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A Beginner’s Guide to Japanese Candlestick Charting By Kent Kofoed, Gecko Softw

A Beginner’s Guide to Japanese Candlestick Charting By Kent Kofoed, Gecko Software, Inc. History of Candlestick Charts: Candlestick charts, which are believed to be the oldest charting style, date all the way back to the early 1700s and were originally used for the prediction of future rice prices. Munehisa Hommaa, a rice merchant from Japan, is considered to be the "father of the candlestick charts" because he is said to be the inventor of candlestick charts. In addition to being the creator of candlestick charts, he also wrote a book on market psychology, which is called The Fountain of Gold: The Three Monkey Record of Money, where he claimed that the psychological aspect of the market is critical to trading success and that traders' emotions have a significant influence on rice prices. He also made the observation that "when all are bearish, there is cause for prices to rise," which is, in essence, a contrarian view that easily can be applied in either direction. Another historical, and rather interesting, piece of information about the history behind candlestick charting is that the various candlestick patterns were originally given names, by Japanese traders, such as "counter attack lines" and "advancing three soldiers," which was, in large part, due to the overwhelming influence that the military had during that era. Technical Analysis Overview: Technical Analysis is the process of analyzing historical market data (with the primary focus typically being on price and volume data) in order to "forecast" the future price of an asset, and, candlestick charting, is simply one of the many tools that are used in technical analysis, by technical analyst's. Technical analysis relies on multiple assumptions, with one of the main assumptions of technical analysis being that market prices are "fundamentally" efficient. This means that whenever new fundamental information reaches the market, prices will immediately adjust in order to reflect that information in the market price; however, technical analysis also recognizes that the current "mood" of the market can have an impact on market prices. For example, traders can become overwhelmed by the many emotions that are inherent in trading (or any other risky activity) and end up making investment decisions that would have, in a majority of circumstances, typically been deemed irrational. Greed, for example, is viewed as one of the main reasons why so many traders tend to pile into the market right before a top while fear, on the other hand, is another common emotion that causes many traders to act irrationally and stampede out of the market, right before it reaches a bottom. If ignored, both of these emotions can quickly bankrupt traders, of any skill level, so it is extremely important to learn how to effectively manage these emotions. The current "mood" of the market can, and will, distort prices in the short-term (mostly due to fear, greed or one of the myriad of other emotions that impact trading decisions); however, prices have a tendency to adjust back to the equilibrium market price, in the long-term, by converging with the underlying fundamentals of the market. In order to be successful, traders need to be able to ignore the many emotions that are the cause of illogical behavior, and learn how to identify when the overall market is acting irrationally in order to take advantage of the market when prices are temporarily out- of-sync with reality. Technical analysis helps traders put emotions aside by giving traders the ability to focus solely on what is currently happening in the market (or what will likely happen in the near future) and ignore the significant amount of market "noise" that is so prevalent in the market. Bar Chart Overview: One of the first technical analysis tools that traders who are new to technical analysis will likely study, will be the various charting styles that are used in technical analysis. These charting styles include line charts, bar charts and candlestick charts (as well as a few other less frequently used charting styles), and are used to visually illustrate the price action of the asset being analyzed. Bar charts are made up of multiple vertical bars and each individual bar is used to represent the price action (i.e., open, close, high, low) that occurred during each individual period (i.e., minute, hour, day, week, etc.). The top of the vertical bar represents the high of the period and, inversely, the bottom of the vertical bar represents the low of the period, and the left and right dashes represent the opening and closing prices of the period, respectively, that was reached during the period. See Figure 1-1: Bar Chart, below, for an example of the typical bar chart. Bar Charts vs. Candlestick Charts: Bar charts and candlestick charts are, essentially, made up of the exact same component (both provide the exact same information), and the main difference between the two is mostly due to how the various components are presented. As shown above, the components of the bar chart represent the opening price (left dash), the closing price (right dash), the low price (bar bottom) and the high price (bar top), of a specific time period, and each of these bar chart components are components of the candlestick chart as well; however, on the candlestick chart, the space that is in-between the opening and closing price bars (the left- and right-side dashes) is filled-in. This filled-in area of the candlestick is called the "real body," and whenever the opening price of the period is lower than the closing price of the period (the price action of the period is bullish) the candlestick will be a "light" candlestick. Inversely, whenever the opening price of the period is higher than the closing price of the period (the price action for the period is bearish) the candlestick will be a "dark" candlestick. Lastly, the area of the candlestick that extends from the bottom of the real body to the low price of the period is called the "lower" shadow and the area of the candlestick that extends from the top of the real body to the high price of the period is called the "upper" shadow. Many traders believe that the opening and closing prices of each period are the most relevant prices, which is mostly due to the belief that these prices provide the most information, and the visual emphasis that the candlestick chart has on these prices is a very important feature of the candlestick chart. See Figure 1-2: Candlestick Chart and Figure 1-3: Candlestick Diagram, below, for an example of a typical candlestick chart and a diagram of the components that make up an individual candlestick, respectively. Candlestick Terms: It is important to emphasize that the candlesticks covered in this section are considered candlestick “terms” and not candlestick “patterns.” Candlestick “terms” are simply the different types of candlesticks that you will come across when using candlestick charts. Candlestick “patterns,” on the other hand, are made up of a series of candlesticks (i.e., candlestick “terms”), and these patterns will be covered in the next section. Additionally, sometimes the terminology of the various candlestick components can vary, depending on which book you are reading or website you are using, but the underlying concepts will typically be the same. The main terminology issue to watch out for is that the upper/lower “shadow” will sometimes be called the upper/lower “wick” and that the light (dark) real body will sometimes be called the empty (filled-in) real body. Candlestick Terms Dark Candlestick- The Dark candlestick occurs when the closing price of the period is lower than the opening price of the period. The color of this candlestick is typically black, blue or red. This candlestick, as mentioned previously, is sometimes referred to as a “filled-in” candlestick. Light Candlestick- A Light candlestick occurs when the closing price of the period is higher than the opening price of the period. The color candlestick will, typically, be either white or green. This candlestick, as mentioned previously, is sometimes referred to as an “empty” candlestick. Shaven Head- The Shaven head candlestick is made up of a lower shadow and a real body, but no upper shadow. Additionally, the color of the real body is not of critical importance and will either be light or dark. Shaven Bottom- A Shaven Bottom candlestick is made up of an upper shadow and a real body, but no lower shadow. Additionally, similar to the “Shaven Head” candlestick, the color of the real body is not of critical importance and will either be light or dark. Candlestick Terms (continued) Spinning Top- The Spinning Top candlestick has a small real body, which appears in the middle of the upper and lower real bodies. The color of the real body is not of critical importance, and will either be light or dark. Additionally, this candlestick is believed to represent equilibrium between the bulls and the bears; however, this equilibrium is only valid when it occurs in choppy markets that are in a sideways trending range. Doji- The Doji candlestick has uploads/Litterature/ japanese-candlesticks-guide.pdf