Candlestick Charting Explained Workbook: Step-by-Step Exercises and Tests to Help You Master Candlestick Charting: Step-By-Step Exercises And Tests ... Charting (PROFESSIONAL FINANCE & INVESTM) - Softcover

MORRIS, Gregory L.

Softcover

ISBN 10: 0071742212 ISBN 13: 9780071742214

Publisher: McGraw Hill, 2011

Synopsis

A practical, hands-on guide to building your mastery of candlestick charting and analysis

Candlestick charting has become one of today’s most popular technical analysis tools for both individual and professional investors. And it’s much easier than you probably think. In fact, creating a candlestick chart demands no more information than traditional charting requires. With candle pattern analysis, the payoff is a deeper look into the minds of investors and a clearer view of supply and demand dynamics.

In this companion volume to his bestselling Candlestick Charting Explained, Gregory L. Morris delivers hands-on knowledge you need to make candlestick charting and analysis a key element of your portfolio-building strategy. With this book you will be able to:

• Identify candle patterns and quickly see what traders and investors are thinking
• Use reversal patterns to enter or reverse your positions
• Identify continuation patterns to establish additional positions
• Utilize charting software to recognize patterns automatically

Packed with study questions, data tables, diagnostic tools, terminology, sample charts, and market analyses, Candlestick Charting Explained Workbook helps you speed up the learning process and ramp up the profits.

About this title

About the Author

Gregory L. Morris is Senior Vice President, Chief Technical Analyst, and Chairman of the Investment Committee for Stadion Money Management, LLC. Widely recognized as an expert on candlesticks, he is often interviewed on national media and frequently speaks at financial conferences. Morris is the author of the bestselling Candlestick Charting Explained.

Excerpt. © Reprinted by permission. All rights reserved.

CANDLESTICK CHARTING EXPLAINED WORKBOOK

Step-by-Step Exercises and Tests to Help You Master Candlestick Charting

By GREGORY L. MORRIS

The McGraw-Hill Companies, Inc.

Copyright © 2012 The McGraw-Hill Companies, Inc.
All rights reserved.

ISBN: 978-0-07-174221-4

Contents

Preface
Acknowledgments
1 Enlistment: Getting Ready for Duty
2 The Foundation: Preparing for Battle
3 Reversal Patterns: Repelling the Advance
4 Continuation Patterns: The Next Attack Wave
5 Intelligence Briefing: Pattern Identification and Filtering
6 Honorable Discharge: Putting It All Together
Appendix A: Other Japanese Charting Methods
Appendix B: Academic Papers on Candlesticks
Sources
Answer Key
Index

Excerpt

CHAPTER 1

ENLISTMENT: GETTING READY FOR DUTY

By purchasing this workbook, you have voluntarily enlisted to participate indoing battle with the markets. The markets are living, morphing entities thatfeed off of human emotion and trader losses. It is my intention to provide youwith the weapons necessary to trade what you see, to help you harness the powerof candlestick analysis, and to avoid unnecessary losses. We will start with thebasics of candlestick lines and patterns and then add weapons to our arsenal aswe progress. First, however, let me step you through my journey that has broughtus together at this point in time.

WHY BOOT CAMP?

In 1971, after graduating from the University of Texas with a bachelor ofscience degree in aerospace engineering, I was faced with a country inrecession, and the marketplace for new engineers was scarce, so I joined theUnited States Navy to become a fighter pilot. Of course, that meant that I hadto become an officer, and that, in turn, meant that I had to attend Officer'sCandidate School in Pensacola, Florida. No problem, right?

In October, 1971, I drove from Dallas, Texas, in my 1962 nonair-conditioned,faded-blue, four-door, standard transmission, six-cylinder Chevrolet Bel Air.This fine automobile had been with me since I was a junior in high school andhad close to 175,000 miles. In the trunk, I had a box of my aerospaceengineering books because I knew the Navy would be impressed and probably wantme to teach others about aerodynamics, heat transfer, and boundary-layer theory.I started to include my golf clubs but later decided that I wouldn't have thatmuch spare time between learning to be an officer, teaching aerodynamics, andengaging in all the social aspects of being a Navy pilot. Additionally, I hadbeen a private pilot since 1967 and assumed that I knew all there was to knowabout flying airplanes. Wow, was I in for a shock!

After checking into a World War II barracks (I knew this was justtemporary), I was told that I did not need anything from my car and would needonly the clothes on my back. I was excited as I thought that I'd be issued myjet flight equipment and some officer uniforms. Then I was told to get a goodnight's rest and expect to get up fairly early. When I dropped off to sleep thatnight (the barracks was not air-conditioned), it was the last moment of thatpart of my life.

At 0500 hours (5 a.m., which later became 2 bells), I was startled awake with ahorribly loud banging sound and someone yelling at me. The banging sound wasmade by a metal trash can being kicked down the hallway (which later becameknown as the passageway). The yelling came from a lean, muscular guy in a Marinedrill instructor uniform, which was complete with a Smokey the Bear hat.Clearly, he was not aware of why I was there and had me confused with a felon,escaped convict, or something.

This was the beginning of a four-month period of my life that I honestly believeI can recall every single minute of because it was so dynamic, frightening,tiring, scary, disconcerting, exhausting—need I go on? If you have neverbeen on the other side of a United States Marine drill instructor, you havemissed one of life's remarkable events. His goal over the next four months wassimple: break me down to almost nothing, and then build me up the way the Navywanted me to be—an officer first, a pilot second. He did it.

I could write volumes on just those four months, but this isn't the place. Hencecame the idea of calling this companion book to my Candlestick ChartingExplained a "boot camp." It is designed to clarify, simplify, and quiz youon the details of Japanese candlestick analysis.

INTRODUCTION

I attended a Market Technician Association seminar in Phoenix, Arizona, in 1988.There was a large contingent of Japanese traders present, and they presentedtheir charting techniques. It was the first time that I had ever heard of HiAshi, which is what the Japanese call their candlestick chart. I was workingwith N-Squared Computing then, and my colleagues and I decided to create acharting product using Japanese candle patterns with automatic recognitioncapability. I traveled to Japan and stayed with Takehiro Hikita, who was anactive red bean and rice trader in Yokohama. I had known Hikita for yearsbecause he was a devoted customer of N-Squared Computing. He was intent onteaching me the art of candlestick analysis, as well as helping me to translatemany of the books that are listed at the end of this book (see Sources).

There are many books out now on candle patterns, and most software programs havecandlestick charting capability. However, very few have the correct (originalJapanese) methodology. This book discusses only the candle patterns that camefrom original Japanese literature, with two exceptions: The Three Outside andThree Inside patterns were created when I was at N-Squared Computing to enhancethe Engulfing and Harami patterns. They do this quite well, but please realizethat they are not real Japanese candle patterns.

Note: I find it amusing that in new books on candlesticks, the Three Outside andThree Inside patterns generally are included as if they are actual Japanesecandle patterns. I think only Steve Nison and I did any original research; therest obtained their knowledge from us.

For additional study, I humbly recommend that you refer to the third edition ofmy book, Candlestick Charting Explained, published by McGraw-Hill. Icover all the patterns included in this book, the single-day patterns, and manyothers that were created to fill holes in the Japanese literature. This workbookclosely follows the details laid out in that book, which was first published in1992 and in its third edition includes a vast amount of statistics.

GENERAL COMMENTS AND OPINIONS

The following are "need to know" information pieces that I have put together inthe last 20 years after giving numerous lectures and presentations oncandlestick analysis. If you think that I have become opinionated over thistime, you are correct. However, I always keep in mind that when dealing with anart form such as this, one should never speak in absolutes. Even though thefollowing seems to be said absolutely, I am only expressing my opinion.

Why Are Single-Day Candle Patterns Not Recommended for Trading?

Every day the market sends a message. Here is what I say about single-daycandlesticks: They are not candle patterns that allow you to see the evolutionof trader psychology through multiple days, like you can with more complexcandle patterns. I also say that single-day candlesticks still send a messagethat should neither be traded nor ignored.

Can You Use Candle Patterns on Intraday or Weekly Data?

Of course you can, but I don't recommend it. The Japanese were adamant about theperiod of time between the close of one day and the open of the next day asbeing critically important to the psychological evolution of traders indeveloping the pattern. With intraday charts, that time period is just the nextdata tick—not a lot of time to develop a thought. Weekly charts truly voidthe concept because the open is Monday's open, the close is Friday's close, thehigh is the high for the week (it could occur on any day of the week), and thelow is the low for the week (again, it could occur on any day of the week). Infact, the open, high, and low all could occur on Monday, with the close onFriday. The trading activity for the last four days of the week would not beseen in a weekly candlestick. However, as with any art form, if it works foryou, use it.

What Mistakes Do I See the Most in the Analysis of Candle Patterns?

Let's begin with a question: If you find a bullish reversal candle pattern, whatdoes that mean? First, it is supposedly reversing something, right? What is itreversing? It is reversing the preceding trend. Second, if it is bullishreversal, wouldn't the preceding trend have to be down or bearish? Yes, and manypeople tend to ignore this critical element in pattern identification. Patternanalysis in isolation is poor analysis.

What Do You Use to Determine the Trend?

Originally, and in my book, I used a 10-period exponential average to determinethe trend. If the midpoint of the body of the first day was above the 10-periodaverage, then the trend was up. In an uptrend you can only have bearish reversaland bullish continuation patterns, and in a downtrend you can only have bullishreversal and bearish continuation patterns. Since that time, I have developed aproprietary method of trend analysis that is only available in my MetaStockadd-on product, Greg Morris' Japanese Candle Pattern Recognition.

Price-based Support and Resistance

You will find that when candle patterns occur near support or resistance levelsthat are based on price, they generally will work better than when they are not.Price-based means that the support and resistance lines are horizontal. Thisworks well because investors and traders all have a strong tendency to anchor onprices, whether from when they bought or when they sold.

Candle Pattern Filtering

I developed candle pattern filtering in the very early 1990s as an attempt toenhance the quality of signals generated from candle patterns. The concept isreally quite simple. If you consider a common technical indicator such asStochastics %D, you know that whenever %D rises above 80, it isjust a matter of time before it will drop back below 80 for a sell signal. Icall this period of time when %D is above 80 the bearish presignalarea. Thus, now if you also can find a bearish reversal candle pattern thatoccurs while %D is above 80, you are getting an emotionally driven sellsignal prior to getting a technically based price sell signal. Of course, theinverse is to find bullish reversal patterns when %D is in itsbullish presignal area below 20.

Think of the area above 80 and below 20 as the presignal area; it is a placewhere reversal patterns generally will fire before price-based indicators.

The Ideal Candle Pattern and Variations that Are Acceptable

There are many sketches of the candle patterns included in this book. Figure1.1 shows you the "ideal" pattern. One rarely do you find the ideal patternin real life and trading, but you must have some feel for what it should looklike. You then can see how the pattern identified by a software program can varyfrom the ideal. In developing the software to identify candle patterns, I havekept the parameters fairly tight on the identification engine because the closerthey are to ideal, the better they are generally. However, you cannot have theidentification parameters too tight, or very few candle patterns would appear.

Why There Are More Reversal Patterns than Continuation Patterns

I think that it should be obvious that identifying the beginning and end of atrend is more important for trading than identifying that a trend is continuing.While the continuation patterns should not be ignored, they rarely offer atrading opportunity. They are more of a confirmation that the trend is still inplace. However, if you did not take a position in the early stage of the trend,the continuation would be a second opportunity to place a trade.

Why There Are More Bullish Reversals than Bearish Reversals

If you have ever studied long-term charts of the markets or stocks, you canquickly see that when they are developing tops, they are usually long, drawn-outaffairs (distribution), and the decision making of selling is more difficult formost investors. However, at bottoms, the emotions are quicker, and bottoms tendto be more sharp and defined. This is why there are more bullish reversalpatterns than bearish reversal patterns.

CHAPTER 2

THE FOUNDATION: PREPARING FOR BATTLE

Japanese candlestick analysis has been in existence for hundreds of years and isa valid form of technical analysis. Candlestick charting has its roots in themilitaristic culture that was prevalent in Japan in the 1700s. One sees manyterms throughout the Japanese literature on this topic that reference militaryanalogies, such as the Three White Soldiers pattern presented in Chapter3. Unlike more conventional charting methods, candlestick charting gives adeeper look into the mind-set of investors, helping to establish a clearerpicture of supply/demand dynamics.

Japanese candlestick charts do not require anything new or different as far asprice data are concerned. Open, high, low, and close are all that are needed toconstruct a candlestick chart. There are two main elements in the constructionof a candlestick, the real body and the shadows.

The real body (Figure 2.1) is the box that makes up thedifference between the opening and closing prices. The height of the body is therange between the day's opening price and the day's closing price. When the bodyis black, or filled, this means that the closing price was lower than theopening price on that day, which is considered bearish. When the closing priceis higher than the opening price, the body is white, or hollow, which isconsidered bullish.

Shadows (Figure 2.2) are the small, thin lines that can appearabove and/or below the body. These lines represent the high and low pricesreached during the trading day. The upper shadow represents the high price, andthe lower shadow represents the low price. It is these shadows that give theappearance of a candle and its wick(s). Candles do not have to have shadows. Incases where the opening and closing prices also represent the high and lowprices for the day, no shadow is present. These candles are calledMarubozu, which are explained later in this chapter.

A long day or long candle (Figure 2.3) is a large pricemovement for the day between the opening and closing prices. In other words, theopening and closing prices are considerably different. Long days should beclassified as such within the context in which they appear. It is best to usethe most recent price action to determine what is long and what is not. SinceJapanese candlestick analysis is based solely on short-term price movement,comparing the length of a candle with the most recent 5 to 10 candles should beadequate. Long white candles show dominance by buyers during the trading day,whereas long black candles show dominance by sellers.

Short days or short candles (Figure 2.4) also may be based onthe same methodology as long days, with comparable results. There are alsonumerous days that do not fall into either the long or short day category. Shortdays represent indecision among traders because the opening and closing pricesare very close. The color of the real body is not as important as the appearanceof the short body itself. Short days are especially noteworthy when they appearin trending markets because they signify that a market that once was trending isnow showing signs of a struggle for short-term price direction.

Marubozu means "close-cropped" or "close-cut" in Japanese. Otherinterpretations refer to it as a "bald or shaven head." In either case, themeaning reflects the fact that there is no shadow extending from the body at theopen, the close, or both (Figure 2.5). Marubozu come in four types:

Black Marubozu. This is a long black body with no shadows at either end.This is considered an extremely weak line. It often becomes part of a bearishcontinuation or bullish reversal candle pattern, especially if it occurs duringa downtrend.

White Marubozu. This is a long white body with no shadow on either end.This is an extremely strong line when considered on its own merits. Opposite ofthe Black Marubozu, it often is the first part of a bullish continuation orbearish reversal candle pattern.

Closing Marubozu. This has no shadow extending from the close end of thebody, whether the body is white or black. If the body is white, there is noupper shadow because the close is at the top of the body. Likewise, if the bodyis black, there is no lower shadow because the close is at the bottom of thebody. The Black Closing Marubozu is considered a weak line, and the WhiteClosing Marubozu is considered a strong line.

Opening Marubozu. This has no shadow extending from the open price endof the body. If the body is white, there would be no lower shadow, making it astrong bullish line. The Black Opening Marubozu with no upper shadow is a weakand therefore bearish line.

Spinning Tops (Figure 2.6) are candlestick lines that have smallreal bodies with upper and lower shadows that are of greater length than thebody's length. The color of the body of a Spinning Top, along with the actualsize of the shadows, is not important. The small body relative to the shadows iswhat makes the Spinning Top. Spinning Tops carry much more weight becauseindecision patterns warn of a potential reversal when a market is trending.Their appearance in sideways or choppy markets has little meaning.

A Doji (Figure 2.7) occurs when the body of a candle line is sosmall that the open and closing prices are equal. The lengths of the shadows canvary. The perfect Doji has the same opening and closing prices, but someinterpretation must be considered. If the difference between the opening andclosing prices is within a few ticks (minimum trading increments), it issatisfactory.

Determining a Doji day is similar to the method used for identifying along day; there are no rigid rules, only guidelines. If the previous days weremostly Doji, then the Doji day is not important. If theDoji occurs alone, this is a signal that there is indecision and mustnot be ignored. A Doji in a sideways, choppy market has little meaning,but a Doji in a trending market means that a trader needs to sit up andtake notice. The appearance of a Doji does not guarantee a trend change;it merely warns that a trend change could occur. There are four specifictypes of Doji that each has its own implications for price behavior.

The Long-Legged Doji has upper and lower shadows in the middle of theday's trading range, clearly reflecting the indecision among buyers and sellers.Throughout the day, the market moved sharply higher and then sharply lower, orvice versa, before eventually closing at or near the opening price. Figure2.8 shows an example of a Long-Legged Doji.

(Continues...)

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Excerpted from CANDLESTICK CHARTING EXPLAINED WORKBOOK by GREGORY L. MORRIS. Copyright © 2012 by The McGraw-Hill Companies, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc..
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Edition details

• Publisher: McGraw Hill
• Publication date: 2011
• Language: English
• ISBN 10: 0071742212
• ISBN 13: 9780071742214
• Binding: Paperback
• Number of pages: 176