Japanese Candlestick Charting

Taso Anastasiou Director: FX/PM Global Technical Strategy GroupUBS Investment Bank

Phone : +44 (0)20 7567 6870E-Mail : taso.anastasiou@ubs.com

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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 a unified country by pacifying the 60 Daimyo feudal lords. This facilitated more freedom to trade between the provinces as well as towns such as Edo and Osaka. (Osaka became the centre of this trading activity). Even today, the traditional greeting in Osaka is �Mokarimakka�, which translated means, �are you making a profit?�

♦ Early records show charts were first used in Japan in the early 16th Century to record price fluctuations on feudal Japan�s rice exchanges

♦ 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 rice warehouses were accepted as payment and hence the first futures contracts were effectively traded

♦ Sokyu Honma (1716�1803) was a brilliant rice merchant who is widely acknowledged as being the grandfather of Candlestick charting

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

♦ Honma developed a series of rules which were called the �Soba samni 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 construct a typical bar chart i.e. open, high, low and close

♦ Candles are colour coded for; up closes i.e. close > open and down closes 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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�Jittai��The Real Body

♦ The Real Body represents the area between the opening and closing prices

♦ The closing price is the most important piece of information since it concludes the sessions trading and provides an insight into market sentiment

♦ Most technical indicators use the closing prices as the basis for their calculations

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The Real Body

♦ The size of the real body can provide useful clues regarding prospective corrective / reversal points

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

Open

Close

Open

Close

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Impact of opening vs previous closing

Neutral�correction

Normal�continuation

Danger�reversal

Short term consolidation

Danger�reversal

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�Uwakage�Shitakage�� Shadows

Critical support

Short coveringand buying pressureoff this level

�TAKURI��Testing the Water

The longer the shadow the moresignificant the level

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The 50% level�Market Profile©

♦ To understand the importance of the 50% level it is necessary to understand the concept of Fair Price and Market Profile©. For any given distribution there will be a level which is accepted by the market i.e. an equilibrium point. A close above the Fair Value area serves as a very useful guide what that consensus is

Fairvalue area

Buyers

Sellers

Extremes

Extremes

Fair pricePoint of control

Close

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The dynamics of a candle line

RB�becoming smaller Long shadows either side

Closes below previous equilibrium price

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The dynamics explained

♦ A normal candle is called a strong line, this simply means it represents a positive continuation of either a bullish or bearish move

♦ The smaller the real body, the weaker the line. Typically this reflects consolidation when uncertainty exists and traders square positions 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 potential reversal once confirmation has occurred

The classification and single candle linesSECTION 2

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The classificationThe 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 continuation move. They have strong real bodies and small lower / upper shadows. They will not provide you with any specific clues in terms of a potential change in market direction, they merely reinforcethe existing directional bias

(+)

(�)

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Standard lines

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2a. The Koma�spinning top

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

♦ Generally the market is considered to be consolidating when thispattern is formed. The market has little directional conviction

(+/�) (+/�)

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Koma

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2b. The star��Hoshi�

♦ A potential top reversal pattern

The market has become very weak and is showing signs of imminent reversal

A �Koma� that gaps away from the market becomes a �Hoshi� or star

The Gap is a window or �Ku�

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Hoshi

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3. The Doji�reversal

♦ The Doji is very important, it is considered to be a reversal line or warn 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 man��Juji�

♦ The Long Legged Doji�(Rickshaw man), shows a potential turning point where the upper and lower shadows are long and of approximately equal length

Juji

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The Rickshaw man��Juji�

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3b. The Gravestone Doji��Tohba�

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

Market rejects this level strong selling pressure

Tohba

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Doji�NIKKEI

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3c. The dragonfly Doji��Tonbo�

♦ This is the opposite of a Gravestone and is found at market bottoms

Strong buying pressureat this level�criticalsupport pointTakuri -

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3d. The Doji Star

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

�Hoshi�

�Ku�

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Doji Star

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4. The Umbrella��Karakasa�

♦ 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. �Karakasa��Umbrella reversal

♦ There are two distinctive variations of the umbrella pattern

♦ The Hanging Man which appears at a market top and the Hammer which appears at a market bottom

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

♦ The umbrella is widely regarded as a reversal line but confirmation 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 to the direction of the closing as this gives additional weight to the pattern

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4a. The Hanging Man

♦ The market has to be in a clearly defined up-trend

♦ The market shows signs of weakness and aggressively tests the downside

♦ The session however closes much higher than the recorded low

Support

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The Hanging Man (continued)

Shooting Star

Dark Cloud Cover

Hanging ManLIFFE Lg-Gilt

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4b. The Hammer

♦ The Hammer is a very important bottoming reversal pattern

♦ The colour of the real body is less important than for the Hanging Man as the market has bounced off a low in a downtrend

♦ Strong buying has occurred, and indicates a good level of support

♦ The long shadow is indicative of the strong buying pressure

Support

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Hammer

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Karakasa

Inverted Head and

Shoulders Reversal

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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. Notice the resistance that has been established following the formation of the hammer.

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5. Inverted Hammer�reversal

♦ This pattern is the direct opposite of the umbrella lines or 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

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Shooting Star

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Shooting Star

Shooting StarShooting Star

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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

Opening Marubozu

Closing 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, especially after the release of economic data. Corrections are likely in the period following after the pattern

50% level critical

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The Long Standard line

♦ The Long Standard line is easily identifiable as a single candle line which 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 quite common to draw corrective retracements along the length of the move in order to be able to ascertain the ability of the trend to continue in its actual direction and to sustain the momentum ofthe trend

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

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The Long Standard line

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The classification

Positive or negative�depends on the colour of the real body

1 2 3 4 5 6 7 8

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The classification (continued)

Neutral�Koma market has little directional conviction

1 2 3 4 5 6 7 8

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The classification (continued)

Reversal�Juji�Tohbo at bottom�Tonbo at top�Hoshi

1 2 3 4 5 6 7 8

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The classification (continued)

Reversal�At bottom Tonkachi very strong.At top Kubitsuri quite weak

1 2 3 4 5 6 7 8

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The classification (continued)

Reversal�Tohba at top very strong. Nagare Boshi at bottom very weak

1 2 3 4 5 6 7 8

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The classification (continued)

Continuation�Opening Bozu�hits resistance in an uptrend.Very strong close in a downtrend

1 2 3 4 5 6 7 8

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The classification (continued)

Continuation�Closing Bozu�hits support in an downtrend.Very strong close in an uptrend

1 2 3 4 5 6 7 8

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The classification (continued)

Corrective�Marabozu�no shadows usually very aggressive

1 2 3 4 5 6 7 8

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The Japanese candlestick chartPart 2 reversal patterns

�Sandome no shojiki�

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Reversal patterns two-day lines

♦ In section 1 we looked at the individual classification of the various candle lines and have assigned a nominal value to the moves 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 the opening vs the previous session closing value as this often provides directional clues

♦ We also look at a technique which is derived by combining the open 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 greater understanding of changes in market sentiment

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GyakushushenCounter attack lines

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1. The Tsutsumi line

Bearish Tsutsumi line Bullish Tsutsumi line

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1a. The Bearish Engulfing line�Tsutsumi line

♦ The Engulfing Line is one of the strongest reversal patterns and is an effective method for identifying changes in market sentiment

♦ The market has to be trending for this pattern to be validated

Tsutsumi line

Close

Trend

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1a. The Bearish Engulfing line�Tsutsumi line

♦ The next period opens higher than the previous close, creating a gap or �Ku�, (in section 1 we saw this phenomena is usually a sign of market weakness)

♦ The real-bodies are obviously of opposite colours

Open

Gap

Tsutsumi line

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1a. The Bearish Engulfing line�Tsutsumi line

♦ The close of the current candle line is lower than the previous session open�engulfing the whole of the last real-body

♦ The shadows are not taken into consideration at this stage

Tsutsumi line

Open

Close

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1a. The Bearish Engulfing line�Tsutsumi line

♦ The open of the first day and close of the second day would result in the entire session resembling a, Tohba or Shooting Star

♦ This technique gives additional understanding to the analyst and suggests that this pattern does not require confirmation

Tsutsumi line

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1a. The Bullish Engulfing line�Tsutsumi line

Tsutsumi line ♦ Is the reverse of the bearish engulfing pattern and is very strong with the 2DC forming a hammer

♦ There must be a reasonable trend in place for this pattern to to be effective

♦ Trading strategy is to square trades that are positioned with the prevailing trend and get ready to reverse if second day follows through�(confirmation is not necessarily required if all the rules have been adhered to)

(2 day line�classification = Tonkachi = Positive)

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The Tsutsumi line

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The Tsutsumi line

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2. The Kabuse line

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Bearish Deaisen

♦ The Bearish meeting line is found at the top of a trending market

♦ Price action initially gaps away from the previous close but closes into the real body of the previous session

♦ The most common pattern in the bearish meeting line family is Dark Cloud Cover

Major support

Gap

2/D,C

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Examples

Bearish Deaisen

Two Crows

Bearish Engulfing Pattern

Hammer

USDJPY

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2. Dark cloud cover�Kabuse line

♦ Very similar to the Engulfing pattern but does not engulf the whole of the previous �Jittai�

♦ A sustained up-trend is required, with price action of the active session opening higher than the close of the last session and in turn closing well into the previous real-body

♦ The greater the penetration into the previous period the stronger the signal

♦ Trading strategy�close long positions, go short when trend reversal confirmed

Kabuse line

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2. Dark cloud cover�Kabuse line (continued)

2/D,C

(2 day line�classification = 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

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Kabuse

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Counter attack lines�Deaisen

♦ Deaisen is a meeting line�in effect two periods of price action converge, to form a reversal pattern known as the Piercing line

♦ Sashikomi occurs when a big gap occurs between the close and the opening of two sessions with price action returning to close on the high meeting the old price action

♦ The 2/D,C Shows the long Takuri and suggests that price action has touched a key support but confirmation is required prior to reversing a position i.e. a new high in the next trading session

Major support

2/D,C

Gap

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3. The Piercing pattern�Kirikomi line

♦ Similar to the Engulfing pattern but does not engulf the whole of the previous �Jittai�

♦ An important feature of this pattern is that you must get significant penetration into the previous real body to call a reversal

♦ The greater the penetration into the previous period the stronger the signal

♦ Trading strategy�close long positions, go short when trend reversal confirmed

Kirikomi line

50%

(2 day line�classification = Red Closing Tonkachi = Positive)

2/D,C

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Kirikomi

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3. The Piercing Pattern�Kirikomi line

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

Kirikomi Line 2/D,C

50%

2/D,C

Tonkachi Bozu

2/D,C

Standardline

Positive Neutral Continuation

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5. The Harami line

Harami Harami Cross

SupportSupport

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5a. The Bearish Harami line

♦ The Harami similar to an inside day with the body of a session contained within the previous sessions real body

♦ A market must be trending before this pattern can be considered a reversal

♦ The market opens lower than previous close and immediately becomes corrective as opposed to a reversal signal

♦ Colours of the two bodies are different

2/D,C

ShootingStar

Support

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5b. The Bullish Harami line

♦ Confirmation is required ( a break in the direction of the reversal on the third day would suffice).

♦ Trading strategy�exercise extreme caution when you see one of these patterns, adjust your stop-loss level accordingly. If expecting a full trend reversal it is imperative to seek confirmation prior to acting.

2/D,C

Tonkachi

Resistance

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5c. The Harami Cross�Harami Yose Sen

♦ Because the last line is a Doji this pattern is much more significant than the standard Harami line

♦ Shadows are excluded (except in the case of Tweezers which will be covered later)

♦ Trading strategy�close current positions and look for opportunity to stop and reverse where possible

Also known asthe Doji cross

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Harami

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6. The Doji Star�Doji bike

♦ 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 a standard line (3-line reversal pattern, see later)

2/D,C 2/D,C

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Doji Star

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7. The Separating line�Iki Chigai sen

♦ The basis for this line starts in a trend when (as in the example) the market closes higher as expected. The next opening creates a huge gap on the open � however price action closes lower on the day near the previous days close.

♦ Both days should be long days.

♦ The pattern created in the 2/D,C does not break down into a significant pattern �no insight into the trend.

2/D,C

Gap

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Separating line vs Meeting line

♦ Separating line tends to be more explosive at the outset and arecontinuation patterns.

♦ Meeting lines tend to be weaker.

Meeting lines Separating lines

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8a. Tasuki

♦ Shadows are not taken into consideration as we are primarily concerned by the open of the real body which opens into the previous days session suggesting Harami�but closes lower than the previous session open

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

Support Resistance

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Tasuki

Upside Tasuki Gap

Bullish TasukiPiercing Line

Bearish Engulfing Pattern

Bullish TasukiBullish Tasuki

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7b. Tasuki Gap

♦ The Tasuki Gap is a form of star, but rather than a spinning top or Doji the gap is part of a Standard line. The Ambush line is the third Confirmation line which closes the window and forces the change in the trend and sentiment

Support Resistance

Upside Tasuki Gap Downside Tasuki Gap

Upside Tasuki Gap Downside Tasuki Gap

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Tasuki and Tasuki Gaps

Tasuki Upside Tasuki Gap

Aggressive Sellers below 0.8389

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Reversal patterns

♦ 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 reversalsSandome no Shojiki

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Evening Star Morning Star

8. The Morning and Evening Star

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8a. The Evening Star

1

2

3

Evening Star♦ The market has to be trending

♦ The second session is a small star that has gapped away from the price action

♦ The third session is always the opposite colour of session 1

♦ The related pattern (2d/c) would result in a bearish engulfing line/dark cloud cover so is extremely negative

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The Morning Star

Morning Star

♦ The market has to be trending

♦ The second session is a small star that has gapped away from the price action

♦ The third session is always the opposite colour of session 1

♦ The related pattern (2d/c) would result in a bullish engulfing line / piercing pattern so is extremely positive

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8b. The Doji Star

Evening Doji Cross or Northern Star

Morning Doji Cross or Southern Star

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8b. Sute Go � Abandoned baby

Sometimes known as the abandoned baby and is distinguished by a trading session that gaps away from lines 1 and 3. This pattern does not require confirmation and is very powerful. Essential that the entire session gaps away.

1

2

3

1

2

3

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Upside Gap 2 CrowsShita banare niwa garasu

Upside Gap Two Crows

1

2

3

♦ Another 3 line bearish reversal pattern �market is in an uptrend and gaps higher in second session

♦ Third session again opens higher and engulfs the body of session 2.

♦ Session 2 and 3 gap away from session 1.

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Unique 3 River Bottom

Sankawa Soko Zukae

1

2

3

Sankawa Soko Zukae

♦ This pattern is extremely rare

♦ Session 1 is in a downtrend with a lower closing

♦ Session 2 is a Harami line of sorts but has the lower close so the colours of the real bodies are the same in sessions 1 and 2

♦ Session 2 has a long lower shadow and in itself is a hammer or Takuri

♦ Session 3 is a positive session below the middle day (can be a meeting line).

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10. Three White SoldiersAka Sanpei

1

2

3

Aka Sanpei

♦ This pattern shows a bullish reversal

♦ Session 1, 2 and 3 are all bullish standard lines

♦ The sessions all open roughly in the middle of the previous real body and close higher as bearish sentiment falters

♦ No confirmation is required

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Advance BlockSaki zumari

1

2

3

Saki zumari

♦ This pattern is potentially a bearish reversal and certainly defines weakness in the current trend

♦ The three positive sessions in a sustained up trend all open within the previous sessions real body

♦ The advance block is highlighted by the long upper shadows leaning towards a shooting star

♦ Confirmation is required

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11. Three Black Crows

1

2

3Aka Sanpei

Saki zumari

♦ This illustrates a bearish reversal pattern

♦ Three consecutive down sessions are formed

♦ Each line opens within the previous days real body and closes on or near its lows, but lower than previous session

♦ No confirmation is required

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12. The Harami age and Harami sage

Support Resistance

Harami sage Harami age

1

2

3

1

2

3

Confirmation of a Harami pattern

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13. The Tsutsumi age and Tsutsumi sage

SupportResistance

Tsutsumi sage Tsutsumi age

1

2

3

1

2

3

Confirmation of an Engulfing pattern

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14. The Tweezers Top & Bottom�Kenuki

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

♦ Tweezer tops or bottoms are more effective when they form part of a reversal pattern.

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15. High Wave Warning�Takane nochiai

Trend

1

2

3

4

5 6

78

Support

♦ This usually occurs after a strong rally, the high wave is made up of a series of spinning tops, doji�s and umbrellas

♦ There are lots of clues to the direction of the breakout, but seek a confirmation line

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15. Tower Tops and Bottoms�Ohtenjyou

1 2

Trend Support

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

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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 Explained�Gregory L. Morris

♦ Japanese Candlestick Charting Techniques�Steve Nison

♦ Beyond Candlesticks�Steve Nison

♦ The Japanese Chart of Charts�Seiki Shimozu Stocks & Commodities

♦ Pattern Recognition & Candlesticks�Gary S. Wagner & B.L. Matheney

♦ Compressing Candlestick Patterns�Jean-Olivier Fraisse & K.D. Armstrong

♦ Candlesticks & Preserving Capital�Gary S. Wagner & B.L. Matheney

♦ Candlesticks as a leading indicator�Gary S. Wagner & B.L. Matheney

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Disclaimer

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