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The Power of Japanese Candlestick Charts by Fred K. H. Tam
1. Core Concept & Theoretical Foundation
Primary objective of this chapter: To introduce the author’s own proprietary trading tool — the P.I. System Trader — as a solution to a specific, honestly-acknowledged weakness of candlestick analysis: patterns are not always easy to spot. The chapter’s short case study opens by showing a chart where a Bearish Engulfing pattern is obvious and easy to trade, then immediately contrasts it with a similar chart where no clear reversal pattern is visible at all, even though a genuine reversal is happening. The P.I. System Trader is presented as the tool that catches that second, harder-to-see case.
Foundational theory: The P.I. System Trader is explicitly designed to mimic candlestick reversal patterns — it is not a competing or alternative methodology, but a mechanical, programmable proxy for the same reversal logic already taught in Chapters 4 (and referenced again here). Its signals are timed to coincide with where a candlestick reversal pattern would appear, generated automatically even when the human eye can’t confidently identify one.
Underlying market psychology / rationale: The author frames the core trading principle behind the tool in one sentence: “winning in the markets is all about buying low and selling high.” Because of this, the P.I. System Trader is deliberately built to detect reversal signals only — not continuation signals — since catching a turn as early as possible (buying near the low, selling near the high) is what the tool is optimized for.
Historical context: The author states he developed the P.I. System Trader in 1998. No further historical or etymological background is given (the name “P.I.” itself is not expanded upon in the extracted chapter text).
2. Key Terms & Definitions
| Term | Definition |
|---|---|
| P.I. System Trader | A proprietary technical system developed by the author in 1998 that generates automated buy/sell arrows on a chart, timed to mimic the appearance of candlestick reversal patterns — used to catch reversals that are difficult to spot visually. |
| Reversal signal (in this context) | The only type of signal the P.I. System Trader is designed to detect — a signal marking a change in trend direction, as opposed to a continuation/consolidation signal. |
| Weekly P.I. System Trader | A longer-timeframe version of the same tool, used specifically to filter out false signals generated by the (shorter-timeframe) Daily P.I. System Trader. |
| 50-day Simple Moving Average (as used in this chapter) | The specific trend-defining tool the author recommends pairing with the P.I. System Trader in his step-by-step trading rules (Step 1), though he notes other trend tools can substitute for it. |
(Note: this chapter does not introduce new candlestick patterns or Western indicators of its own — it reuses and references patterns and indicators already defined in Chapters 2–7, such as Bearish Engulfing, Bullish/Bearish Harami, Doji at the Top, Dark Cloud Cover, Three-River Evening Doji-Star, and Fred Tam’s White/Black Inside Out Up/Down, all shown as examples of what the P.I. System Trader’s signals line up with in Figure 8.1.)
3. Anatomy, Rules, & Construction Mechanics
The chapter does not disclose the internal calculation/formula behind the P.I. System Trader (it is proprietary) — instead, it defines the tool by behavior and usage rules rather than by construction mechanics:
How the P.I. System Trader behaves
- Displays arrows on a chart marking buy or sell signals.
- Signal timing is designed to coincide with candlestick reversal pattern signals — in the chapter’s own example, a Bearish Engulfing pattern gives a sell signal on candle 4 in an “easy” case, while in a “harder” case with no obvious candlestick pattern, the P.I. System Trader still flags a sell signal, this time on candle 6.
- Only detects reversals — explicitly does not generate continuation-pattern signals.
The Trading Rules for P.I. System Trader (step-by-step mechanics)
Step 1: Check the 50-day moving average indicator to establish the longer-term trend.
Step 2 (if 50-day MA is bullish):
- (a) Take all buy signals (arrows) from the P.I. System Trader (Daily).
- (b) Ignore all sell signals (arrows) from the P.I. System Trader (Daily) — or, at most, use them to close existing longs, but do not open new shorts.
Step 2A (if 50-day MA is bearish):
- (a) Take all sell signals (arrows) from the P.I. System Trader (Daily).
- (b) Ignore all buy signals (arrows) from the P.I. System Trader (Daily) — or, at most, use them to cover existing shorts, but do not turn long.
Substitution note: Step 1’s trend filter does not have to be the 50-day MA specifically — the author explicitly allows substituting trend lines, daily RSI, DMI, Momentum, MACD, CCI, or the Weekly P.I. System Trader to define the prevailing trend before applying Step 2.
4. Practical Trading Application
Core application — the tool’s primary use case: When a candlestick pattern is ambiguous or simply not present, the P.I. System Trader’s arrow signal substitutes for (and is timed to match) what a candlestick confirmation would have told the trader — meaning a trader is never left without a signal just because the current candle formation is hard to classify.
Critical risk-management warning (the chapter’s most important caveat): The author explicitly states that using the P.I. System Trader as a standalone tool can produce false signals — the exact same limitation that applied to standalone candlestick analysis in Chapter 6. His recommended fix is identical in spirit to the whole book’s filtering philosophy:
- Pair Daily P.I. System Trader signals with the 50-day SMA, or any of the oscillators covered in Chapter 7 (RSI, DMI, Momentum, MACD, CCI, etc.), to define the primary trend first.
- Alternatively, use the Weekly P.I. System Trader to filter/validate the Daily P.I. System Trader’s signals.
Full recommended workflow (tying everything together):
- Use a trend-defining tool (50-day MA, trendlines, or a Chapter 7 oscillator, or the weekly P.I. System Trader) to establish the primary trend direction.
- Switch to the Daily P.I. System Trader and take only the signals that agree with that established trend — this is the same Rule of Multiple Techniques / filtering discipline applied throughout Part II, just substituting the P.I. System Trader’s arrows for raw candlestick pattern recognition.
Key philosophical point reinforced here: The author is explicit that the goal is never to rely on candlestick patterns alone, or on the P.I. System Trader’s signals alone, to execute trades — both must be filtered through a defined trend, consistent with everything taught since Chapter 6.
5. Active Recall Quiz
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What specific limitation of candlestick pattern recognition does the P.I. System Trader address, based on the chapter’s opening two-chart comparison?
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What year did the author develop the P.I. System Trader, and what is explicitly stated as the only type of signal it is designed to detect (reversal vs. continuation)?
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Walk through the full two-step trading rule for the P.I. System Trader: what should a trader do with Daily buy signals versus sell signals when the 50-day moving average is bullish, and what changes when it is bearish?
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According to the chapter, what happens if a trader uses the P.I. System Trader as a completely standalone system without any trend filter, and what two alternatives does the author suggest to filter out false signals?
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The author states that “winning in the markets is all about buying low and selling high.” How does this principle directly explain why the P.I. System Trader was deliberately built to detect only reversal signals and not continuation signals?