CHAPTER 1
INTRODUCTION
自業自得
One ’ s act, one ’ s profit.
In the bustling markets of Japan’s Tokugawa, buyers and sellers of
rice coupons relied on candlesticks to study price movement, interpret
investor sentiment, and determine market patterns. By the mid-1700s, years
of quantitative research and trading experience prompted seasoned Japanese
traders like Munehisa Homna to rely on candlestick price action charts to
maximize profits and decrease market risk. The hollow or filled portion of the
candlestick, “body”, marked the rice coupon’s opening and closing price. The
long, thin lines above and below the body, “shadows,” depicted the high/low
price range. Generations of use in Asian markets helped refine this early form
of price action analysis. Today, candlestick chart analysis is not just a trading
tool; it is a form of market analysis in its own right.
In the early 1990s, candlestick analysis made its way to the United
States. The reliability and utility of candlesticks to provide early indications
of market turns, furnish market insights, and enhance Western charting
analysis, ignited the interest of investors and traders alike. Since candlesticks
provide a clear and easy-to-identify set of patterns that are highly accurate in
predicting market trends, they are the preferred charting technique of
momentum, swing, and intra-day traders. We will use the terms candles and
candlesticks interchangeably throughout the book.
BACK TO THE FUTURE: 21
ST CENTURY MONEY AND 16
TH
CENTURY JAPANESE CANDLESTICKS
You may be thinking, “We are a couple-centuries late to the rice
coupon trading boom, candles were made obsolete by electricity, and no one
asked for a history refresher.” To which I respond, 1) you are destined to be
forever-single with that kind of attitude and 2) candles are hardly obsolete,
Newell Brands (NYSE: NWL), makers of Yankee candle, is trading at about
$27 per share.
In all seriousness, the services candlesticks provided in the 16
th
century apply to the 21
st century. What services? Well, for one thing,
candlesticks tell you where a stock has been and where it is going. Further,
candlesticks illustrate market sentiment. That is, candlesticks help traders and
investors determine whether buyers, sellers, or neither are in control of a
stock at any point in time. A large bullish candlestick tells us buyers are in
control, and you may want to join them. A large bearish candlestick suggests
sellers are in control, and you may wish to consider exiting the trade.
JAPANESE CANDLESTICKS
When you think “best friend,” an image of candlesticks should come to
mind. Why? Because candlesticks and candlestick charts:
Are easy to read: It does not take a rocket scientist to read
candles and thereby predict a stock’s price movement.
Are psychic: Well, as good a psychic there is. Candlestick
patterns, i.e., one or more candles in a group, often warn the
chartist, i.e., you, that the price of the stock may change course
in the opposite direction. If the price of the stock was trending
lower, and your best friend candlestick appears, you may want
to listen and ride the bullish price movement train to profitland; and vice-versa.
Are powerful: Candlesticks may look and sound cute, but they
kick harder than a mule. Like my dad likes to say, “don’t get
caught staring at an ass, or you just might get a kick to the
face.” If you are drooling over a stock and the candles warn you
the price of the stock will drop, look elsewhere, or, you get the
point (kick to the face).
Are efficient: Because of the immediate visual warning sent out
by candlestick patterns, they will make your stock market
analysis faster and much, much more efficient.
At its core, we use candlesticks for analyzing and identifying patterns and
setups that suggest what the stock’s future will be. We find a pattern, evaluate
the direction (up, down, or sideways) the stock was trading leading up to that
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