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Chartered Market Technician Exam Preparation Class. Candlesticks. Class One. Japanese Candlesticks The Worlds Oldest Charting Technique Chapter 1: Introduction Chapter 2: Historical Background Chapter 3: Constructing Candles Chapter 4: Reversal Patterns Chapter 5: Stars
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Chartered Market Technician Exam Preparation Class Candlesticks
Class One Japanese Candlesticks The Worlds Oldest Charting Technique Chapter 1: Introduction Chapter 2: Historical Background Chapter 3: Constructing Candles Chapter 4: Reversal Patterns Chapter 5: Stars Chapter 6: More Reversal Patterns Chapter 7: Continuation Patterns Chapter 9: Putting it all Together
History • Japanese rice trade • Patterns derived from studying historical price of rice • Interesting side note: rice became defacto exchange medium • Hard currency failed due to debasing of metal coins
Why Use Candles • Easy to understand • Alert to market turns earlier • Better entries / exits • Provide unique market insight • Enhance western TA • No TA should be used in isolation • Increase efficiency of analysis • Helps Judge Market Psychology
Bars vs Candles • Bar charts are 2 dimensional • Originally did not have open / close sides • Lack visual clarity of internal bar moves • Candles bring 3rd dimension • Much clearer open / close • Visually depicts price action inside bar
Candlestick Uses • Work on all time frames • Weekly charts (hedgers) • Daily charts (swing traders) • Intraday charts (scalpers) • Should be used to confirm the next higher order chart • Hourly Charts should support daily charts, etc.
Cautions • Patterns are not perfect • Don’t use them in isolation • Lack of specificity • Japanese did not write extensively • Risk of missing the big picture • Don’t loose the forest through the trees
Drawing • Open, High, Low, Close High Close Open Open Close Low
Terms (cont’d) • Shadow, Body Upper Shadow Real Body Lower Shadow
Terms (cont’d) • Shaven Tops No Shadow
Terms (cont’d) • Shaven Bottoms No Shadow
Terms (cont’d) • Spinning Tops Much Smaller Real Body
Terms (cont’d) • Dojis No Body
Psychology • Bodies • Large bodies are powerful moves • Smaller bodies are less powerful • Dojis are indecision or pause • Shadows • Short shadows give body credibility • Long shadows can reveal strong support or resistance
Psychology (cont’d) • Shaven Head • Bullish close, powerful move up • Bearish close, strong resistance • Shaven Bottom • Bullish close, strong support • Bearish close, powerful move down
Warning Signals • Spinning tops example • Rising trend line for support
Warning Signals (cont’d) • Spinning tops (cont’d) • Falling trend line for resistance
Introduction • Market Timing • Price clues hint at shifts in market psychology / changes in trend • Trend changes are usually gradual • Markets rarely reverse abruptly • Trend Reversal Patterns… • Implies the former trend is likely to change, but not necessarily reverse • Typically results in sideways action
Introduction (cont’d) • Reversal Pattern usage • Important to only use reversal patterns if signal is with overall trend • Bearish signal in uptrend doesn’t mean it’s time to sell • Bullish signal in downtrend doesn’t mean it’s time to buy • Consider for profit taking instead
Umbrella Lines • Recall shaven tops • Long shadows & short bodies • Two varieties • Hammer (bullish) • Comes at the end of a downtrend • Hanging man (bearish) • Comes at the end of an uptrend
Umbrellas (cont’d) • Hammer & Hanging Man Small Body Long Shadow
Umbrellas (cont’d) • Recognition • Occurs at extreme trading range • Shadow at least twice a small body • Has no (or very short) upper shadow • Differences • Hammers valid after short decline • Hanging man comes after long advance • Hanging man must be confirmed
Umbrellas (cont’d) • Hammers • Bodies either white or black • Longer shadow, greater support • Close very near high is bullish • Not necessary to confirm, but usually best to wait for additional pattern • Example – hammer at bottom, followed by a doji at support, is better than the hammer by itself
Umbrellas (cont’d) • Hammer occurs at bottoms
Umbrellas (cont’d) • Hanging Man • Come only after long advance • Require confirmation • Not a good “stand alone” signal • Usually followed by sideways move • Long lower shadow typically a bullish indicator as well • Holds market up longer • Hammer is already at market bottom
Umbrellas (cont’d) • Hanging man occurs at tops
Engulfing Pattern • Major Reversal Signal • Must have clearly identified trend • Two candles in the pattern • 2nd candle must “engulf” the 1st • Not required to engulf shadow • 2nd candle must be opposite color • Exception if 1st candle is a doji
Engulfing (cont’d) • Factors Increasing Strength • 1st candle small body, 2nd candle long • 1st candle shows dissipation of strength • Pattern follows extended market • Overbought / oversold principle • Heavy volume on the 2nd candle • Additional reading is Part 2 of book • Engulfing patterns give strong hints as to support / resistance
Engulfing (cont’d) • Bearish Resistance
Engulfing (cont’d) • Bullish Support
Engulfing (cont’d) • Breakouts Resistance becomes Support
Engulfing (cont’d) • Breakouts (cont’d) Support becomes Resistance
Dark Cloud Cover • Bearish Pattern • Similar to Bearish Engulfing • Main difference 2nd candle doesn’t engulf • 1st candle is strong white candle • 2nd candle opens above previous high • 2nd candle closes deeply inside 1st • Some Japanese technicians require 50% penetration of 1st candle
Dark Cloud (cont’d) • Factors • Greater penetration, greater signal • If 2nd candle opens above resistance, then closes below during the pattern, chances of a top increase • Very high opening volume on 2nd candle indicative of blowoff • High open interest in futures
Dark Cloud (cont’d) • Bearish Resistance
Piercing Pattern • Bullish Pattern • Similar to Dark Cloud Cover • Difference is color & occurrence • 1st candle is strong black candle • 2nd candle opens above previous low • 2nd candle closes deeply inside 1st • Some Japanese technicians require 50% penetration of 1st candle
Piercing (cont’d) • Factors • Greater penetration, greater signal • If 2nd candle opens below support, then closes above during the pattern, chances of a bottom increase • Very high opening volume on 2nd candle indicative of blowoff • High open interest in futures
Piercing (cont’d) • Bullish Support
Piercing (cont’d) • Caution • Piercing patterns have less flexibility than dark cloud covers • Dark cloud covers that penetrate large percentage of 1st candle not hard rule • Piercing patterns need greater penetration to be valid signals • Harder to turn a market bullish than bearish • 3 other Japanese candle formations • On neck, in neck & thrusting
Piercing (cont’d) • On neck, in neck, thrusting
Introduction • Stars • Small real body • Black or white • Gaps away from preceding candle • Body can be in preceding shadow • Key point is bodies don’t overlap! • If it’s a doji, then it’s a “doji star” • Warning that prior trend is ending
Morning Star • Bullish bottom reversal pattern • 3 candle formation • 1st candle has extended black body • 2nd candle has small black body that doesn’t touch 1st candle body • 3rd candle deeply penetrates 1st candles body • Can enter 2nd candles body, but if not it’s even more bullish
Morning Star (cont’d) • Bullish Support
Morning Star (cont’d) • Morning Doji Star Support
Morning Star (cont’d) • Limitations • It takes 3 candles to complete • Waiting misses part of the move • Lessens reward-to-risk ratios • Best to enter market following a subsequent correction • Recall trading tactics of channel breakouts, Fibonacci retracements, etc
Morning Star (cont’d) • Flexibility • Ideal pattern occurs when 2nd body doesn’t touch 1st or 3rd bodies • Not as fast a rule in markets where open is off the previous close • Forex • Semi-conductor & Drug indices • Intraday charts • 15 minute, 30 min, etc
Evening Star • Bearish counterpart • 3 candle formation • 1st candle has extended white body • 2nd candle has small white body that doesn’t touch 1st candle body • 3rd candle deeply penetrates 1st candles body • Can enter 2nd candles body, but if not it’s even more bearish
Evening Star (cont’) • Bearish Resistance