Introduction:
·
Candle charts open new avenues of analysis and
offer many advantages over bar charts
·
Shows supply-demand situation pictorially but
bar charts do not
·
Shows the trend and the force behind the move
·
Gives clues of imminent reversals in 1 to 3
sessions, unlike bar charts.
Chapter 1 – Overview
·
Gives a glance of what is discussed in the book
Chapter 2 – The Basics
·
The Japanese started trading in the market in
the 1600s, the birth of Japanese rice futures market.
·
The Japanese technical analysis was born trading
in rice futures. The most famous trader was Homma, when he discovered that
although there is a link between supply-demand, the markets were strongly
influenced by the emotions of the traders.
·
He understood there is a difference between the
value and the price of rice.
·
Homma wrote the book, “The fountain of Gold- The
Three Monkey Record of Money”.
·
The Three Monkeys:
o See
no Evil:
§ There
is always a rotation of Yang (bullishness) and Ying (bearishness).
§ Within
each bull market, there is a bear market, and within each bear market, there is
a bull market.
§ When
you see a bullish(bearish) trend, consider it an opportunity to sell(buy)
o Hear
no Evil:
§ When
you hear a bullish or bearish news, don’t trade on it.
§ It
may be safer to take a position after you determine how the market reacts to a
news rather then initiating a trade when the news is released.
o Speak
no Evil:
§ Don’t
speak to others about what you are going to do in the market.
§ It
is safer not to speak to anyone about you plan unless you believe, they have a
better insight.
·
Evolution of Candle Charts:
·
Real body candle
·
Shadows (the lines up and below)
·
Support & Resistance
·
Support/Resistance at half point mark of a long
body
·
Support/Resistance at end of shadow of a long
body
·
Prior High/Low as resistance/support
·
Breaching of support/resistance
·
Lateral price movement, frequency of colors of
candles may tell you which way the price may breakout
·
Long upper/lower shadow
·
Spinning tops – small body with long upper/lower
shadow
·
Accumulation – At a low price level, high volume
session with stagnant prices
·
Distribution – At high price level, there is
heavy volume but virtually frozen price
·
Doji – a session with a horizontal line instead
of a read-body – the session’s open and close are the same
o Hits
a reversal or a continuation – need to check the candles after the doji session
to determine the direction
o Gravestone
doji – looks like a wooden memorial used in Buddhist funerals
·
Shadows
o Tall/long
upper shadow
§ Appears
at high-price level, or a resistance area, or when the market is overbought
§ hint
that there is either heavy supply entering at higher prices or evaporation of
buying
o Long
lower shadow
§ Appears
in an oversold market
§ Clue
that bears are losing control
Chapter 3 – The Patterns
·
Hammer – a long lower shadow and a close near or
at the high
o Reversal
Indicator/Bullish signal – must appear after a significant downturn or in an
oversold market to have significance
o MUST
appear during a downtrend
·
Hanging Man – Very long lower shadow, a small
real body (white or back) near the upper end of the trading range. Little or no
upper shadow.
·
An important aspect of the hanging man is that
there should be a bearish confirmation
o Wait
to see if the next session’s close is under the hanging-man’s body.
·
Change of polarity principle
o A
penetrated support price becomes a new resistance
o Or
a penetrated resistance become a new support
·
Shooting Star
o Long
upper shadow, small real body, near the bottom end of the trading range
o Means,
the bears have been able to sharply drag the prices back from their highs
o MUST
appear after an uptrend
o Reflects
market rejection of higher prices
DUAL CANDLE LINES:
·
Dark Cloud Cover – Bull to Bear reversal
o Appears
after an uptrend
o 1st
candle is a strong white, 2nd – open high and closes under the
center of 1st candle
·
Piercing Pattern – Bear to Bull reversal
o Opposite
of Dark Cloud Cover
o Appears
after a downtrend
o White
body that closes within the prior black body. Should close above the center to
be a strong indicator
·
Engulfing Patterns
o Bullish
– during a downtrend, a white body wraps around a black body (including its
shadows)
o Bearish
– during a rally, a black body envelops a white body (including its shadows)
o If
any of the above follows a doji, then in may strengthen the signal
·
Last Engulfing Patterns
o Last
Engulfing Top (Bearish) - A bullish engulfing pattern appearing during a price rally
§ Potential
for bearish top reversal signal
o Last
Engulfing Bottom (Bullish) - A bearish engulfing pattern appearing during a
price decline
§ Potential
for bullish bottom reversal signal
·
Harami
o A
LONG body and a following small body withing it’s range
o The
1st body has to be unusually long relative to the preceding bodies
o It
is the opposite of the engulfing pattern
o Ideal
Harami has the 2nd body in the middle of 1st body
o Either
candle of the Harami pattern can be white or black
o High-Price
Harami – after a rally, the 2nd body is near the upper-end of 1st
body
o Low-Price
Harami – after a downtrend, the 2nd body is near the bottom-end of 1st
body
§ High
or low-priced Harami, the chances of consolidation is higher rather than price
reversal
o Harami
Cross – if the 2nd candle is a doji instead of a small body, it
increases the probability of reversal.
THE WINDOW
·
Rising Window
o The
top of yesterday’s upper shadow should be under the low of today’s lower shadow
o Can
act as a support in latter sessions
·
Falling Window
o The
low of yesterday’s lower shadow should be above the top of today’s upper shadow
o Can
act as a resistance in latter sessions
·
Windows are continuation patterns in which the
market resumes the trend taken before the continuation pattern emerged
·
Trend Void/Reversal
o If
there is a rising window between $83 and $85 and the market closes under the
bottom of the window (under 83), the uptrend can be considered as over.
o If
there is a falling window between $62and $60 and the market closes above the
top of the window (above 62), the uptrend can be considered as over.
·
General Window Indicators
o If
a window is not filled within 3 sessions, it is confirmation that the market
should move in the direction of the window
·
Three Windows
o A
market that has had three rising or falling windows in a row may indicate that
the market has reached maturity
o The
market in such a scenario is viewed as overextended and a correction is likely
·
Two Black Gapping Candles
o Two
black candles immediately following a dropping window
o Reinforces
that the trend has turned from up to down
·
Gapping Doji
o A
doji session that gaps lower during a decline
o Selling
meets more selling and thus is a bearish signal
THREE OR MORE CANDLE LINES
·
Evening Star/ Evening Doji Star
o 3
candle stick pattern
o An
uptrend market in which a long-white candle is following by a small body candle
o The
small body candle can be black or white and should not touch the body of candle
1
o 3rd
candle is a black body that does not usually touch the body of 2nd
candle
o 3rd
candle closes well into the white candle
o If
the 2nd candle if the evening star is a doji, then this pattern is a
Evening Doji Star
o Collapsing
Doji Star
§ If
there is a gapping doji after a white candle in an uptrend
§ The
next session after the doji is a black candle
§ Difference
is that the EDS has the doji above the tall white body and CDS has the doji
gapping under the 1st white candle.
·
Morning Star/ Morning Doji Star
o Happens
in a downtrend
o 3
candle pattern
o 1st
candle – black
o 2nd
candle - a small body candle can be black or white and should not touch the
body of candle 1
o 3rd
candle is a white that pushes into the 1st
o If
this is a doji, then it is called Morning Doji Star
·
Abandoned Baby
o Special
case of Morning Doji Star (MDS)
o Doji
session has a gap before and after
RECORD SESSIONS
·
Record session High
o Confirm
that the low price for the move has occurred
o After
a new low, the next session made a higher-high (record session 1)
o After
8 or 10 sessions, looks for reversal patterns
o There
may be 1 or 2 sessions that may be skipped (may not be consecutive)
o But
if 3 or 4 sessions skipped, then restart the count
·
When there are 8 to 10 record sessions, there is
possibility that the current trend may reverse
Chapter 4 – Candles and The Overall Technical
Picture
·
“An action that ignores the condition of the
market is only asking for a loss & an ambush encounter”
·
Must always consider the overall market
condition before trading with candles
·
“Even monkeys fall from trees”
·
STOPS
o In
the market there is no “room for hope”
o Hoping
the market will turn in your favor is like “To lean a ladder against the
clouds”
o Head
& Shoulder pattern (SHS) aka Three-Buddha pattern
§ Two
shoulders (two arches) and a head in-between (bigger arch) and a neckline that
connects the lows of the bottom of the arches
·
RISK/REWARD
o “The
side that knows when to fight & when not to will take the Victory”
o Waiting
for just the right moment is virtuous
o Just
because there is a candle pattern, it does not mean that the “time is ripe” for
a trade
o Calculate
the Risk (stop loss), and Reward (target price). If Reward < Risk, the trade
is not worth, although there may be a pattern formation.
·
TREND
o “It
is easier to run down a hill than up one”
o Recommendations
§ Place
a new trade in the direction of the prevailing trend
§ Offset
a position when there is a reversal signal against the prevailing trend
§ Bullish
candle signal in a bull trend could be used to place a new long position
·
Becoming a Market Chameleon
o Adaption
to changing market conditions – because, the expectation you have about the
market when you place a trade, may change quickly and you need to have an
action plan to execute when the market goes against your expectation
·
Other points to remember
o Candle
patterns can never be viewed in isolation
o Always
have to consider the surrounding technical picture
o How
you trade with candles will depend on your trading philosophy, your risk
adversity, and temperament.
PART 2 – THE DISPARITY INDEX AND
NEW PRICE CHARTS
·
“Consider the Past and You Will Know the Future”
Chapter 5 – How the Japanese Use Moving Averages
·
“Money grows on the tree of patience”
·
Popular moving averages
o Short-term:
5, 9, or 25 day
o Long-term:
13, 26 week, or 75 & 200-day
·
THE GOLDEN AND THE DEAD CROSS
o Golden
Cross (bullish sign)
§ If
short-term MA crosses over the long-term MA
o Dead
Cross (bearish sign)
·
The DISPARITY INDEX
o Or
Disparity Ratio, compares, as a percentage, the latest close to a chosen MA.
o It
is an effective method to show if the market is oversold or overbought
o An
oversold condition can be relieved in one of two ways:
§ Either
a sharp bounce
§ Or
a side-ways action (box action)
o Another
use of disparity index is to monitor divergence
§ When
two disparity indices are in the oversold territory, but the 2nd
peak is lower than the 1st peak
§ The
1st disparity peak corresponds to 1st high-price, 2nd
disparity index corresponds to 2nd high-price. But the 2nd
price is higher than the 1st high-price
o Divergence
Index
§ It
is the same as the disparity index; it is just scaled differently
§ For
example, a 13-day divergence of 102% means that the market is 2% above the
13-day moving average. A 13-day disparity reading of +2% also means that the
market is 2% above the 13-day moving average.
Chapter 6 – Three-Line Break Charts
·
“Weigh the Situation, Then Move”
·
More subtly form of point and figure charts
where the reversals are decided by the market and not by arbitrary rules.
·
Series of white & black blocks(lines) of
varying heights
·
Constructing
o Using
the closing price a new white line is added if the previous high is exceeded
o A
new black line is drawn if the market reaches a new low for the move
o If
there is neither a new high or a new low, nothing is drawn
o If
the rally/sell-off is powerful enough to form 3 consecutive white lines/black
lines, then the low of the last 3 white lines (the high of last 3 black lines)
has to be exceeded before the opposite color line (turn-around line) is drawn.
o 3
is a break number that the Japanese use most often. This can be changed
according to you needs
·
Other names:
o 3-step
new price
o New
price 3-line break
o Surpassing
3 lines
o 3-line
turnaround method
o New
price 3-step bars
·
Reading the chart signals
o If
there are 3 consecutive white or black lines, it confirms a trend
§ 3
white lines – confirms a bull trend
§ 3
black lines – confirms a bear trend
§ A
series of white and black lines reflects a trend-less market
§ Basic
trend reversal signal is produced when a turnaround line moves under the 3
consecutive white/above the 3 consecutive black lines
·
Trading Techniques
o Basic method of using the 3-line break is
buying on a white line & selling on a black line.
o Some
reversal signals are sent well after the new trend has started
o However,
many traders are comfortable with this insofar as they believe that it is safer
to be in the major part of the trend rather than trying to pick a top or
bottom.
o 3-line
break chart requires a CLOSE to confirm a turnaround-line
o 3LB
can be used in adjunct to candle charts
§ 3LB
can define the prevailing trend and candles can be used as an entry mechanism
to trade in the direction of the prevailing trend
o A
white/black turnaround line can be used as a signal to exit a trade
·
Sensitivity of reversal signals
o Short-term
traders would usually use shorter reversal amounts – 2 or 3 line breaks
o Long
term traders/investors could use 5 or upto 10 line breaks
o The
number of breaks that works best for you is based on trial & error
·
Extra confirmation of reversal
o One
can wait for confirmation of the turn-around by waiting for the next white or
black line
o The
longer the wait, the greater the likelihood of being correct, but lower the
profit potential
o “even
though one will get a slow start and the profits will be smaller, the false
moves will be less and safety factor will increase”
·
Black Shoe, White & Black Suits, & a
Neck
o Black
Shoe - A short black line
o White
Suit – white turnaround line
o A
short white line that comes immediately after the white turnaround line (white
suit)
o “Buy
when the neck emerges from the white suit with black shoes”
§ Neck
serves as extra bullish confirmation
·
Neck, Black Suit & Black Shoe – opposite of
the above – bull reversal into bear
·
Record Sessions - When there are 8 to 10 consecutive
white/black lines, then the market is considered overextended in that direction
·
Western Patters with 3LB charts - Techniques
like support & resistance, trend lines etc. applies to 3LB charts as well
Chapter 7 – Renko Charts
·
“Consider the Past and You Will Know the Future”
·
Also termed as neri, training or zigzag chart
·
Similar to 3LB but instead of lines, there are
blocks referred to as “BRICKS”
·
“renga” means bricks in Japanese
·
In 3LB, another line is added as the market
moves in the direction of the prevailing trend, no matter how small the move.
·
In Renko, a line is drawn in the direction of the
prior move only if a fixed amount has been exceeded.
·
The bricks in Renko charts are of the same size
·
Unlike the 3LB & Kagi charts, the trading
techniques available with Renko charts are limited
Chapter 8 – Kagi Charts
·
“Like the Right Arm Helping the Left”
·
“Kagi” is a Japanese word for an L shaped
old-fashioned key
·
Other names: price-range shart, hook chart,
delta chart, or the string chart
·
Kagi charts open new & rich methods of
analysis that are unavailable with any other chart
·
Yang line – the thick kagi line
·
Yin line – the thin kagi line
·
Inflection line – short horizontal line
·
Trading techniques
o Basic
technique is to buy when the kagi line goes from thin to thick and sell when
the line changes from thick to thin
·
Line-break, Renko & Kagi charts are trending
tools and non-trending markets can cause traders to frequently move in &
out of the market
o One
way to address this is by adjusting the sensitivity
·
Shoulder – is a prior high
·
Waist – is a prior low
·
A series of shoulders & waists with
ascending highs or descending lows can relay much information about the
underlying tone of the market.
·
Length of Yang & Yin
o if
think & thin lines are of the same length, then it is viewed as a doji
o if
thick line is longer, then the bulls are in control
o if
thin line is longer, then the bears are in control
·
In longer kagi lines, the center of the line is
important.
o In
a uptrend, if the correction stops above the center point, then it is bullish
o In
a downtrend, if the correction stops below the center point, then it is bearish
·
Double Windows
o Can
be top or bottom reversal patterns
o Double
Window Bottom - Downtrend- reversal
§ 1.
During a downtrend, the market bounces and forms a shoulder (at S1). This
shoulder’s high is lower than the prior waist W1
§ 2.
The following waist W2 is also above shoulder S1
§ If
there are more then one shoulder, it would still be considered double window if
the highest shoulder does not overlap the waists to the left & right
o Double
Window Top - Uptrend reversal
§ Waist
in-between two shoulders
§ W2
is higher than S1 & S2
§ If
there are multiple waists, the lowest wait is still above S1 & S2
·
Tweezers
o Double-top
pattern – can be used in conjunction with candle topping patterns
·
Three-Buddha & Reverse Three-Buddha
o Similar
to western Head & Shoulder & Inverted Head & Shoulder patterns
o A
sell signal is sent when the “right shoulder” of the three Buddha is pierced
downward
o A
buy signal is sent when the “right shoulder” of the three Buddha is pierced upward
Recommended Books:
·
Technical Trader’s Guide to Computer Analysis of
the Futures Market, by Charles LeBleau & David Lucas
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