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Japanese Candlestick Charting

Taso AnastasiouDirector: Technical Strategy

UBS Investment Bank

Phone : +41-44-239 91 04E-Mail : [email protected]

London November 2006


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Brief HistorySECTION 1


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Aims and Objectives of The Session

Interpretation

Timing trades with candlestick patterns

Money management identifying risk levels


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Candlestick History

By the early 15th century the Shogun Tokugawa had created aunified country by pacifying the 60 Daimyo feudal lords. Thisfacilitated more freedom to trade between the provinces as well

as towns such as Edo and Osaka. (Osaka became the centre of thistrading activity). Even today, the traditional greeting in Osaka isMokarimakka, which translated means, are you making aprofit?

Early records show charts were first used in Japan in the early 16thCentury to record price fluctuations on feudal Japans riceexchanges

Rice was essential to the Japanese economy; a unit of exchange

and the primary dietary staple of the Japanese people


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Candlestick History (continued)

There were as many as 1,300 rice traders working in Osaka at theDojima Rice exchange. As trade developed, receipts from ricewarehouses were accepted as payment and hence the first futures

contracts were effectively traded

Sokyu Honma (17161803) was a brilliant rice merchant whois widely acknowledged as being the grandfather of Candlestickcharting

Honma was such a successful trader that he eventually attainedthe status of bushi or samurai an amazing accolade for the timeas merchants were regarded as being very low on the social ladder

Honma developed a series of rules which were called the Sobasamni no den or the Sakata Constitution


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The Different Types Of Chart

Line chart Anchor line

Bar chart

Close

Open Close

Open

Point and fig chart

Close

Open Close

Open

oo


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What is a Candlestick Chart?


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Open

Close

Open

Close

Candlestick Components

A Candlestick shows the same

four price plots used to constructa typical bar chart i.e. open, high,low and close

Candles are colour coded for; up

closes i.e. close > open and downcloses i.e. close < open


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Candlestick Composition

Jittai

Uwakage

Shitakage

Upper shadow

Real body

Lower shadow

The Candlestick Is Divided Into 3 Distinct Areas

Upper Shadow Real Body Lower Shadow

H

L

O

C


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Candle / Bar Chart Comparison


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JittaiThe Real Body

The Real Body represents the area between the opening andclosing prices

The closing price is the most important piece of information since

it concludes the sessions trading and provides an insight intomarket sentiment

Most technical indicators use the closing prices as the basis fortheir calculations


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The Real Body

The size of the real body can provide useful clues regardingprospective corrective / reversal points

The colour of the real body can be used to identify directionalchanges in any given market, over any given time frame

Open

Close

Open

Close


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Impact of opening vs previous closing

Neutralcorrection

Normalcontinuation

Dangerreversal

Short term consolidation

Dangerreversal


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UwakageShitakage Shadows

Critical support

Shortcoveringand buyingpressure

off this level

TAKURITesting the Water

The longer the

shadow the moresignificant the level


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The 50% levelMarket Profile

To understand the importance of the 50% level it is necessary tounderstand the concept of Fair Price and Market Profile. For anygiven distribution there will be a level which is accepted by the

market i.e. an equilibrium point. A close above the Fair Value areaserves as a very useful guide what that consensus is

Fairvaluearea

Buyers

Sellers

Extremes

Extremes

Fair pricePoint of control

Close


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The dynamics of a candle line

RBbecoming smaller Long shadows either side

Closes below previousequilibrium price


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The dynamics explained

A normal candle is called a strong line, this simply means itrepresents a positive continuation of either a bullish or bearishmove

The smaller the real body, the weaker the line. Typically thisreflects consolidation when uncertainty exists and traders squarepositions looking for a potential reversal or correction

Lengthening shadows herald the existence of weakness in a trend

Significant penetration into the previous line is a potentialreversal once confirmation has occurred


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The Classification And Single Candle LinesSECTION 2


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The classification

The original eight

2 3 4 5 6 7 81


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A new perspective

Any market can only make one of eight moves

Interpretations may vary in different markets but the basis

remains the same

There are no other possibilities

Once you understand the eight moves you then apply them to

the markets you are trading

This is the key to the technique


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1. The standard line

The standard line is generally considered to be a continuationmove. They have strong real bodies and small lower / uppershadows. They will not provide you with any specific clues in termsof a potential change in market direction, they merely reinforcethe existing directional bias

(+)

()


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Standard lines


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2a. The Komaspinning top

The Spinning Top is a neutral pattern and is distinguishable by itssmall real body and long shadows either side of the real-body

Generally the market is considered to be consolidating when this

pattern is formed. The market has little directional conviction

(+/) (+/)


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Koma


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2b. The starHoshi

A potential top reversal pattern

The market has become

very weak and is showingsigns of imminentreversal

A Koma that gaps away from themarket becomes a Hoshi or star

The Gap is a window or Ku


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Hoshi


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3. The Dojireversal

The Doji is very important, it is considered to be a reversal line orwarn of indecision

The Doji represents the area where Bulls and the Bears meet.Opening / closing prices are equal. Doji means same as, in

Japanese

Juji Tohba Tonba


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3a. The Rickshaw manJuji

The Long Legged Doji(Rickshaw man), shows a potential turningpoint where the upper and lower shadows are long and ofapproximately equal length

Juji


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The Rickshaw manJuji


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3b. The Gravestone DojiTohba

It is called the gravestone because of its shape. This candle isconsidered to represent the onset of an impending reversal ifobserved in an up-trend

Market rejects this levelstrong selling pressure

Tohba


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DojiNIKKEI


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3c. The dragonfly DojiTonbo

This is the opposite of a Gravestone and is found at marketbottoms

Strong buying pressureat this levelcriticalsupport pointTakuri -


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3d. The Doji Star

One of the strongest reversal patterns, found at tops andbottoms. Is known as a pattern of three, though at this stage theDoji that gaps away from the previous close is warning enough

Hoshi

Ku


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Doji Star


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4. The UmbrellaKarakasa

At the top of the market this pattern is called a hanging man,but at the bottom of the market it is known as a hammer

Takuri

Hanging Man

Takuri

Hammer


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4. KarakasaUmbrella reversal

There are two distinctive variations of the umbrella pattern

The Hanging Man which appears at a market top and theHammer which appears at a market bottom

An umbrella should have a small real body with little or no uppershadow. The lower shadow should be two to three times thelength of the real body

The umbrella is widely regarded as a reversal line butconfirmation of reversal is required

The colour of the real-body is usually not considered to be

important but would recommend that you do pay attention tothe direction of the closing as this gives additional weight tothe pattern


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4a. The Hanging Man

The market has to be in aclearly defined up-trend

The market shows signs ofweakness and aggressivelytests the downside

The session however closes

much higher than therecorded low

Support


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The Hanging Man (continued)

Shooting Star

Dark Cloud Cover

Hanging ManLIFFE Lg-Gilt

4b Th H


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4b. The Hammer

The Hammer is a veryimportant bottoming reversalpattern

The colour of the real body isless important than for theHanging Man as the markethas bounced off a low in

a downtrend

Strong buying has occurred,and indicates a good levelof support

The long shadow is indicativeof the strong buying pressure

Support

H


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Hammer

K k


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Karakasa

Inverted Head and

Shoulders Reversal

H


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Hammer

Hammer

Piercing Line

Hammer

Bearish Engulfing Pattern

The Hammer in Zone 1, fails to confirm the positive tonethe weight of the signals following the hammer are -ve.

The Hammer in Zone 2, fails to confirm at first. Noticethe resistance that has been established following theformation of the hammer.

5 Inverted Hammer reversal


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5. Inverted Hammerreversal

This pattern is the direct opposite of the umbrella linesor Karakasa

The shooting star can be a powerful reversal signal in an up-trend

(but only on a new high)

An inverted hammer is indicative of a strong area of resistance,confirmation is sought prior to entering any new long positions

Shooting Star Inverted Hammer

Shooting Star


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Shooting Star

Shooting Star


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Shooting Star

Shooting StarShooting Star

Shooting Star


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Shooting Star

6/7 The Bozu Line


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6/7. The Bozu Line

Also known as a Belt Hold lines or Shaven Top and Bottom.These are regarded as continuation lines

ClosingMarubozu

OpeningMarubozu

OpeningMarubozu

ClosingMarubozu

8 The Marubozu


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8. The Marubozu

The Marabozu is a candle line with no upper and lower shadow

The period opens and closes on the low and high

The Marabozu is very common in short term charts, especiallyafter the release of economic data. Corrections are likely in theperiod following after the pattern

50% levelcritical

The Long Standard line


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The Long Standard line is easily identifiable as a single candle linewhich is two to three times the length of a normal standard line(it stands out)

Like the Marabozu this line generally corrects and it is quitecommon to draw corrective retracements along the length of themove in order to be able to ascertain the ability of the trend tocontinue in its actual direction and to sustain the momentum ofthe trend

Because of the abnormal size of the move a correction orconsolidation phase is likely to occur after this particular line



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The classification


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The classification

Positive or negativedepends on the colour of the real body

1 2 3 4 5 6 7 8

The classification (continued)


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( )

NeutralKoma market has little directional conviction

1 2 3 4 5 6 7 8



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( )

ReversalJujiTohbo at bottomTonbo at topHoshi

1 2 3 4 5 6 7 8



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( )

ReversalAt bottom Tonkachi very strong.At top Kubitsuri quite weak

1 2 3 4 5 6 7 8



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ReversalTohba at top very strong.Nagare Boshi at bottom very weak

1 2 3 4 5 6 7 8



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ContinuationOpening Bozuhits resistance in an uptrend.Very strong close in a downtrend

1 2 3 4 5 6 7 8



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ContinuationClosing Bozuhits support in an downtrend.Very strong close in an uptrend

1 2 3 4 5 6 7 8



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CorrectiveMarabozuno shadows usually very aggressive

1 2 3 4 5 6 7 8

Sandome no shojiki


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The Japanese candlestick chart

Part 2 reversal patterns

Reversal patterns two-day lines


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In section 1 we looked at the individual classification of thevarious candle lines and have assigned a nominal value to themoves in terms of positive, negative and neutral

In this section we look at the two-day (session) reversal patterns

In this section it is essential to understand the impact of theopening vs the previous session closing value as this oftenprovides directional clues

We also look at a technique which is derived by combining theopen of the first day and close of the second day to look at thecandle formation as a single line. This is done to achieve a greaterunderstanding of changes in market sentiment


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GyakushushenCounter attack lines

1. The Tsutsumi line


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Bearish Tsutsumi line Bullish Tsutsumi line

1a. The Bearish Engulfing lineTsutsumi line


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The Engulfing Line is oneof the strongest reversal

patterns and is an effectivemethod for identifyingchanges in marketsentiment

The market has to betrending for this pattern tobe validated

Tsutsumi line

Close

Trend



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The next period openshigher than the previousclose, creating a gap or Ku,(in section 1 we saw thisphenomena is usually a signof market weakness)

The real-bodies areobviously of oppositecolours

Open

Gap

Tsutsumi line



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The close of the currentcandle line is lower than theprevious session openengulfing the whole of thelast real-body

The shadows are not taken

into consideration atthis stage

Tsutsumi line

Open

Close



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The open of the first dayand close of the secondday would result in theentire session resemblinga, Tohba or Shooting Star

This technique gives

additional understandingto the analyst andsuggests that this patterndoes not requireconfirmation

Tsutsumi line

1a. The Bullish Engulfing lineTsutsumi line


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Tsutsumi line Is the reverse of the bearishengulfing pattern and is verystrong with the 2DC forminga hammer

There must be a reasonabletrend in place for this patternto to be effective

Trading strategy is to squaretrades that are positionedwith the prevailing trendand get ready to reverse ifsecond day followsthrough(confirmation isnot necessarily required ifall the rules have beenadhered to)

(2 day lineclassification = Tonkachi = Positive)

The Tsutsumi line


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The Tsutsumi line


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2. The Kabuse line


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Bearish Deaisen


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The Bearish meeting line isfound at the top of atrending market

Price action initially gapsaway from the previousclose but closes into the realbody of the previous session

The most common patternin the bearish meeting linefamily is Dark Cloud Cover

Major support

Gap

2/D,C

Examples


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Bearish Deaisen

Two Crows

Bearish EngulfingPattern

Hammer

USDJPY

2. Dark cloud coverKabuse line


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Very similar to the Engulfingpattern but does not engulf thewhole of the previous Jittai

A sustained up-trend is required,with price action of the activesession opening higher than theclose of the last session and inturn closing well into the

previous real-body

The greater the penetration intothe previous period the strongerthe signal

Trading strategyclose longpositions, go short when trendreversal confirmed

Kabuse line

2. Dark cloud coverKabuse line (continued)


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2/D,C

(2 day lineclassification = Shooting Star = Negative)

a

b

This line is a reversal but is weaker than the

engulfing pattern therefore a close below point(a) would act as a confirmation.

Kabuse line

Kabuse


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Counter attack linesDeaisen


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Deaisen is a meeting linein effect two periods of priceaction converge, to form areversal pattern known as the

Piercing line

Sashikomi occurs when a big gapoccurs between the close and theopening of two sessions with

price action returning to close onthe high meeting the old priceaction

The 2/D,C Shows the long Takuri

and suggests that price actionhas touched a key support butconfirmation is required prior toreversing a position i.e. a newhigh in the next trading session

Major support

2/D,C

Gap

3. The Piercing patternKirikomi line


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Similar to the Engulfingpattern but does not engulfthe whole of the previousJittai

An important feature of thispattern is that you must getsignificant penetration intothe previous real body to

call a reversal

The greater the penetrationinto the previous period thestronger the signal

Trading strategyclose longpositions, go short whentrend reversal confirmed

Kirikomi line

50%

(2 day lineclassification = Red Closing Tonkachi = Positive)

2/D,C

Kirikomi


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3. The Piercing PatternKirikomi line


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The importance of closing well into the previous real body ishighlighted by the 2D/C

Kirikomi Line 2/D,C

50%

2/D,C

Tonkachi Bozu

2/D,C

Standardline

Positive Neutral Continuation

5. The Harami line


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Harami Harami Cross

SupportSupport

5a. The Bearish Harami line


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The Harami similar to aninside day with the body ofa session contained withinthe previous sessions realbody

A market must be trendingbefore this pattern can beconsidered a reversal

The market opens lowerthan previous close andimmediately becomescorrective as opposed to areversal signal

Colours of the two bodiesare different

2/D,C

ShootingStar

Support

5b. The Bullish Harami line


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Confirmation is required ( abreak in the direction of thereversal on the third daywould suffice).

Trading strategyexercise extreme cautionwhen you see one ofthese patterns, adjust

your stop-loss levelaccordingly. If expectinga full trend reversal it isimperative to seekconfirmation prior to

acting.

2/D,C

Tonkachi

Resistance

5c. The Harami CrossHarami Yose Sen


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Because the last line is a Doji this pattern is much more significantthan the standard Harami line

Shadows are excluded (except in the case of Tweezers which willbe covered later)

Trading strategyclose current positions and look foropportunity to stop and reverse where possible

Also known asthe Doji cross

6. The Doji StarDoji bike


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This pattern was already outlined in section 1 but if a trend isactually underway then the gap at the open of the Doji indicatesa strong possibility of reversal. This pattern would not be so clear

on a bar chart

This pattern needs to be confirmed as the 2/D,C equates to astandard line (3-line reversal pattern, see later)

2/D,C 2/D,C

Doji Star


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8a. Tasuki


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Shadows are not taken into consideration as we are primarily

concerned by the open of the real body which opens into theprevious days session suggesting Haramibut closes lower than theprevious session open

This pattern is closely related to the Tasuki Gap which is a three line

reversal pattern

Support Resistance

Tasuki


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Upside Tasuki Gap

Bullish TasukiPiercing Line

Bearish Engulfing Pattern

Bullish TasukiBullish Tasuki

7b. Tasuki Gap


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The Tasuki Gap is a form of star, but rather than a spinning top orDoji the gap is part of a Standard line. The Ambush line is thethird Confirmation line which closes the window and forces thechange in the trend and sentiment

Support Resistance

Upside Tasuki Gap Downside Tasuki Gap

Upside Tasuki Gap Downside Tasuki Gap

Tasuki and Tasuki Gaps


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Tasuki Upside Tasuki Gap

Aggressive Sellers

below 0.8389

Reversal patterns

l l


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Doji***

Shooting Star**

Hanging Man*

Star**

Bearish Engulfing Pattern***

Tasuki Gap**

Dark Cloud Cover**

Harami line*

Doji***

Hammer***

Inverted Hammer*

Star **

Bullish Engulfing Pattern***

Tasuki Gap**

Piercing line**

Harami line*

Top reversal Bottom reversal


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Three line reversals

Sandome no Shojiki

E i St M i St

8. The Morning and Evening Star


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Evening Star Morning Star

8a. The Evening Star

Evening Star


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1

2

3

Evening Star

The market has to be trending

The second session is a small

star that has gapped awayfrom the price action

The third session is always theopposite colour of session 1

The related pattern (2d/c)would result in a bearishengulfing line/dark cloudcover so is extremely negative

The Morning Star

Morning Star


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Morning Star

The market has to be trending

The second session is a small starthat has gapped away from theprice action

The third session is always the

opposite colour of session 1

The related pattern (2d/c) wouldresult in a bullish engulfing line /piercing pattern so is extremely

positive

8b. The Doji Star

Evening Doji Cross Morning Doji Cross


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Evening Doji Crossor Northern Star

Morning Doji Crossor Southern Star

The Doji Star


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8b. Sute Go Abandoned baby


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Sometimes known as theabandoned baby and isdistinguished by a trading

session that gaps awayfrom lines 1 and 3. Thispattern does not requireconfirmation andis very powerful. Essentialthat the entire session gaps

away.

1

2

3

1

2

3

Upside Gap 2 Crows

Shita banare niwa garasu

Upside Gap Two Crows


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p p

1

2

3

Another 3 line bearish reversalpattern market is in an

uptrend and gaps higher insecond session

Third session again openshigher and engulfs the body

of session 2.

Session 2 and 3 gap away fromsession 1.

Unique 3 River Bottom

Sankawa Soko Zukae


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Sankawa Soko Zukae

1

2

3

This pattern is extremely rare

Session 1 is in a downtrend with a

lower closing

Session 2 is a Harami line of sortsbut has the lower close so thecolours of the real bodies are the

same in sessions 1 and 2

Session 2 has a long lower shadowand in itself is a hammer or Takuri

Session 3 is a positive sessionbelow the middle day (can be ameeting line).

10. Three White Soldiers

Aka Sanpei


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1

2

3

Aka Sanpei

This pattern shows a bullishreversal

Session 1, 2 and 3 are allbullish standard lines

The sessions all open roughly

in the middle of the previousreal body and close higher asbearish sentiment falters

No confirmation is required

Advance Block

Saki zumari

This pattern is potentially a bearish


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1

2

3

Saki zumari

p p yreversal and certainly definesweakness in the current trend

The three positive sessions in asustained up trend all open withinthe previous sessions real body

The advance block is highlighted by

the long upper shadows leaningtowards a shooting star

Confirmation is required

11. Three Black Crows

Saki zumari

This illustrates a bearish reversal


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1

2

3

Aka Sanpei

This illustrates a bearish reversalpattern

Three consecutive down

sessions are formed

Each line opens within theprevious days real body andcloses on or near its lows, butlower than previous session

No confirmation is required

12. The Harami age and Harami sage

1 Confirmation of a Harami pattern


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Support Resistance

Harami sage Harami age

2

3

1

2

3

13. The Tsutsumi age and Tsutsumi sage

1 Confirmation of an Engulfing pattern


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SupportResistance

Tsutsumi sage Tsutsumi age

2

3

1

2

3

14. The Tweezers Top & BottomKenuki


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Tweezers can be found at a market top or a bottom. The highs oftwo sessions (top) or the lows of two sessions (bottom) are thesame. Includes the body (for example one day can be aMarubozu). Indicates support or resistance.

Tweezer tops or bottoms are more effective when they form partof a reversal pattern.

15. High Wave WarningTakane nochiai


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Trend

1

2

3

4

5 6

7

8

Support

This usually occurs after a strong rally, the high wave is made upof a series of spinning tops, dojis and umbrellas

There are lots of clues to the direction of the breakout, but seeka confirmation line

15. Tower Tops and BottomsOhtenjyou


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1 2

Trend Support

This pattern would equate to a double top and the break belowthe support following the second tower and bearish engulfingpattern gives ample warning of the trend reversal

Identify The Patterns


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Bibliography and References

Candlestick Charting ExplainedGregory L. Morris

dl k h h


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Japanese Candlestick Charting TechniquesSteve Nison

Beyond CandlesticksSteve Nison

The Japanese Chart of ChartsSeiki Shimozu Stocks & Commodities

Pattern Recognition & CandlesticksGary S. Wagner & B.L. Matheney

Compressing Candlestick PatternsJean-Olivier Fraisse & K.D. Armstrong

Candlesticks & Preserving CapitalGary S. Wagner & B.L. Matheney

Candlesticks as a leading indicatorGary S. Wagner & B.L. Matheney


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Technical Trading Approach

For FX MarketsTaso AnastasiouDirector: Foreign Exchange Technical StrategyUBS Investment Bank

Phone : +44 (0)20 7567 6870E-Mail : [email protected]

What Are We Looking At?

Underlying Principles


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Momentum plays an important role in defining thestrength of an existing trend

Japanese Candlestick techniques are effective inpinpointing the early stages of a directional play orthe resumption of an existing trend effectivetiming signal

Momentum assists in verifying the candlesticksignal

Pinpointing The Turn.

Dark Cloud Coverreversal pattern identifiesthe potential t rning point

Dark cloud cover


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the potential turning point

The combination of a

negative momentumcrossover reinforces thesignificance of such areversal

If momentum is

overbought or oversold,the signal is deemed to bemore significant

Momentum is overbought

How Does Momentum Fit In?

Momentum defines theclimate, either bullish orbearish the market is in atthat point in time1

2

Dark cloud cover signalsa reversal in trend withmomentum alreadydisplaying a bearishclimate


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Momentum - RSI and amoving average of the RSI

1 Pattern is identifiedas a Piercing Pattern.Momentum though isdeclining and suggests ahigher probability the

bullish pattern will fail.

2 Price actioncompletely reversespattern 1 and suggests aresumption of the trend.

Positive and negativemomentum is defined bythe crossover of the blackline (RSI) above or belowthe red line (MA)

2

Bullish pattern ignored

given the fact thatmomentum was stilldeclining

climate

Example 1 - GBPCHF

Bearish Engulfing

pattern develops followingstrong uptrend suggestinga mature trend

Bearish Engulfing


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a mature trend

Momentum confirms abearish reversal andreinforces the potentialsignificance of the candlestick pattern.

Entry - opening price

next day

Subsequent price actionconfirms the bearishoutlook.

Subsequent breach oftrendline support alsoreinforces the change insentiment

Summary

A signal is deemed validonly when momentumconsiderations are in line

Bearish pattern deemedvalid given the fact thatmomentum was declining


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considerations are in linewith price signals

A bearish price patternwithin a positivemomentum environmentsuggests the market is notin vogue

Momentum helps toidentify any false reversalsignals

Bullish patternignored given the factthat momentum wasstill declining

Risk And Objective

Underlying Principles


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Early trend reversal would apply a maximum 2% stop loss(subjective decision).

Such a trend reversal has typically resulted in a 3%directional move. Therefore the trade is expected togenerate 3%, however this is actively managed.

A signal that marks a resumption of trend uses the high /low of the signal day or most recent corrective high / lowas the risk parameter. Maximum allowable risk remains2%

Risk and objectives are actively managed

Identifying The Turning Points In CHFJPY

13

Trade 3 resulted in a loss although theoriginal 2% stop loss would have beentightened and not incurring themaximum stop loss


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2

Identifying The Turning Point In EURNOK


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Stop loss wasappropriatelytight

Identifying The Continuation In EURCAD


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Achieves objective of 1.6230

Identifying The Turning Point In USDZAR


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Entry 6.0207

Target 6.2013

Identifying The Continuation In USDCHF

Target 1.3200


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Information


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Information


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Information


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Information


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