TRADING TECHNIQUES
Analyzing Candlesticks Quantitatively
Coding Candlesticks (II)
by Viktor Likhovidov
Few charting innovations have become so widely accepted in the US since their introduction from Japan as candlesticks. Until Viktor Likhovidov's article in the November 1999 issue of STOCKS & COMMODITIES, their interpretation was subjective. With his article, however, he showed how to develop quantitative values for candlesticks -- values that could be used in software to create indicators for trading. His proposal did draw one critique, from Jan W.E. Roberts (see "Letters to the Editor"). We thought the results of their exchange and Likhovidov's Excel spreadsheet for coding would be valuable for our readers to study.
Jan W.E. Roberts's letter (see "Letters") questioned the quantitative approach to candlestick charting that I described in the November 1999 S&C. The issues that he discussed deserve discussion that could help readers to better understand the basis and possible application of my method.
FIGURE 1: BEARISH ACTION. Both candles end up on the day, but one shows active bears seeking lower price levels. CandleCodes capture this action.
My idea of assigning a numeric value to a single candlestick is based on
the principle that the relationship between opening and closing prices
is the most important for interpretation of the candle. So in construction
of the quantitative characteristic of a candle, I took these prices into
account as the main factor.
My method uses a candle's binary code (see sidebar, "How to code a candlestick"), so characteristics of opening and closing prices should be reflected in the highest bits of this code. This gives them the greatest weight. The parameters of the candle's shadows are placed in lower bits of the code, giving them lower weight. Thus, the numeric representation of the code is the weight of the candle. This automatically assigns the highest influence on the candle's weight to the body.
A candle's binary code also has the sense of a candle's weight because binary representation is additive: a candle's weight is equal to the sum of its body's weight, plus its upper shadow's and lower shadow's weights.
THE BODY
A candle's color is the main factor in evaluation of its sense from the point of possible market movement. A white candle (close > open) shows bullish market movement, so with all other circumstances being equal, it more clearly expresses bullish market sentiment than does a black candle (close < open).
Considering candles individually, without taking into account the context created by nearby candles, any white candle is more bullish than any black one, independent of their sizes and shadow configurations. My method is designed for description of isolated candles, so I place "1" in the highest bit for a white candle and "0" for a black candle. Now, any white candle has a higher value than any black candle, since a white candle's code cannot be less than 1000000 = 26 = 64, while a black candle's code cannot be greater than 0111111 = 25 + 24 + 23 + 22 + 21 + 20 = 32 + 16 + 8 + 4 + 2 + 1 = 63.
Coding and weighing groups of candles is another problem and it demands another approach, although aggregating individual candles' codes into an indicator is a start.
...Continued in the March 2001 issue of Technical Analysis of STOCKS & COMMODITIES
Viktor Likhovidov, a financial analyst and consultant based in Vladivostok, Russia, performs research in the areas of pattern recognition, neural networks, and mathematical methods in currency markets analysis. He may be reached at ltfx@fastmail.vladivostok.ru or lita@math.dvgu.ru.
Excerpted from an article originally published in the March 2001 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2001, Technical Analysis, Inc.
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