Market Watch : Candles Light the Way
In the mid-1700s, the Japanese found something intriguing--and beautiful--about patterns in the price of rice, as plotted on paper charts. And so the first market technicians were born: analysts who try to predict market trends by studying recent price movements.
Today, the Japanese are still avid chartists, and pretty good ones at that. But American technical analysts in stocks, commodities and other investments have almost completely ignored Japan’s rich history of chart reading and the lessons that can be gleaned from 250 years of experience.
Now, Steve Nison, a Merrill Lynch analyst in New York, is single-handedly trying to educate analysts and investors about the value of the Japanese system of “candle charts.” Nison, who was in Los Angeles recently to meet with Merrill brokers, says he’s getting a great response from brokers and investors who are looking for new clues to market movements.
The 39-year-old analyst began studying Japanese charts several years ago, working with a Japanese broker in New York. Nison doesn’t speak Japanese and has never visited the country, so his learning was painstaking via translated Japanese books on chart-reading. But the education was fun, he says, partly because of the interesting names the Japanese ascribe to chart patterns.
The chart below, for example, shows U.S. wheat futures trading in the summer of 1989 (measured in cents per bushel), according to Japanese candle charting.
The Japanese system is called candle charting because of the way the daily price fluctuations are drawn: the opening price and closing price for each day form the boundaries of the daily candle. If the candle is white, it means prices rose for the day (the closing price is at the top of the candle, the opening price at the bottom). If the candle is black, prices fell (the closing price is at the bottom, the opening price at the top).
Also, the “wicks” (or “shadows” to the Japanese) that extend through many of the candles mark the high and low prices for each day.
In 250 years of candle charting, the Japanese have noted many patterns that often foretell price movements. And with the traditional Japanese flair for delicate poetry, many of the patterns have been given evocative names that describe what they foretell:
* A three-day “evening star” pattern is a bearish signal, often foretelling a fall in prices. The reverse is a three-day “morning star” pattern, which signals a potential bottoming of prices.
* A “shooting star” is another bearish signal, often signaling a short-term top in the market. A shooting star is a small candle at the lower end of the commodity’s price range, with a long wick at the top of the candle, indicating a high price for the day far above the open and close.
* An “umbrella” is a candle with little or no top wick, but a long bottom wick indicating a low price for the day far below the open and close. An umbrella can either be bullish (rain ending?) or bearish (rain coming?) depending on where it is in the trend. An umbrella that appears during a downtrend in prices is a “hammer,” meaning the market is hammering out a base.
The Japanese also have some not-so-delicate references to more ominous chart patterns:
* A “hanging man” is an umbrella at the top of a prolonged price rise, usually indicating that it’s time to get out of the market.
* A “bearish engulfing pattern” is a long black candle side by side with a previous day’s white candle, so that the black candle completely engulfs the white candle.
Nison says the Japanese use candle charts for all markets--stocks, commodities, bonds, etc. Nison himself doesn’t follow the U.S. stock market but uses the candle charts to plot movements in currencies and commodities. “I find that it gives you really good entry points,” he says of the Japanese system. Using his candle charts, Nison advises Merrill brokers and traders in currencies and commodities from within the firm’s securities research and economics department.
The candle charts aren’t infallible, of course, Nison says. His advice to other technicians and to traders is to use the candle charts “in addition to what you’re using now, for confirmation of trends.” Even so, Merrill Lynch likes the concept enough that it will begin regularly publishing candle charts for all futures contracts starting in October.
Currently in the commodities markets, Nison says sugar futures showed a “bullish morning star” during July 17-19, although he says the “major trend is still downward.” In soybeans, a bullish hammer appeared on July 23, Nison says.
Knowing Japanese candle-charting trends is valuable for another reason, Nison says: It can show Americans how the Japanese are viewing our markets at any particular moment and thus whether they’re likely to put money into a particular market or take it out.
