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Showing posts with label candlestick charts. Show all posts
Showing posts with label candlestick charts. Show all posts
I saw my profit go up to around $754 towards the close of the U.S. market yesterday and saw it shrink to zero in today's early trading in Asia. In fact, USDJPY retested the 91.00 support level. Currently, I am still up $450 at the current levels of 91.32.
A weakness in the daily chart seemed to have formed at the current price levels. A pattern similar to an "Evening Star" has formed on the daily chart (see the figure below).
As I have discussed in my previous post, for the market direction, I always take my cue from the monthly candlestick charts as a general rule. Although the above candlestick pattern formed in the last three trading days shows a possible reversal pattern, I consider this merely as a sign of a market weakness in the current market direction (uptrend), and does not warrant any action to be taken. Besides, the reversal of the USD downtrend in the monthly candlestick chart has remained intact.
Today's trading will be very volatile as the market anticipates important developments on Obama's bailout plan and the U.S. Fed's announcement on it's rescue plan for the banking institution. The jobless claims numbers may also add up to today's volatility.
I shall be holding on to my current position and will maintain my stop as well as my objective.
Please feel free to send your comments or questions regarding any of my posts.
BASIC ASSUMPTIONS ON THE USE OF CANDLESTICKS ON SPOT CURRENCY TRADING
USD AGAINST THE MAJORS
There is no doubt that the currency market still regards the USD as the currency to contend with. The bulk of the volume traded in the spot currency market worldwide is still concentrated in the buying or selling of the majors against the USD. This actually simplifies the task for us since we only need to track the rise or fall of the dollar, resulting from the strengthening or the decline of the U.S. economy relative to the economies of the four majors. More often than not, the strengthening of the U.S. economy is often accompanied by the appreciation of the dollar against the majors in varying degrees and conversely, the decline of the U.S. economy is usually followed by the depreciation of the dollar against the majors.
THE TELLTALE SIGNS WE SHOULD BE LOOKING FOR
Similar to all the other technical analysis tools, we also use the candle sticks to determine strengths and weaknesses in market movements. The candlesticks will be our road signs which will tell us whether a market is trending in a particular direction or not, whether a particular trend is about to end, whether a particular trend has been reversed. In short, Japanese Candlestick charts also have their own reversal patterns, patterns that show a continuance of a trend, patterns that warn us of a weakening market movement.
When I first lectured on the Japanese Candlestick Charts to a group of investors in San Francisco in 1990 the seminar participants never failed to laugh as I mentioned the names of the different candlestick patterns. For example, when I discussed the "Harami" which is basically the "inside day" formation on the Western Charts (where the current price traded in a very narrow range and well inside the range of opening and closing prices of the previous session), my audience had a big laugh when I explained that the Japanese word meant "pregnant woman". You may find the names of the candlestick patterns very amusing and at times very traditional but they vividly express the underlying collective sentiment of the market players at the time the particular pattern was formed. The basic candlestick patterns include such names as "Shooting Star", Evening Star", "Morning Star", "Hammer", "Dark Cloud Cover", Dragon Fly", and many more seemingly simplistic terms.
The success of the Japanese Candlestick charting technique lies in this simplistic pattern recognition. The "Evening star" carries the connotation of a reversal of a bull run, happening as it is after an extended uptrend. The star is basically characterized by a narrow trading range where the opening price is almost the same as the closing price.
I Shall give you a walk through of all these patterns as they appear in the course of my live demo trading starting Monday. In the meantime, let me lay out the rules I follow in the use of the candlesticks.
1. You must give more importance to candlestick patterns which appear and are formed at or near significant highs or lows or at and around recognized support and resistance lines.
2. A confirmation of the pattern after its formation must first occur before you initiate a trade. A confirmation must consist of a candle whose closing at least falls beyond the mid point of the previous sessions candle.
3. When initiating a trade, set a tight auto stop by using the previous candle's close as your stop if you are on a buy, or the previous candle's open if you are on a sell (for USDJPY, USDCHF and vice versa for EURUSD, GBPUSD).
4. Adjust your stops after each session (like a trailing stop) always using the previous session's candle as your reference point.
5. Do not buck the trend. Trade only in the direction the candles are leading you. Consult the monthly candlestick chart for the market trend. Use the daily candle charts to initiate positions. Shorter period charts like the hourly and 5 minute charts are only for day traders. I have found candlestick charts to be more effective for position traders (and not so effective for scalping).
6. Every position taken must not only be based on a candle pattern but should also have an underlying economic fundamental currently existing or as anticipated by major market players.
7. When you are on a buy, use the nearest most significant resistance as your first profit objective and immediately take profits by liquidating positions when the current candle fails to break the resistance towards the close of the session. When you are on a sell, use the nearest most significant support as your first profit objective. (for USDJPY, USDCHFonly, vice versa for EURUSD, GBPUSD).
For now, these are the ground rules we will follow when we begin to trade on Monday. I shall discuss the others as we trade.
THE USDJPY CANDLESTICK CHART AND WHAT IT TELLS US
With the benefit of hindsight, we can easily see the effectiveness of the candlestick patterns in determining market reversals. A classic Reversal Pattern called "The Evening Star" was formed from May, 2007 to July 2007 after USDJPY reached a historical high somewhere around 124. This was when the "bubble started to burst" as predicted by many economists. The reversal brought the rate down to around 96 in March, 2008. The dollar made a laborious run up to around the 111 high in August, 2008. The run up was characterized by narrow trading ranges which tells us that the rally is not attracting dollar buyers at all and that the dismal outlook on the U.S. economy is more pervasive and it is keeping the dollar bulls sidelined. True enough, another classic candlestick reversal pattern was formed. August, 2008 developed what is termed as the "Evening Star" promptly followed by a confirmation candle(September, 2008) which significantly closed below the midpoint of the reference candle (July, 2008). The reversal brought the price down to the January, 2009 low of 87. Significantly, a market weakness (possibly a reversal) in the current downtrend is evident. A "Hammer" was formed last month signalling a possible near term run up for the USD. This must however, be confirmed with close above the 93 level this month.
With an economic stimulus package almost in place, a better than bleak outlook for the U.S. economy may be in the offing and a dollar rally may be had in the near term..
Notes:
EVENING STAR
Recognition: A three candle pattern at the top of an uptrend. The body of the first candle is white, confirming the current uptrend. The second candle is an indecisive formation. The third candle is black and should close at least halfway down the white candle.
Pattern Psychology: After an apparant uptrend the Bears step in and open the price lower than the previous day's open. The price finishes lower for the day and the Bulls are concerned and begin selling to take their profits.
SHOOTING STAR
Recognition: One candle pattern appearing in an uptrend. The shadow (or tail) should be at least two times the length of the body. The color of the body is not important, although a black body has slightly more Bearish indications.
Pattern Psychology: After a strong uptrend the Bulls appear to still be in control with price opening higher, but by the end of the day the Bears step in and take the price back down to the lower end of the trading range. Lower trading the next day reinforces the probability of a pullback.
HAMMERS and HANGING-MAN
Recognition: The lower shadow (or tail) should be at least two times the length of the body. The color of the body is not important although a black body has slightly more Bearish indications and a white body has slightly more Bullish indications.
Pattern Psychology: This pattern at the bottom of a down trend is called a Hammer. This pattern at the top of an uptrend is called a Hanging-Man
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.)
Image by Getty Images via Daylife
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