Candlesticks and Ichimoku Strategies

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Harami

This is s two candlesticks pattern which could be either bullish or bearish
depending on the combination of the prior and subsequent candlesticks
development. In a downtrend, after a long black-bodied candlestick hitting a new
low, the second candlestick has a small white body and is completely confined
within the range of the previous candle. The Japanese word ‘Harami’ means
pregnant, the pattern itself looks like a woman carrying a baby (needs some
imaginations). The subsequent development is also important in order to
provide confirmation, the candlesticks after the ‘Harami’ should start turning
upwards, which means it should be followed by series of white candles.


The second candlestick could appear in different forms such as doji







Bullish Engulfing Pattern

This is a reversal pattern which can be bearish or bullish, when it appears at the
end of a downtrend, it would be a bullish engulfing pattern. The pattern starts
with a small body candlestick, then followed by a candlestick whose body
completely engulfs the previous candle’s body as buyers outnumber the sellers,
this would reflect in the chart by a long white real body candlestick.


Again this pattern needs confirmation and the long white candle should be
followed by series of white candlesticks to confirm a low formation.

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3.2 – Major Bearish Patterns

Shooting Star

This is a single candlestick reversal pattern made up of a small real body, ideally
to be black but could be white, with a long upper shadow but a very short or even
non-existent lower shadow. This candlestick should be formed after an uptrend,
the top of the shadow marks a new high and then followed by black candlesticks.
Therefore it is grouped under bearish reversal patterns



Doji

The characteristics of a doji top is similar to the doji bottom as explained earlier,
only in different direction.





Evening star

This is a three steps bearish reversal pattern at the top of an uptrend, just like
the Morning star pattern, consisting of three candlesticks, starting with a long
real body white candlestick after an upmove, a small body candlestick (could be
black or white but a black body tend to have stronger indication) that gapped up
on the open and closed above the high price of the previous candlestick (which
make that candlestick appears isolated from prior bar), finally a long real body
black candle which gapped down on the open and closed near the low or at least
well below the mid-point of the previous white candle.


If the star itself is a shooting star or doji, this normally suggests a stronger
reversal signal and the subsequent impact is more likely to be bigger.

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Harami

This is s two candlesticks pattern as indicated previously in the Harami bottom.
In an uptrend, after a long white-bodied candlestick hitting a new high, the
second candlestick has a small black body and is completely contained within the
range of the previous candle. The subsequent development is also important in
order to provide confirmation, the candlesticks after the ‘Harami’ should start
turning downwards, which means it should be followed by series of black candles.


The second candlestick could appear in different forms such as doji





Bearish Engulfing Pattern

This is a reversal pattern appears at the end of an uptrend, which starts with a
small body candlestick, then followed by a candlestick whose body completely
engulfs the previous candle’s body as sellers outpace the buyers, this would
reflect in the chart by a long black real body candlestick.



Again this pattern needs confirmation and the long black candle should be
followed by series of black candlesticks to confirm a top formation.



There are actually more bullish and bearish candlestick patterns, some are
reversal (e.g. Hanging Man, Abandoned Baby and Dark Cloud Cover) and some
are continuation (e.g. Rising/Falling Three Methods and Tasuki Gap), we are
going to discuss them in details in the second part .

To sum up, applying the candlestick chart patterns analysis gives the investor an
added advantage especially with the reversal signals. Candlestick chart should be
used in conjunction with other traditional technical analysis tools such as
oscillators in order to confirm top and bottom formation.

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CHAPTER 4

Ichimoku Analysis

4.1 – Introduction

Ichimoku Kinko Hyo is a technical indicator invented and published by Japanese
people for more than 30 years, a tool to measure momentum and project future
support and resistance.

First of all, the Japanese word "Ichimoku" means "one glance", "Kinko" means
"balance / equilibrium and "Hyo" means "chart", in short Ichimoku Kinko means
to see the equilibrium at a glance. Basically, the indicator is best used to define
market trend, support and resistance and finally generate buy/sell signals.

Ichimoku Kinko Hyo consists of 5 lines and a "Kumo" or known as "cloud" as
most people call it. Whilst Ichimoku Kinko Hyo utilizes five separate lines, they
shall not to be used independently but rather to use them together to form a
comprehensive view of the price action in order to formulate trading strategies.

After studying these indicators, one should be able to understand market
sentiment, momentum and relative strength of a trend "at a glance".

By studying each of the five components that make up Ichimoku Kinko Hyo, one
shall be able to have a clear perspective of the relative equilibrium of the market
as these lines can reflect market force, the balance between buyers and sellers.


4.2 - The 5 lines of Ichimoku

Tenkan-Sen (Conversion Line)
Kijun-Sen (Base Line)
Chikou Span (Lagging Span)
Senkou Span A
Senkou Span B


Tenkan Sen

The Tenkan Sen, also known as short-term line (according to the Japanese
meaning), conversion line and turning line. This line is calculated by:

(Highest High + Lowest Low) / 2, for the past x periods (Traditionally x=9)

There are quite some people compare the Tenkan-Sen to a simple 9 period
moving average (no matter it is a simple one or a exponential one) and consider
the two are quite similar to each other, however, the fact is that the Tenkan-Sen
is very much different from the moving average as it measures the average of
price’s highest high price and the lowest low price for the past 9 period. It is
believed that by applying the average of the price upper and lower range over a
certain period of time is better in measuring market equilibrium than only using
the average of closing price, especially in volatile market condition like the
modern days.



as you can see in the above chart, the Tenkan Sen reacts better than the 9 period
simple moving average when there are more volatile movements, such as the
quick rebound from the bottom, this is because the Tenkan Sen takes into
account of the highest high price and lowest low price. In addition, the average of
the highest high price and lowest low price enables the line to stay at the midpoint
when market is in a ranging situation.

The Tenkan Sen can serve a purpose to track the trending moves and in a rising
market, the line shall act as a level of support whilst in a falling market, it will
likewise act as a line of resistance.

The slope or angle of the Tenkan Sen provides additional information of the
relative strength of the trend over the past given period. In general, a steeper
slope indicates a stronger momentum whilst a flatter line or more horizontal
Tenkan Sen signals weakening of near term momentum.

After a period of trending moves, the break of Tenkan Sen should be treated as
an early sign of a temporary change in direction or at least a pause of current
trend. Hence, consolidation shall take place and some correction of the previous
decline or rise would be seen, however, whether it is really going to be a top or
bottom formation or reversal will need confirmation provided by other Ichimoku
components.

A main use of the Tenkan Sen is to apply it together with the Kijun Sen as the
cross-over of the two lines can provide bullish and bearish signals, we will
discuss it in further details after explaining the characteristics of Kijun-Sen.

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Kijun Sen

The Kijun-Sen, also known as base line, which is primarily used to measure
medium term price momentum and it is calculated as :

(Highest High + Lowest Low) / 2, for the past y periods (Traditionally y=26)

Although the formula is quite similar to the one of Tenkan Sen (calculating the
sum of the highest high and lowest low divided by two), as the Kijun Sen takes a
long time frame into account (the past 26 time periods) which enables the line to
provide the different perspective in understanding the change in short to
medium term trend.

Generally, when price is moving sideways, the Kijun Sen will reflect by moving
horizontally (flat ground) and once price exceeds either the highest or the lowest
price within the indicated time periods (e.g. 26), then the time will start rising or
falling accordingly. Therefore, the direction of the Kijun Sen can be used to
measure the short-term trend and the strength of momentum of the trend can be
indicated by slope or the relative angle of the Kijun Sen.

Whilst there are countless applications of the Kijun Sen, as mentioned above,
one important use of this base line is in conjunction with the Tenkan Sen, take
the crossover of the two line to initial a trading position.



As indicated in the above chart, a buy signal is generated when the Tenkan Sen
crosses above the Kijun Sen and one can hold on to the long position as long as
the Tenkan-Sen remains above the Kijun-Sen and once the Tenkan-Sen crosses
below the Kijun-Sen, this is a signal to exit the long position immediately.

As the Kijun Sen is using a relatively longer time frame, it is considered as more
reliable way to express price equilibrium (just as the name of the indicator
“Kinko”) and therefore, the Kijun Sen itself can be relied as a significant level of
resistance (in downtrend) and support (uptrend).

An additional use of Kijun Sen is the pullback effect (just like the moving
average), as the Kijun Sen is a good expression of price equilibrium, whenever
price moves too far away from the Kijun Sen, which also represents an
overbought or oversold condition, the price should not stay in that extreme level
for too long and it is quite common to see price moves back towards the Kijun
Sen, i.e. brings price back to equilibrium. This effect is particularly obvious when
the Kijun Sen is moving horizontally which also indicates time of consolidation is
taking place.


To sum up:

A buy signal is generated when Tenkan Sen cross above the Kijun Sen from
below and it will be considered as a stronger signal if market price is above both
lines.

A sell signal is generated when the Tenkan-Sen crosses below the Kijun-Sen from
above and it will be considered as a stronger signal if market price is below both
lines.

When a position is entered in reaction to such a signal, one can use the Kijun Sen
to set stop-loss level, one can put stop-loss below the Kijun Sen for long position
and for short position, the stop-loss should be placed above the Kijun Sen.

Actually there are more applications of the Kijun Sen, we will discuss it in further
details in next part which will focus more on the advance use of
Ichimoku Kinko Hyo.

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The Kumo / “ cloud”

The Kumo (or most people call it cloud and actually it does mean cloud in
Japanese) is probably the most famous part of Ichimoku Kinko Hyo analysis and
is getting more popular among chartists for the use of identifying support and
resistance area. Some people even consider the Kumo as the core or key of this
charting system. In fact the cloud itself is the most instantly visible component
among the other lines in Ichimoku Kinko.

Actually the Kumo / cloud is referring to the area between 2 lines, they are the
Senkou Span A and the Senkou Span B. Since the two lines are derived from the
Tenkan Sen and Kijun Sen; highest high and lowest low respectively, so the
Kumo is able to provide a deeper perspective of the market equilibrium. This
cloud area also brings a better way when compare to other traditional chart
analysis methods to represent price support and resistance, which is not only a
single level but rather an area that would react on market volatility.

The Senkou Span A is calculated as:

(Tenkan-Sen + Kijun-Sen) / 2, shifted forwards y periods (Traditionally y=26)

The line is basically the mid-point between the Tenkan Sen and Kijun Sen but
being plotted 26 periods ahead, the logic behind is that prior support and
resistance tend to have impact on current price level, in other word the current
price level normally pays respect to previous support and resistance. Therefore,
when this line is drawn with 26 periods (for a daily chart, that would represent
the data of approximately 1 month ago) forward displacement, it can give
Ichimoku chartists a quick comparison of current price level with the prior
support and resistance at a glance.

The Senkou Span B is calculated as:

(Highest High + Lowest Low) / 2 for the past z periods, shifted forwards y
periods (Traditionally y=26 and z=52)

This line is always drawn alongside the Senkou Span A and is another
component of the Ichimoku Kinko Hyo to create the Kumo / cloud. This line
represents a relatively longer term view of the market equilibrium in the charting
system, instead of calculating the past 26 periods data, the Senkou Span B
measures the average of the highest high price and lowest low price for the past
52 periods (2 months data on daily chart) but again shifts forwards by 26 periods.

Therefore, when putting the two lines, Senkou Span A and Senkou Span B,
together and forming the Kumo, the cloud can cover both short-term (26 periods)
and longer term (52 periods) data, hence providing a multi time frame
perspective in understanding market equilibrium.

When the market trend is down, the Senkou Span A is located below the Senkou
Span B; in a rising market, the Senkou Span A is located above the Senkou Span
B. So the indicators are also used to predict the change in market direction when
the two Senkou Spans cross over with each other.

Once the two lines are drawn, the area in between Senkou Span A and B, the
shaded area, known as Kumo or cloud can be used to predict future support and
resistance area.

When price is trading above the Kumo, the prevailing trend is said to be up and
the Kumo will be treated as the support area whilst if price is below the Kumo,
the trend is said to be down and the cloud will become resistance area instead.

The thickness of the Kumo (cloud) also indicates the market volatility as the
cloud contracts and expands based on past price fluctuations. A thin layer of
cloud reveals the lower historical volatility whilst a thick cloud implies higher
historical volatility.

As explained above, the Kumo provides a different view of support and
resistance and the thickness of the cloud provide additional information
regarding the relative strength of the support and resistance. Normally the
thicker the Kumo, the stronger is the support or resistance will be provided by
the cloud. When price runs into a thick layer of Kumo, that usually suggests a
non-trend situation and sideways trading is more likely to take place.



In the above chart, we can see price paid respect to the boundaries of the Kumo,
Senkou Span A and B, in several occasions. From the far left of the chart, price
started turning down after rising for some times, once the upper Kumo or the
Ichimoku cloud top is broken, this normally indicates a temporary top is formed
and correction has commenced, then the next line of support will be the lower
Kumo or the cloud bottom. When price is trading inside the cloud area, the two
lines, Senkou Span A and B, formed the upper and lower limit of the trading
range and until price is able to break outside of this range, choppy consolidation
within the cloud area would take place. Once price rises above the cloud area, the
Kumo would turn from resistance to support and buying interest normally
emerges above there, pushes price higher.

An additional advantage of using Ichimoku Kumo is that it provides a different
perspective of the concept of support and resistance when comparing with the
traditional technical analysis method. In the above chart, after breaking point A,
according to traditional technical analysis techniques, it also ended the series of
higher highs and higher lows which means an end of the prevailing trend.

Traditional chartists might have sold the currency pair on such a break in
anticipation of a correction of the upmove, however, price was not able to break
below the Ichimoku cloud (not on a closing basis) and found support at point B
and C around the Ichimoku cloud bottom, then headed back north again and
resumed the uptrend subsequently.

The Kumo itself could also express market sentiment and therefore can show
bullish or bearish signs, we will discuss the use of Ichimoku cloud in further
details in the second part.

Finally, the Chikou Span which is basically the current closing price time-shifted
backwards by 26 time periods. This line is originally used to make quick
comparison with the current closing price to the closing price of 26 time periods
ago, if current closing price is higher than that of 26 periods ago, then it means
there are more bullish potential and vice versa. However, in our approach, we
prefer and remove the Chikou Span (which leave a chart a bit more clear) and
simply use the other 4 lines.

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CHAPTER 5

Putting them together – Trade Examples



In this part , we will put the aforesaid technical analysis methods
together and formulate objective trading strategies. Real life examples, based on
those actual trading recommendations , will be used to explain the methodology.

Basically, we have been and are still using 4 hour candlestick chart with
Ichimoku Kinko indicators for the analysis and we will pick some examples in
rising market, falling market and ranging market situations for discussion.
On 20 May 2009, in EUR/USD we have a chart as follow:



Despite the relative strong correction from 1.3722, the single currency found
decent demand right at the Ichimoku cloud bottom around 1.3425 and rallied
from there, later on the Tenkan-Sen crossed above the Kijun-Sen at point A,
generated a strong buy signal (as price is above the two lines as well as the Kumo)
and one should buy the currency pair on pullback to the Tenkan-Sen, a general
pullback target in anticipation of a resumption of upmove. However, since we
are not a real time trading strategies provider (price did eased back to the
Tenkan-Sen and being contained by the Ichimoku cloud top) , when it came to
our update time, price already jumped to new high and as price is getting too far
away from both Tenkan-Sen and Kijun-Sen, we gave a buy on pullback
recommendation as follow:



This recommendation is based on the concept that a resistance after being
penetrated will turn into a support, so in this case resistance at 1.3722 became a
support level and we set our entry right above there.




Then price could only made marginal high to 1.3837 and did retreat to our entry
level, renewed buying interest emerged as expected and euro rebounded. At this
point, we suggested to keep our long position with stop raised to just below the
Tenkan-Sen at 1.3710 as this line should hold if price is going to resume its
uptrend, hence the following recommendation was made accordingly.


Euro did stay above the Tenkan-Sen and resumed the uptrend in line with our
expectation, met our upside target at 1.3840 without any difficulty.


On 21 May 2009, in USD/JPY we have a chart as follow:



Although the greenback just resumed the decline by breaking support at 94.55,
as the correction to 96.69 was not strong enough, just slightly more than 38.2%
Fibonacci retracement at 96.56, suggesting downside would be limited and the
currency pair may find support around 94.07 (50% projection of 99.80 to 94.55
measuring from 96.69). In addition, as price is getting a bit too far from both
Tenkan-Sen and Kijun-Sen, it is quite common to see recovery back towards
these lines due to the pullback effect. Therefore, whilst the trend is still down, we
gave strategies to trade both sides of the market as:

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A suggestion was made to venture long at 94.10 for a corrective rebound back
towards the Tenkan-Sen and Kijun-Sen, expecting price to stay well above chart
support at 93.55 and the 61.8% projection at 93.45.



The greenback fell again after meeting renewed selling at the Tenkan-Sen,
however, as price is still trading above indicated support level, we are holding on
to our long position entered at 94.10 in anticipation of a much-needed correction.






The greenback finally found good support at 93.85 and rebounded above the
Tenkan-Sen, this was the first sign that a temporary low was formed and
correction to the Kijun-Sen was a reasonable expectation. In addition, the
sideways moving Tenkan-Sen and Kijun-Sen also suggested the trending move
had paused and consolidation would take place. Hence, we were holding on to
our long position entered at 94.10 but with a lower target as the Kijun-Sen
located at a similar level of the 50% Fibonacci retracement of 96.69 to 93.85 at
95.26-95.27 respectively, which normally implied a stronger resistance would be
seen around this confluence point.

The greenback finally found good support at 93.85 and rebounded above the
Tenkan-Sen, this was the first sign that a temporary low was formed and
correction to the Kijun-Sen was a reasonable expectation. In addition, the
sideways moving Tenkan-Sen and Kijun-Sen also suggested the trending move
had paused and consolidation would take place. Hence, we were holding on to
our long position entered at 94.10 but with a lower target as the Kijun-Sen
located at a similar level of the 50% Fibonacci retracement of 96.69 to 93.85 at
95.26-95.27 respectively, which normally implied a stronger resistance would be
seen around this confluence point.

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The greenback hit our upside target at 95.00 and met indicated resistance right
at the level of Kijun-Sen. With both the Tenkan-Sen and Kijun-Sen turned
horizontal, further sideways consolidation should unfold with upside bias for
correction of the entire fall from 99.80 towards the indicated retracement levels
and 38.2% at 96.12 should be the next upside target, then chart resistance at
96.69.




On 18 June 2009, in USD/JPY we have the following chart:


Although the greenback dropped to 95.51 after breaking below the Ichimoku
cloud bottom, as a ‘ Morning star ’ candlestick pattern was formed, suggesting a
possible low formation. We reacted on this near term bullish reversal pattern
and gave a recommendation to buy at market level. The horizontal moving
Kijun-Sen also suggested it was more likely to see consolidation instead of
further selloff.




Price continued to trade sideways as the horizontal moving Kijun-Sen suggested,
further consolidation should unfold and we kept our long position entered at
95.57 and with stop raised to just below support at 95.51 in anticipation of
recovery towards minor resistance at 96.78. However, only a sustain break above
the Ichimoku cloud bottom and the Kijun-Sen would signal an actual trend
reversal.

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On 30 June, in EUR/JPY we have the following chart:


Despite falling to 131.41, the single currency quickly rebounded from there and a
‘hammer’ candlestick bullish reversal pattern was formed, the subsequent rally
gave confirmation to this pattern, i.e. low has been formed at 131.41, however,
price faltered below the Ichimoku cloud top and turned sideways for few days in
reaction to the horizontal moving Kijun-Sen. Another ‘hammer’ like (with small
real body and long lower shadow) candlestick pattern was formed at 133.36 and
euro headed north again but this time the currency pair finally broke above the
upper Kumo. Although euro then retreated from 135.95, this breach of the
Ichimoku cloud confirmed a reversal was taking place and the Kijun-Sen should
contain pullback, bring another rally.

Therefore, we gave a buy recommendation with entry level being set just above
the Kijun-Sen. From a traditional chart pattern point of view, this could also be
interpreted as an inverse head & shoulder reversal pattern.



On 07 July 2009, in EUR/USD we have the following chart:



The single currency rebounded after falling to 1.3876 and although euro then
retreated after meeting resistance near the Ichimoku cloud bottom, as the
correction from 1.3876 had not reached the minimum 38.2% Fibonacci
retracement of 1.4202 to 1.3876 at 1.4001, unless price could break below the
support at 1.3876, another corrective bounce cannot be ruled out but upside
should be limited to the Ichimoku cloud top and Kijun-Sen which was exactly the
50% retracement level at 1.4039 and renewed selling interest should emerge
there, bring selloff later. As the sideways moving Kijun-Sen also suggested
further consolidation would take place, therefore, we gave a sell on recovery
recommendation with entry just below the Kijun-Sen in anticipation of a
resumption of the decline from 1.4202.