TRADING TECHNIQUES

Market Timing
And Candlesticks

by Gary S. Wagner and Bradley L. Matheny
When to buy and what? Those are the questions that have plagued market participants the world over. Here's a proposal on how to use candlesticks to time the market.

"To be successful, you have to be in the right place at the right time. There are two parts to that adage, both equally important; the first refers to location, while the second relates to timing. For stock traders, this saying is especially apropos if you consider the location in question to be the selection of which stocks to buy, and the timing in question to be when to buy."

Although the index is made up of many stocks, its price reflects the collective sum of the stocks within the index.

CANDLESTORY AND RESEARCH
More than two centuries ago, Japanese merchants created a technique by which to trade the country's most precious commodity, rice. Tracking the changing price of rice by hand using paper and a brush, they identified specific patterns, which they called candlesticks, that represented market reversals, trends, tops and bottoms. One man, Sokyu Honma, is credited for developing the fundamentals of this technique, and many of the common candlestick patterns in use today.

For our work, we developed computer algorithms to search for candlestick patterns and measure the frequency of occurrence.

Figure 1: S&P 100 cash index, June to December 1996. During this period, it reached a low of 582.85 on July 16, 1996, and a record high of 739.23 less than six months later, on December 3, 1996. The stocks that collectively form the S&P 100 had gained 26.8% in six months.

"Let's look at a recent example. Figure 1 is a candlestick chart of the S&P 100 cash index from June to December 1996. During this period, it reached a low of 582.85 on July 16, 1996, and a record high of 739.23 less than six months later, on December 3, 1996. The stocks that collectively form the S&P 100 had gained 26.8% in six months. We will look at five points during that period, highlighted areas in Figure 1."

Gary S. Wagner, CTA, a registered commodity broker since 1984, and Bradley L. Matheny, a systems analyst who develops custom software applications, are currently developing technical market analysis software for International Pacific Trading Co. Together, they developed the Candlestick Forecaster, a candlestick-interpretation program based on artificial intelligence.
Excerpted from an article originally published in the March 1997 issue of Technical Analysis of STOCKS & COMMODITIES magazine. 
© Copyright 1997, Technical Analysis, Inc. All rights reserved.
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