / reward ratio) might not be the most attractive. A more conservative strategy would prefer to wait for a rebound (which might not have happened) and use the top of the bearish pattern as a resistance level. This level was maintained during the next two attempts of the index to rise above 8200 (on the second attempt the level was broken within the day. But didn't close above him). Market close above the bearish engulfing pattern (or below a bullish pattern) seen as a breakthrough. And this leads to an important aspect of candlestick charting patterns - a recognized candlestick signal does not mean that trading is guaranteed at that particular moment in time.. It is necessary to assess the risk / reward ratio of this transaction.
"WINDOW"
"Window" in Japanese candlesticks means the same, as the gap in Western technical analysis. The "growing window" appears, when yesterday's high is below today's low. That is, there is a vacuum between yesterday's and today's prices.. "Falling window" appears, when yesterday's session low is above today's high. "Windows" visually provide information about the market - they indicate its one-sided mood.
The rising window is seen as a bullish pattern, Falling window – like bearish. To trade with them, you need to use them as support (Growing window) or resistance (Falling window). There is a saying in Japan about "windows": "The reaction will reach the" window ". It means, that somewhere inside the "growing window" there will be support for correction. And with a "falling window" , there will be resistance to bounce inside it.
Buy signals
"Windows" in points 1. 2. 3 "Window" 1 Is the usual "growing window", which becomes a support. The "window" was pierced, but, closing of this candle, so the puncture is considered support testing. «Windows» 2,3, were not just "windows", but also gaps, crossing the previous resistance line. In Western technical analysis, they are known as "breakout gap", because the market breaks through the resistance level in one fell swoop. In classical Western chart analysis, such a price gap is considered bullish.. Adding to it the possibilities of candles, more precisely using "growing windows" as support, can be concluded, that point 2 And 3 (both - breaking the gap) are buy signals.
Support may end up inside a "growing window". Small "window" provides less space (narrow zone) for support or resistance. The large "window" presents difficulties in determining the location of these zones since the entire "window" is a potential zone of support and resistance..
Intraday Chart . whose support zone extends by 30 points - from the top of the "window" (about 3360) to the bottom of the "window" (near 3330). Support needs to exist somewhere inside these 30 points. Later, in session 17 December, series of candles with long lower shadows, allowed to conclude, what support was 3340. This support was confirmed the next day with a hammer.. An important level of support in the "growing window" is its bottom, but in this example, support was higher, than the bottom of the "window".
Candles and ratio “risk / return”
Nison Research International, Inc. (www.candlecliarts.com) uses a unique approach to trading, which is called The Trading Triad® (Trade Triad). This approach combines three analytical techniques.: candles, Western analysis and capital preservation.
The usefulness of combining candles with Western technique has already been mentioned., a Rice. 52 demonstrates the importance of the third leg of the Trade Triad® - capital preservation. Should you buy, when you see a bullish engulfing pattern
Before making a decision, consider the risk and potential return of this trade. Risk (that is stop) in a bullish engulfing pattern is equal to the low of the pattern. In our example, the minimum is in the area $24, where is the potential target? Your reply, undoubtedly, depends on the technical and fundamental prospects of the stock, according to your analysis. but, in this example, there is one remarkable thing - the potential resistance zone in a small “Window” near $25.5, just before a bullish engulfing pattern. In this way, Having $25.5 as first resistance, you can estimate the ratio of risk and reward in this transaction. I.e, if you buy at the end of a bullish engulfing pattern ($25.25), it happens close to the resistance zone. In this way, this market is not conducive to a long position, despite the bullish engulfing pattern. The moral of this example – before, how to enter the deal, always consider the risk / reward ratio.
Exploring candlestick patterns
Rice. shows a clearly formed “milkweed”, which you can, in general, take as a potential reversal signal. But, as the Japanese say, the overall technical picture is much more important than a single candlestick or pattern.
With that in mind, Note, what happened on the day “Hammer”. Appeared “falling window” – bearish signal. The potential bullish strength of this hammer, hence, should have been confirmed by closing above this window.
After “Hammer” the market continued to fall, (which is not surprising, given the bearish urge “window”). Can you find any clue, indicating that the market is losing bearish momentum in this case? Hook-
|Long bottom shadows of the day “Hammer” and two days after it. Their appearance proves, that the bears could not hold, the market is at the bottom of the trading session. Although these signals are not bullish., they reduce bearish efforts to reduce levels. The reversal signal appears as a bullish engulfing pattern in mid-December.
Japanese proverb says: “The strength of the drawn bow depends on the timing of the bowstring.”. Synchronization “lowering the bowstring” depends on many factors, not mentioned here. There are times, when candlestick signals should be ignored. All comes with experience. Nison Research International analyzes and evaluates candlestick charts in conjunction with many other factors, including risk-reward ratios of a potential trade, the relationship between the candlestick pattern and current market conditions, as well as market actions after the transaction. This integrated approach is recommended when using Japanese candlesticks and, maybe, they will help improve your trading.
