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All About CANDLESTICK CHARTING
THE EASY WAY TO GET STARTED
By WAYNE A. CORBITT The McGraw-Hill Companies, Inc.
Copyright © 2012The McGraw-Hill Companies, Inc.
All rights reserved.
ISBN: 978-0-07-176312-7
Excerpt
CHAPTER 1 The Illuminating Power of the Candle
For centuries the candle has been used to illuminate our surroundings. Without light, simple tasks such as walking across a familiar room become much more difficult. Maybe you are new to trading or maybe you have been trading for a while. In either case, if you feel like you are lost or groping in the dark when it comes to making solid trading decisions, this book is for you. My goal is to show you how the extra layer of analysis provided by candlestick charting can allow you to see the markets in a whole new light. The concepts discussed in this book will be of benefit to traders of all time frames and temperaments. Whether you realize it or not, everyone is a trader because every trade has to have an entry and an exit. Some trades may be entered into and exited from in the same day, whereas others may be held for weeks, months, or even years. Together we will build from a foundation of candlestick patterns and add different indicators to enhance your odds for trading success. This journey will demonstrate the value of Japanese candlestick charting and allow you to apply the concepts presented here to read the subtle signals given by the market every single trading day. Although most of the examples in this book involve daily charts, these concepts can be used in any time frame, from intraday to monthly.
Japanese candlestick charts were developed in Japan over 200 years ago but have become a standard charting methodology in Western culture only over the last 20 years, largely as a result of the work of Steve Nison and Greg Morris. Munehisa Honma developed candlestick charting around 1750 to analyze price movements at his local rice market in Sakata. Honma's efforts allowed him to accumulate vast wealth while becoming a legendary trader. The culture in Honma's day was heavily influenced by the military. Throughout the book you will notice that candlestick charting employs many militaristic terms, which makes it similar to battle scenarios. Success in a military campaign requires planning, patience, discipline, and unwavering execution. These are also traits of the most successful traders in the financial markets.
This ancient methodology has an advantage over more modern Western charting styles because of its appealing appearance and ability to show intraday data relationships effectively, most notably the relationship between the opening and closing prices. A dark (or filled) candle body shows that the closing price was lower than the opening price, and a white (or hollow) candle body shows that the closing price was higher than the opening price. Figure 1-1 illustrates how candlestick colors show the relationship between the opening and closing prices. These differences in appearance can give a trader a quick report on whether the efforts of buyers were stronger than those of sellers or vice versa for the time period being examined, whether it is intraday, daily, weekly, or monthly.
The simple open-close relationship creates the foundation for more complex and revealing analysis. Groups of candlesticks, or candlestick patterns, are also easily identifiable and have unique names such as dark cloud cover, three white soldiers, and counterattack lines. Once you unlock the wealth of information that is available in a candlestick chart, I am confident that it will become your first choice among charting styles. Before we dig deeper into candlesticks, let's lay the groundwork for later sections of the book that blend the ancient art of candlestick charting with the more modern Western discipline of technical analysis.
WHAT IS TECHNICAL ANALYSIS AND WHY SHOULD YOU USE IT?
The writings of Charles Dow around the turn of the twentieth century provided the foundation from which modern technical analysis has evolved. Dow's early writings constituted what is now known as Dow theory.
Modern technical analysis is based on the following principles:
1. The market discounts everything that can affect the price of a security.
2. Prices are driven by the expectations of market participants.
3. Price movements are not totally random.
4. What price did is more important than why it did it.
5. History tends to repeat itself.
The Market Discounts Everything That Can Affect the Price of a Security
Technicians believe that the current price level of any security is based on the collective knowledge of all market participants. Those participants represent a broad array of investment styles and methodologies used by technical analysts, fundamental analysts, institutions, and portfolio managers, among others. This melting pot of approaches and opinions provides what amounts to a fair price for a security.
Prices Are Driven by the Expectations of Market Participants
Prices are affected by the consensus of opinion among buyers and sellers. These opinions or expectations for future price growth drive decisions made to buy or sell a security. These collective actions provide the foundation for trends, or the tendency of price to move in one direction over time. Trends are covered in Chapter 5.
Price Movements Are Not Totally Random
If price movements were totally random, it would be virtually impossible to make money by using any form of rational market analysis. Using technical analysis over different time frames can identify times when shares are being accumulated or distributed by major institutions. This concept dovetails with the previous point about the expectations of market participants. If expectations are favorable, systematic accumulation should be visible as price makes higher highs and higher lows. Conversely, if expectations are unfavorable, systematic distribution should be visible as price makes lower highs and lower lows.
What Price Did Is More Important Than Why It Did It
Building on the concepts outlined above, it stands to reason that if price action discounts all available news, represents the collective outlook of market participants, and shows systematic accumulation or distribution of shares, all necessary information should be reflected in the direction and magnitude of price moves. A true technician does his or her best to block out news and opinions and concentrate solely on charts.
History Tends to Repeat Itself
Technical analysis captures the mood or sentiment of market participants. By looking for specific price and volume patterns, technicians can develop reasonable expectations for future price movement.
By using a disciplined approach that is based on these principles, a trader can develop a sound trading system that yields profits. Technical analysis is based on expectations that are based on expected outcomes, not hard and fast predictions. The goal of technical analysis is not to be right 100 percent of the time but to alert a trader to high-probability opportunities for profit that can be exploited in the market.
TECHNICAL ANALYSIS MEASURES SUPPLY AND DEMAND
Many insults have been hurled at market technicians over the years by those who do not understand the simplicity of price and volume plots. Technical analysis has been referred to as reading chicken entrails, reading tea leaves, and, one of my favorites, reading squiggles. What these uninformed souls fail to recognize is that in its simplest form, technical analysis measures the supply and demand of the security being charted.
There is no other method I know of that captures the supply and demand picture of a security better than a price and volume chart. Supply a
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Excerpted from All About CANDLESTICK CHARTING by WAYNE A. CORBITT. Copyright © 2012 by The McGraw-Hill Companies, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc..
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