Sunday, September 28, 2008

THE MYSTERY AND THE MYTH OF JAPANESE CANDLESTICK CHARTS


I have been using the Japanese Candle Stick Charts in trading the spot foreign currency market since I came across Steve Nison's book "Japanese Candlestick Charting Techniques" second edition sometime in early 1990's. I was assigned in Singapore then. My "batting average" and profitability did improve significantly when I incorporated the newly acquired knowledge from this book into my daily trading regimen. When Nison's second book ("Beyond Candlesticks") came out, I was already assigned to our San Francisco office. By that time, I have proclaimed myself as a Nison follower and a Japanese Candlestick chart fanatic. (I wouldn't trade without taking a closer look at candlestick charts first!) The second book was actually a big let down to me. I was expecting to read trading techniques using the candlesticks since the first book dealt mainly on the discussions about what the candlestick is. Nison wanted to come out with a clear cut guideline on how to use Japanese Candle Stick Charting Techniques in trading the various financial markets in the second book, unfortunately much of his discussions was made with the benefit of "hindsight". His dissertations were based on past price movements which were already known to him at the time of the book's writing. So, l resigned myself to doing my own experimentation and interpretations based on real live market feeds with a focus on the forex market with which I was passionately involved with. At about this time, Nison was, I believed, doing the same thing although much of his work was focused on the stock market. (Many of his website contents and cd's came out 8-10 years after his first book was published.)

Before anyone accuses me of being a charlatan, I wish to clarify that I am not claiming to be an expert on the use of the Japanese Candle Stick Charting Technique here. My intention for this blog post is to share with you my experiences and difficulties in using this remarkable charting technique which has now become a necessary fixture in every trader's desktop.

For backgrounders, let me brief you on what the Japanese Candlestick Chart is.

Candlestick charts are said to have been developed in the 18th century by legendary Japanese rice trader Homma Munehisa. The charts gave Homma and others an overview of open, high, low, and close market prices over a certain period. This style of charting is very popular due to the level of ease in reading and understanding the graphs. Since the 17th century, there has been a lot of effort to relate chart patterns to the likely future behavior of a market. This method of charting prices proved to be particularly interesting, due to the ability to display five data points instead of one. The Japanese rice traders also found that the resulting charts would provide a fairly reliable tool to predict future demand.

The method was picked up by Charles Dow around 1900 although Dow's version (bar charts) was way different from Nison's (candle stick charts).

(Charles Henry Dow was an American journalist who co-founded Dow Jones & Company Company with Edward Jones and Charles Bergstresser. Dow also founded The Wall Street Journal, which became one of the most respected financial publications in the world. He also invented the famous Dow Jones Industrial Average as part of his research into market movements. Furthermore he developed a series of principles for understanding and analyzing market behavior which later became known as Dow theory, the groundwork for technical analysis.)


Steve Nison, on the other hand is regarded as the “Father of Japanese Candlesticks.” Based on his intense study of original manuscripts on Japanese Candlestick charts which were exclusively translated for him, Nison was literally the author of the first books ever written and published about the subject.


I have been trading currencies long before Nison's first book came out. I was properly schooled in the Western methods of technical analysis (to my dismay and confusion). So, when I came across Nison's book, I was an instant convert, and with good reason.


One of the many mistakes I made as a start up trader at that time was to over indulge myself with using the various Western methods of technical analysis like Stochastics, MACD, Momentum Index, Elliot Wave Theory, etc. My over-indulgence with these technical tools made me mistakenly believe that the markets must move according to the technical models I have so painstakingly pieced together. My technical savvy made me forget the fact that markets are moved by real people, traders who buy or sell because of personal conviction or belief in a particular fundamental. My over indulgence with my better than average technical analysis skills made me forget that the basic objective of these technical tools I so fondly acquired through these years is to approximate the underlying sentiment of the market so as to come up with a calculated future market direction. I totally lost sight of the basic fact about charts and what they are supposed to provide us - the real underlying sentiment of the market, its hesitation, its strength! I totally ignored the basic thing about charts - that every chart is suppose to tell us a story, the story of the greater majority of traders trading at that particular time, whether they are buying or selling or staying on the sidelines; or whether they are buying/selling with conviction or on mere speculation!


Nison's Japanese Candlestick Charting Technique made me remember and made me go back to basics! The vivid graphical presentation of the underlying market sentiment by Japanese Candlestick charts is so simple and so remarkably clear that you are able to discern immediately market strengths and weaknesses. It so vividly reveals the over-all emotion the market has at any given time. To me, it serves as an effective radar that measures, detects, and translate market movements no matter how big or small they may be. It is so super sensitive that it is able to graphically illustrate (in the form of varying candlestick formations) the real story behind every market movement. It is so damn effective that I became an instant convert and a fanatic user of it. I really can never trade any market without first taking a close look at a Japanese Candlestick chart and read the story it wants to tell me.


The mystery of Japanese Candlestick Charts is in its simplicity. The myth lies in its usage.


(Next: Understanding Japanese Candlestick charts.)



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