Candlestick charting can operate like good theory in science. A good theory, scientists tell us, not only brings order to what might otherwise seem chaotic data, but it also takes you places you didn't know you could go.

In the hands of a careful observer and thinker, a technical device such as candlestick analysis becomes more than just an alternative charting method. It becomes a window to market opportunities you may have overlooked.

Take the way Dan Gramza uses candlestick analysis to find trading opportunities in the CBOT® agricultural futures contracts.

Candlesticks, in Gramza's hands, become an alternative or an extension of Market Profile® analysis, at least in part. The advantage of Market Profile analysis, Gramza says, is that it creates a visual image of the collective behavior of market participants. By arraying futures prices on the vertical axis of a chart and noting when prices trade in terms of letters representing 30-minute segments of the trading day, the image ultimately develops. Often, it takes on the aspect of a vertical bell-shaped curve. A bulge in the profile indicates market acceptance of the price levels within the bulge. A thin area indicates market rejection of that range of prices.

In fact, Gramza was in Tokyo, Japan, teaching bank traders how to use Market Profile when he saw a candlestick chart for the first time. He immediately saw a relationship between the information conveyed by the two charting methods. The candle formations tell Gramza about order flow which, in turn, carries clues about what "the market" — the collective intelligence of all the traders involved—wants to do at a given moment. Consider the weekly CBOT July wheat chart of Exhibit 1.






The Basic Message of the Candles

The red candles represent weeks when the market closed lower than it opened. The green candles represent weeks when the market closed higher than it opened. The wick-like extensions above or below the colored areas of the candles, the bodies, are called shadows. Basically, the colored area of a candle represents market acceptance of this range of prices while the shadows represent market rejection of the prices covered by the shadow. You can see the resemblance to a Market Profile graphic.

To show how attention to these chart formations can show you what is happening in the market, Gramza points to the green candle sitting on the 360 line and right on the line separating April and May. The green color indicates a higher close symptomatic of buyer domination, but the topside shadow suggests this market hit resistance above 375. This week was followed by three more weeks when the buyers were more aggressive than the sellers.

"The size of the body", Gramza says, "indicates the degree of buying". Clearly, the long body with little or no bottom shadow and only a relatively modest shadow on top suggests a week where the buyers dominated.

Then, Gramza continues, "as the bodies get smaller and the shadows grow longer, this indicates a loss of momentum". The fourth green candle in this series has almost no body and a very long shadow at the top. "A shadow like this", Gramza says, tells us the market is rejecting prices above 415. This shadow formation tells us sellers are becoming more active". And the sellers dominate July wheat for the next three weeks, as the three red candles show.

"Notice the equal drama to the downside", Gramza urges. "The first red candle shows strong selling, but notice how closely the second red candle matches the second green candle. By the third week, the sellers still have the upper hand, but they are losing momentum. And the buyers came back in at 360".

The last green candle in the uptrend, with its almost nonexistent body and long upside shadow suggests that it might be time to go short this market.

Similarly, during the first three weeks in April, you can see a series of such candles—very short bodies and relatively long shadows on at least one end. This suggests a market with no idea where it wants to go. This seems a useful signal to at least be ready to act once the market decides on a direction.


Shedding Light on Trading Opportunities

"Most people think of the big contracts—CBOT corn or soybeans—when you mention agricultural futures", Gramza says. "They tend to overlook a more lightly traded market like CBOT rough rice, yet you can find some interesting opportunities in rice".

To illustrate, consider Exhibit 2, a daily candlestick chart of July rough rice futures.





From April 24 to May 8, Gramza notes, "this market traded lower but with no gusto". You can see that most of the candlesticks during this period have relatively short bodies and are about evenly divided as to color. This was a market with no sense of direction.

"If you've sold a market and it begins to behave like this, you want to be cautious", Gramza says. "Along about May 9, you might have thought about buying".

Indeed, after May 8, the rice market moved up strongly with the body of each green candle completely above the body of its predecessor. Gramza calls special attention to the large green candle that formed on May 15.

"This is a benchmark candle", Gramza says. "It shows how dominant the buy-side is at this point and tells of an upside bias in this market".

Reading this signpost, you might feel justified in holding onto a long position despite the few days when the rice market seemed to be on hold and the sellers seemed to win a few rounds. The May 22 and 23 markets would have amply rewarded your tenacity.Suppose, having bought this market at $8.45 per hundredweight on May 9, you had waited until May 24 to sell. The red candle shows the sellers to have dominated the market on that day, and suppose you had managed a sale price of $9.20. Based on these conservative assumptions, this rough rice trade would have earned $0.75 per hundredweight or $1,500 per contract.Solid analysis can uncover solid opportunity in a market you may have been overlooking. Indeed, candles can be more illuminating than you might think.


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About article author:
Dan Gramza, who has been called "King of Candlesticks", uses candlestick charting to develop a sense of order flow. For the purposes of this booklet, he applies this to the grain markets and uses a weekly CBOT wheat futures chart to show how this kind of analysis can apply to longer-term trading. Further, he shows how this analytical approach can help you discover fruitful trading opportunities in a contract you may have overlooked, such as CBOT rough rice futures.

The views and opinions given herein are solely those of the individuals quoted and do not necessarily represent the views and opinions of the Chicago Board of Trade.

The information in this publication is taken from sources believed to be reliable. However, it is intended for purposes of information and education only and is not guaranteed by the Chicago Board of Trade as to accuracy, completeness, nor any trading result and does not constitute trading advice or constitute a solicitation of the purchase or sales of any futures or options. The Rules and Regulations of the Chicago Board of Trade should be consulted as the authoritative source on all current contract specifications and regulations.