Friday, September 24, 2010

Demystifying the Candlestick Myth

For forex traders, stock traders, commodity futures traders, bond traders!

Since Steve Nison came up with his first book "Japanese Candlestick Charting Techniques" in 1991, forex traders stock traders, commodity futures traders all over the world have been awed and mystified by this centuries old charting tool! The ensuing interest for, and the widespread popularity of this trading tool was simply magical. Every Tom, Dick, and Harry dealing with any form of trading was scrambling for whatever available Candlestick tutorials, books, and lessons there are! Practically everyone in the investment industry was mesmerized by the simplicity and the seemingly promising trading results Candlestick will bring to its users!

Richard Alcantara, Basic AuthorIt is a well accepted fact that the Japanese are regarded as one of the most efficient money managers and smartest trading partners in the world. The introduction/revelation of their purportedly 'secret' trading tools to the rest of the world would naturally lend an air of mysticism to the event!

But everyone wonders if the Japanese Candlestick Charting Technique is really a well-kept secret intentionally hidden from the rest of the world for centuries!?....Until, Steve Nison accidentally discovered it in the '90's!?

My answer is a categorical no! No, the Japanese Candlestick Chart was not a well-kept secret! Let us start uncovering the truth behind the mysteries and mysticism that shrouds Candlesticks by looking back at Japan's history.

What might have contributed to the mystical atmosphere surrounding the the Candlesticks debut  in the western world (as initiated by Nison) was the fact that  Munehisa Homma(1724-1803), the Nison acknowledged "Father Of Candlestick Charts", lived at the time when Japan was barely coming out of a self-imposed seclusion from the rest of the world! The Sakoku Edict of 1635 issued by the shogun of Japan kept the Japanese within Japan's boundaries. The Edict was issued primarily to prevent Catholicism from taking roots in Japan. Strict rules were set to prevent the Japanese from leaving the country, and if any such attempt was made, they would face penalty of death. Europeans who entered Japan illegally would face the death penalty as well.Catholicism was strictly forbidden. Those found practicing the Christian faith were subject to investigation, and anyone associated with Catholicism would be punished ( This isolationist policy lasted for nearly  200 years until 1858 when Commodore Perry of the United States signed a treaty with Japan through the Convention of Kanagawa.

It is evident here that whatever Munehisa Homma achieved and have written down during his lifetime was virtually unknown to the western world because of the Edict of 1635 - and not by willful intent to hide the technique. To set the record straight, there are no recorded instances that Homma used Candlestick charting techniques during his time! However, Homma was regarded as the "Father Of Candlestick Charts" because of his writings which set the foundation for the development of the Candlestick charting technique by his predecessors. In particular, Homma's San-en Kinsen Hiroku, The fountain of Gold - The Three Monkey Record of Money which he wrote in 1755 established the underlying principle behind the Candlesticks - 'that the psychological aspect of the market is critical to trading success and that traders' emotions have a significant influence on rice prices'. 

It is believed that candlesticks made their appearance in Japan towards the late part of the 19th century but it is not known where and when it exactly originated. If this is true, where then did the Candlestick references to battlefield analogies and military terminologies such as "the night and morning attacks", "advancing three soldiers pattern", "gravestone", "counter attack lines" come from? Can this be simply because of, as Nison claimed in his book, the influence of the military conditions that suffused Japan for centuries? Or, was it because by then the influence of the Samurai code is now prevalent in all classes of the Japanese society?

After the death of shogun Hideyosi in 1615 and after Tokugawa Leyasu came to power did unity and good governance come to Japan. This was known as the Tokugawa era and ruled through the Bakufu or tent government. They remained unchallenged until the Meiji restoration in 1867. It was in this era that the country became united! It was also in this era where the Samurai class (professional warriors) gained the status as the superior class in the Japanese society! Forbidden to carry out employment of any productive nature and with no more wars to fight, the samurais,  evolved into an elite intelligentsia ruled by the principles of Confucius and Confucian philosophies.(Ultimately, the Samurai code diffused into all of the Japanese society... becoming the model of behaviour for all classes of the Japanese society to imitate.) In 1867, low ranking Samurais, unhappy with the way things are run by the Bakufu government staged a successful uprising and restored power back to the emperor! This marked the start of a concentrated attempt to modernize the social and political structures of Japan and give a new sense of national self identity. One of the most significant changes made at the start if this new regime is their commitment to gathering knowledge and learning from all over the World.

So, there you have it! The Candlestick charting technique evolved in an era when Japan's elite intelligentsia was dominated by the Samurai class ( which explains the use of the battlefield analogies and other military terminologies in the Candlestick charting technique). Using Homma's writings as its foundation (specifically, that of recognizing that the trader's emotions have a significant influence on prices), the candlestick originators must have crafted the techniques with newly acquired western knowledge as models.

Does this then make the Candlestick charting technique less effective or less credible? Of course not!

From its origins, up to its present form, Candlestick charting techniques evolved for one reason alone - to make refinements on Munehisa Homma's basic trading principles. The technique remains as a premier tool that provides a unique graphic visualization of market weakness and signal turns. However, like Homma's method, this technique must be used in the context of previous significant price movements with reference to historical highs and lows.

There is one last point that needs to be stressed at this juncture! However, simplistic the Candlestick charting technique may appear to many, it has successfully served its purpose for many Japanese Traders for centuries now! The reason behind the success is the real secret behind the technique. Steve Nison and other technical analysis pundits out there who have followed the Candlestick charting techniques and written reviews of it have all missed the very key to the successful use of the technique - they all forget the fact that the Japanese has historically incorporated the Samurai Code into their everyday lives - a life of discipline and calmness!

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