CANDLESTICK CHARTING EXPLAINED CANDLESTIC CHARTING EXPLAINED Timeless Techniques for Trading Stocks and Futures Third Edition Gregory L. Morris with Ryan Litchfield Copyright © 1992, 1995, 2006 by Gregory L. All rights reserved. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher.
ISBN: 978-0-07-163217-1 MHID: 0-07-163217-4 The material in this eBook also appears in the print version of this title: ISBN: 978-0-07-146154-2, MHID: 0-07-146154-X. All trademarks are trademarks of their respective owners. Rather than put a trademark symbol after every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefit of the trademark owner, with no intention of infringement of the trademark. Where such designations appear in this book, they have been printed with initial caps.
McGraw-Hill eBooks are available at special quantity discounts to use as premiums and sales promotions, or for use in corporate training programs. To contact a representative please e-mail us at bulksales@mcgraw- hill. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, futures/securities trading, or other professional service.
If legal advice or other expert assistance is required, the services of a competent professional person should be sought. —From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers TERMS OF USE This is a copyrighted work and The McGraw-Hill Companies, Inc. (“McGraw- Hill”) and its licensors reserve all rights in and to the work. Use of this work is subject to these terms.
Except as permitted under the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may not decompile, disassemble, reverse engineer, reproduce, modify, create derivative works based upon, transmit, distribute, disseminate, sell, publish or sublicense the work or any part of it without McGraw- Hill’s prior consent. You may use the work for your own noncommercial and personal use; any other use of the work is strictly prohibited. Your right to use the work may be terminated if you fail to comply with these terms. THE WORK IS PROVIDED “AS IS.” McGRAW-HILL AND ITS LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETENESS OF OR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTHERWISE, AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE.
McGraw-Hill and its licensors do not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted or error free. Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom. McGraw- Hill has no responsibility for the content of any information accessed through the work. Under no circumstances shall McGraw- Hill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages.
This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise. To Dusti, Grant, Derek, and Kane Contents Foreword from the Second Edition Foreword for the Third Edition by Tim Chapman Preface from the Second Edition Preface for the Third Edition Acknowledgments 1. Reversal Candle Patterns 4. Sakata’s Method and Candle Formations 6.
The Philosophy behind Candle Pattern Identification 7. Reliability of Pattern Recognition 8. Candle Pattern Performance 9. Candle Pattern Filtering 10.
Candlesticks for Traders 11. Conclusions Appendix A: Interview with Takehiro Hikita Appendix B: Derivative Charting Methods Bibliography Index Special Offer Foreword from the Second Edition I am a collector of first editions of books. My specialties include astronomy texts written before 1900, such as Percival Lowell’s classic Mars, the first published speculations about the possibility of life on the red planet (which inspired Jules Verne to write The War of the Worlds), and a strange little tome from 1852 that claims astronomer William Hershel spotted sheep on the Moon with his telescope. My collection also includes about 200 business books written by authors I have interviewed through the years.
My inscribed copy of Ivan Boesky’s Merger Mania, for example was appraised a few years ago at $200. But my sentimental favorite is a beat-up old chart book of the Dow Jones Industrials and Transportation Averages going back to December 18, 1896, the day the modern Dow Jones averages were born. (Trivia question: Where did the Dow Industrials close after its very first day of trading? Answer: 38. Back then, the Industrials only had 12 components, and the Transports, with 20 issues, were known as the Rails.
A 90-year-old FNN viewer from Virginia offered it to me in the fall of 1985. “I have been interested in, but not too active in, the market since the early ’20’s” he wrote, “and lived through the ’29 ‘break’ and the great depression which was a ‘tempering’ influence against excessive enthusiasm.” “At age 90 my activities are confined to ‘growth’ stocks and safe investments. I am no longer interested in ‘speculation.’” So he wondered if I would be interested in his chart book. I gladly accepted in exchange for a signed copy of one of Joe Granville’s books.
The book was published in 1931 by Robert Rhea, the famed disciple of Charles Dow and of the oldest form of technical analysis, the Dow Theory. It covers the years 1896–1948, with each page devoted to one year’s trading of both averages. It is one big, faded green rectangle, measuring 11 inches high and 18 inches across. Its heavy cardboard covers are held together by a couple of rusty screws.
I browse through it once in awhile, marveling at its simplicity. Each day’s closing value is designated by a single horizontal hash mark meticulously notched on the graph paper. No intraday highs and lows, no trendlines, no points or figures, just a simple daily record of the debits and credits of civilization. There is the market panic in December of 1899, when the Industrials plunged from 76 to 58 in just 13 trading days.
There is the period from July to December of 1914, when, incredibly, the market was closed on account of World War I. Eerily, half the page devoted to that year is blank. And, of course, there is 1929, when the Industrial peaked on September 3 at 381.17 and hit a bottom, three pages later, in July of 1932 at 41. The book means a lot to me.
Between its covers there is a bit of history, some mathematics, a dose of economics, and a dash of psychology. It has taught me much about a discipline that I once considered voodoo. Good journalists are supposed to maintain an open mind about the stories they cover. Political reporters, for example, should be neither Republican nor Democrat.
And successful financial reporters should avoid being either bullish or bearish. And they should also be familiar with both fundamental and technical analysis. I remember the first time I interviewed a technical market analyst in the fall of 1981, when I was still cutting my teeth on business news. This analyst spoke of 34-day and 54-week market cycles and head-and-shoulder bottoms and wedge formations.
I thought it was so much mumbo-jumbo until the summer of 1982 when the bull market was launched, and the fundamental analysts were still bemoaning the depths of the recession that gripped the economy at the time. That was when I realized the technicians may have something there. He doesn’t know it, but Greg Morris taught me a lot about technical analysis. Or, more accurately, his N- Squared software did.
For a couple of years during the mid-1980s, I hand-entered the daily NYSE advance/decline readings and the closing figures of a few market indices into my computer. I used N-Squared to build charts and draw trendlines. (I hadn’t yet learned about modems and downloading from databanks.) The slow, painstaking process gave me a hands-on, almost organic, feel for the markets. And watching various repetitive chart patterns unfold on the computer screen was a great lesson about supply and demand and about market psychology.
I think I understand how technical analysis works. It’s the why that still puzzles me. I understand the supply and demand implications of support and resistance levels, for example, and I appreciate the theories behind pennant formations and rising bottoms. But I still marvel at what ultimately makes technical analysis work: that intangible something that causes technicians to anthropomorphize the markets without even realizing it.
The market is tired, they say. Or the market is trying to tell us this or that. Or the market always knows the news before the newspaper do. That something, in my mind, is simply the human side of the market, which I suggest American technicians tend to ignore.
Technical analysis is, after all, as much art as it is science. But too many analysts have a mathematical blind spot, and I blame that on computers. Yes, charts represent numerical relationships, but they also depict human perceptions and behavior. Enter Sakata’s Candlesticks, which combine the highly quantitative ratiocination of American technical analysis with the intuitive elegance of Japanese philosophy.
Greg Morris has more that ably turned his attention to this fascinating charting style with this book. It occurs to me that Japanese Candlesticks are the perfect form of technical analysis for the 1990s. I happen to agree with authors John Naisbett and Patricia Aburdene. It won’t necessarily be an overtly religious period, mind you, but rather one subtle, intuitive power we may all develop that allows us to sense things before they actually happen.
It will be a period that embraces a kind of hybrid Eastern philosophy and Western practicality without all the New Age hocuspocus. Just right for Candlestick analysis. The system is precise and exacting, but it charms with its haiku-like names for charts patterns: “paper umbrella,” or “spinning tops,” for example. But I’ll let Greg Morris tell the story from here.
I just hope my 90-year-old friend is still around to read it. I think he would like it. BILL GRIFFETH, Anchor Strictly Business, CNBC Park Ridge, NJ Foreword for the Third Edition I got into the investment business when I was 21 and my timing was impeccable. I opened my first office in June 1982 only two months before the stock market embarked on an 18-year secular bull market.
(I thought I was the catalyst for the market’s improvement!) I was young and knew everything—or at least I thought so. It didn’t take long for me to realize that not only did I not know everything; I actually knew very little. The investment world is a big place and the confounding truth is there is no single “right” way to do it. There are many good ideas and strategies but none are perfect.
I considered myself quite mature at the ripe age of 21, but thankfully I was alone in that assessment. There were very few people standing in line to get investment advice from a kid, which was a good thing because as a result, I had little opportunity to do any damage. One benefit of youth is an openness to ideas, and by setting out on my own I was fortunate to have escaped the traditional training of the big brokerage firms.