The Art of the Candlestick Chart The Intrepid Investor Series (Part 2) Matt Brennan Whether used to set

t a romantic mood at dinner, an enchanted mood during a psychic reading, or a hurry up Synergy and get the power back on mood after yet another black out, the role of candles is firmly entrenched in Perth society. Most fireman however would regard this candle-mania as being to the detrimental of the city, as data from the Department of Fire and Emergency services estimates the number of candle related house fires has almost doubled since 2006. It was the Japanese who set the business world alight, dating back to the 1800s with their innovation of the candlestick chart. This unscented variety of non-flammable candle still produced plenty of heat, as rice merchants noted with surprising accuracy how they were regularly able to predict when the next trend was developing and behave accordingly. Candlestick charts are such an important investment that to this day the Japanese craft is still being continually refined and explored.

Source: ASX Above is a singular candlestick with the wax of the candle being shaded in white as this represents a day when the close was higher than the open, as the price of the security increased during the days trading. The white for gain/black for loss colour combination is unimportant, as long as the colour schematics are consistent then more in-depth analysis can follow. The value of the change is represented by the length of the candle from top to bottom. Candlesticks are even adaptable for when there is no trading (flat line), but in the above example, the wick extends below and above the candle and this suggests uncertainty and volatility in trading on this day. This burning the candle at both ends makes it difficult for investors to pick a market direction, which is why candlesticks are analysed as a collective to determine if the performance is a trend or an anomaly. There are more types of candlestick patterns then there are get rich quick books, but the bullish harami often provides a distinct turning point when good stocks desist their funk and begin to rebound. Firstly, for a trend to exist there must be three distinct data points so using two candlesticks is insufficient information to attempt to base a decision on. A bullish harami results after two consecutive days of price drops followed by a slight but modest rise the following day. Some factors which strengthen this trend include the size of the black candle wax compared to the white candle wax, the price at which the trend is occurring being near the bottom of the companys long term price cycle and a day-by-day decline in trading volumes.

Bullish Harami

Bearish Harmai

Notice how the white candle wax in the bullish harami fits snuggly inside the black candle? This was what lead to the pattern being named harami, as harami is Japanese for pregnant. The word harami has an alternate meaning in Farsi, a dialect language of Afghanistan, which makes sense give that the offspring of these two candles is of a different shade. Harami is Farsi for bastard. Being nimble and being quick with decision making will enable an investor to jump on a candlestick trend, spotting the roots of the growth or decay and then behaving accordingly, which is what candlestick charting was all about even in small Japanese villages in the 19th Century.

Bullish harami. Source: E*Trade Westpac (WBC) provides a recent example of a bullish harami. From the chart above, the bullish harami occurs between the 13/06/2012 15/06/2012. What strengthened this trend is the doji star which is shown on the 18th of June and this has the same effect as the star of Bethlehem, guiding wise investors to the birthplace of new life and growth of the Westpac stock. This was evidently the case as Westpac bank is now trading at $30.33 (when this article was written).

Bearish harami. Source: E*Trade The knowledge of bearish haramis can be just as useful. Gunns timber (GNS) between 07/04/2011 11/04/2011 (the 9th and 10th of April were non trading days) exhibited the clear pattern of a bearish harami, with two consecutive price rises followed by a modest price drop with the wax of the candle on the 11th of April fitting snuggly inside the previous trading day. If a trader hadnt decided to get out already, the presence of the three black crows (the formation occurring between the 11th 13th April, keeping in mind a decrease in price is traditionally a black candle) within a bull market (the All Ords was hovering around 5000pts at this point), is a strong indication of a downturn. This turned out to be the case as less than a year later Gunns have been suspended from official quotation, never reaching a higher price since, ending their listed days at a mere 16c. Candlestick charts vary in reliability in the same manner as market research surveys. Low volume trading days (in some cases no trades) made by a small group of individuals does not properly represent market sentiment, making predictions unsubstantiated. Candlestick charts are strengthened by waiting for overlapping trends to occur as shown above, but in doing so the exit or entry price is no longer as attractive as what was previously on offer. Fundamental analysis would mean some companies would be simply ignored; however candlestick charting is unbiased and only responds to a trend. Gunns for instance, had a brief resurgence in October 2011 leaping more than 244% (from 13.5c to 33c) which raised eyebrows from the ASX and the investment community alike, who had already disowned Gunns purely on the basis of very poor fundamentals (in particular serious debt concerns). Facebook, which is affectionately known as Faceplant because of its instant demise since its IPO, has landed itself in the investments to ignore pile along with channel Ten until the poor fundamentals are corrected, but both still have spurts of growth which would have been detected by candlestick charting. Whilst experimenting with candlestick charts does shed light on new opportunities, it is still playing fire and investors should consider their own risk appetite and wider market conditions before they get burnt.