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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
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
The Long Standard line
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The Long Standard line
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
The classification (continued)
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( )
ReversalJujiTohbo at bottomTonbo at topHoshi
1 2 3 4 5 6 7 8
The classification (continued)
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( )
ReversalAt bottom Tonkachi very strong.At top Kubitsuri quite weak
1 2 3 4 5 6 7 8
The classification (continued)
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ReversalTohba at top very strong.Nagare Boshi at bottom very weak
1 2 3 4 5 6 7 8
The classification (continued)
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ContinuationOpening Bozuhits resistance in an uptrend.Very strong close in a downtrend
1 2 3 4 5 6 7 8
The classification (continued)
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ContinuationClosing Bozuhits support in an downtrend.Very strong close in an uptrend
1 2 3 4 5 6 7 8
The classification (continued)
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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
1a. The Bearish Engulfing lineTsutsumi line
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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
1a. The Bearish Engulfing lineTsutsumi 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
1a. The Bearish Engulfing lineTsutsumi line
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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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Identify The Patterns
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Identify The Patterns
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Identify The Patterns
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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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