While Japanese candlesticks have been around for hundreds of years – they have only been widely applied by Western traders in the past couple of decades.

The man we can credit for introducing Japanese candlestick charts to the West is one Steve Nison.

First, a little history.

Japanese Candlestick Charts – 400 years ago…

Seventeenth century Japan was under the control of military leaders, or Shoguns. If you remember the old Richard Chamberlain movie, you’ve probably got the idea – plenty of samurais wielding swords.

A number of attempts at creating a hard currency had failed dismally, so, rice had a status pretty close to cash.

That meant that rice merchants were the seventeenth-century equivalent of big-city bankers.

However, regional imbalances in supply of rice meant that its price lacked any stability. Merchants attempted to set rice prices, but those who were seen to be doing too well, ran the risk of having their heads chopped off by the local warlord. (There’s an idea for dealing with bankers’ bonuses.)

However, towards the end of the century, the Dojima Rice Exchange developed, which allowed merchants to grade and sell their rice at set prices – without the need for bloodshed.

Derivatives market here we come …

By the mid-1700s this process had developed into a sophisticated exchange, where a receipt (or coupon) for rice in the warehouse could effectively be used as currency.

This Dojima Rice Exchange, also saw the dawn of the futures market – where merchants could “sell” crops from next year (or many years to come) in return for cash in the here and now.

These futures were called “empty rice” coupons, and the futures market had developed to such a degree, that in 1749, 110,000 bales of rice were traded on the exchange, while only 30,000 bales of rice existed in the whole of Japan at the time.

Where do the candlesticks come in?

Don’t worry – I’m getting there.

Onto this scene steps our hero – Munehisa Homma. The Homma family were to rice what the Murdochs are to newspapers. There was even a saying at the time: “I will never become a Homma, but I would settle to be a local lord.” Not very catchy, but you get the drift.

At the age of 26, Munehisa Homma took over the family business, and turned out to be rather good at it.

He kept careful records of rice prices, weather conditions and of trading on the local exchange.

These records led to the development of a theory on forecasting market direction, which came to be known as Sakata rules, and is the backbone of candlestick theory as we know it today.

For his services, Homma was honored with the title of samurai. Not even Warren Buffet has managed that!

Basic anatomy

I can see that I’ve got a bit carried away with talking about samurais here – I haven’t managed to get an actual candlestick in yet.

As we’ve started right at the beginning here, I might as well get right back to basics with the anatomy of a candlestick (forgive me if I’m covering very familiar ground here).

Candlesticks come in many colours and shapes, but these are the basic facts that apply to them all:

If the body is white or green, then the closing price was higher than the opening price.

If the body is black or red, then the closing price was lower that the opening price.

The upper and lower shadows are the “wicks” of the candle, that can appear at the top, or bottom, or both. These represents price movements outside of the realm of the open and close prices – i.e. the highest and lowest price for that period.

Okay, just room for a quick candlestick pattern …

Candles bearing fruits

“Harami” is derived from the Japanese word for pregnancy, and the name is applied to this candlestick pattern because the second day’s candle would fit within that created the day before.

A harami pattern is characterized by a candle with a long body, followed by a candle with a short body, where the open and close prices are both w

ithin the bounds of the open and close the previous day.

A harami signals a reversal. If you have a long black candle followed by a short white one, this is a bullish pattern. If you have a long white candle followed by a short black one, it’s a bearish pattern.

The first thing that you notice when you look at a harami is that the momentum that’s behind the price has stopped, or slowed down. The bulls or the bears who’ve been driving the market are no longer in control.

Although a harami is just two candles long, like most candlestick patterns, it shouldn’t be viewed in isolation – you should wait for the next candlestick to confirm the trend change.