The Power of Japanese Candlestick Charts by Fred K. H. Tam
1. Core Concept & Theoretical Foundation
Primary objective of this chapter: To establish why candlestick charting matters before teaching how to read individual patterns. The chapter answers three questions: where did this technique come from, why did it explode in popularity in the West, and how is a candlestick chart physically built (contrasted with a bar chart).
Foundational theory: Candlestick charts are not just a different way to draw the same price data — they are a visual record of crowd psychology. Each candle is a snapshot of the ongoing battle between buyers (bulls) and sellers (bears) during a single trading session. The core premise of the whole book rests on this chapter’s claim: because candles picture sentiment rather than just plot numbers, they reveal shifts in trader psychology earlier and more intuitively than Western tools like moving averages or MACD.
Historical context: The technique originated in 18th-century Japan, not Wall Street.
- Developed in the rice futures markets of Osaka (the Dojima Rice Exchange) during the Tokugawa Shogunate (1615–1867).
- Credited to Munehisa Homma (1716–1803) of Sakata, born Kosaku Kato, later adopted into the wealthy Homma family. He is said to have logged an astonishing streak of consecutive winning trades and earned the nicknames “Dewa’s long-nosed goblin” and “the god of the markets.” He later became a financial consultant to the Japanese government and was awarded the title of Samurai.
- His trading principles were recorded in his writings (Sakata Senho and Soba Sani No Den) and evolved over generations into the modern candlestick method.
- The technique stayed confined to Japan for roughly 200+ years until American traders encountered it in the 1980s while trading Japanese-influenced U.S. markets. Analyst Steve Nison is credited with translating and popularizing it in the West through his books Japanese Candlestick Charting Techniques and Beyond Candles (Nison also coined the English term “candlestick” — the Japanese term is Ashi, meaning “leg” or “foot”).
2. Key Terms & Definitions
| Term | Definition |
|---|---|
| Candlestick / Ashi | A chart element built from a session’s open, high, low, and close. Ashi is the original Japanese term (“leg”/“foot”); “candlestick” is Steve Nison’s Western coinage. |
| Hi Ashi / Shu Ashi / Tsuki Ashi | Japanese terms for a daily chart, weekly chart, and monthly chart, respectively. |
| Real body | The rectangular “box” formed between the open and close price. Represents the net range/direction of the session. |
| Shadow (upper/lower) | The thin lines extending above and below the real body, marking the session’s high and low extremes. Also called “wicks” in common usage. |
| Shaven head | A candle with no upper shadow (the high equals the top of the real body). |
| Shaven bottom | A candle with no lower shadow (the low equals the bottom of the real body). |
| Doji (pronounced do-gee) | A candle where the open and close are the same or nearly the same, producing no real body. Signals indecision/equilibrium between bulls and bears. |
| White (or red) real body | Indicates the close was higher than the open — bulls won the session. |
| Black real body | Indicates the close was lower than the open — bears won the session. |
| MACD | Moving Average Convergence Divergence — a Western lagging/momentum indicator mentioned as an example of a tool candlesticks can lead in timing. |
3. Anatomy, Rules, & Construction Mechanics
Four data elements required to draw one candle:
- Open
- High
- Low
- Close
Four-step construction process:
- Mark the open and the close.
- Box up the open and close → this rectangle is the real body.
- Close > Open → real body is white/red.
- Close < Open → real body is black.
- Mark the high and connect it to the top of the box → this line is the upper shadow (the session’s high price).
- Mark the low and connect it to the bottom of the box → this line is the lower shadow (the session’s low price).
Special cases:
- No upper shadow → “shaven head.”
- No lower shadow → “shaven bottom.”
- Open ≈ Close (no meaningful box) → doji, signaling indecision.
Candlestick vs. Bar Chart — key structural contrast:
| Feature | Candlestick | Bar Chart |
|---|---|---|
| Data points needed | 4 (open, high, low, close) | 3 (high, low, close) — open is optional, shown as a small left-side tick if included |
| Visual weight | Wide colored box (real body) + thin shadows | Single vertical line with small side ticks |
| Readability of sentiment | High — color and body size instantly show who “won” the session | Low — described in the chapter as “flat,” making psychological shifts harder to spot |
The chapter illustrates this with a side-by-side S&P 500 hourly example (Figures 1.2 and 1.3), showing identical price data rendered as a candlestick chart versus a bar chart to demonstrate how much easier sentiment is to read on the candlestick version.
4. Practical Trading Application
The chapter is largely conceptual/historical, but it embeds several practical claims that justify why a trader should adopt candlesticks, presented as six reasons for their popularity:
- Leading indicator — Candlesticks can flag reversal signals earlier than Western tools such as MACD, because they capture psychological shifts before momentum/trend indicators mathematically catch up (illustrated with a Gold Daily 2013 chart, Figure 1.1).
- Pictorial — Pattern names (e.g., “hanging man,” “shooting star,” “dark cloud cover,” “abandoned baby”) are memorable “word pictures” that help traders recall what a formation means and recognize it quickly on a live chart.
- Versatile — Candlesticks can be combined with Western technical tools (moving averages, RSI, MACD, etc.), unlike point-and-figure charts, which the author says cannot be layered with other indicators. This foreshadows the “filtering” technique that is central to the rest of the book (combining candlestick signals with Western indicators for confirmation).
- Time-frame flexible — Works on any interval, from 1-minute intraday charts up to weekly/monthly charts, suiting both short-term and long-term traders.
- Market flexible — Applicable to stocks, futures, currencies (forex), and commodities across any global market.
- Time-tested — In continuous use for 300+ years, which the author offers as evidence of durability rather than a passing trend.
Practical takeaway for entry/exit: No specific buy/sell signal is given yet in this chapter (that begins in Chapter 2 onward) — the chapter’s practical value is persuasive/foundational: it primes the trader to trust candlestick signals as early warnings and to expect them to be used alongside, not instead of, Western indicators (a philosophy the book calls “filtering,” developed fully in Part II).
5. Active Recall Quiz
-
Who is credited as the historical originator of candlestick charting, and in what market did he trade?
(Test: name + market context — Munehisa Homma, Osaka rice futures market/Dojima Rice Exchange.) -
Name the four price data points required to construct a single candlestick, and explain which two form the “real body.”
-
What does it mean when a candlestick has no upper shadow (“shaven head”) versus when it forms a doji? What does each communicate about the session’s psychology?
-
According to the author, what is the key limitation of point-and-figure charts that candlesticks do not share — and why does this matter for a trader’s overall strategy?
-
List at least three of the six reasons the author gives for candlesticks’ popularity, and explain in your own words why the “pictorial” quality (reason #2) matters for pattern recall.