How many North American traders know that one of the most common stock-charting techniques did not originate in the West, but was in fact developed and used in Japan over 300 years ago? Before the United States was even a nation, the Japanese were using candlesticks to predict future price movements in rice trading.
Candlesticks were not first introduced to North America until 1989, when Steve Nison first wrote an article about them in the magazine Technical Analysis of Stocks & Commodities. Candlesticks allowed the trader to see at a glance where the market opened and closed, along with the high and low of the period. But candlesticks were similar to most other techniques (with the exception of point & figure charting): time and price were plotted on the X- and Y-axes, and whether it was one minute or one year, all price action occurring over that time was squeezed into the one frame. Price could then be plotted arithmetically or logarithmically, but either way, time and price were locked together in a set relationship.
But market action was not under the same constraints. In a slow market, there would be very little price movement, while fast moving markets could witness rapid changes in price. Was an arbitrary representation of price per unit of time the best way to forecast future price movement?
Markets as Energetic Systems
Inventor John Chen didn't think so. After searching for a better way to show price action, Chen decided that markets behaved more like energetic systems than systems confined to the two dimensions of time and price. Current methods were useful for looking at market action in hindsight, but he believed they did little to anticipate future movement. If markets were in effect energetic systems, possessing varying levels of energy, would it not be easier to determine where prices were going with a higher probability of success?
Chen sees markets working as thermodynamic systems. Alternating between periods of equilibrium and chaos, prices seek to find a new balance point after each trend. Think of this behavior as the act of going up or down flights of stairs that are separated by landings. When there is an increase in buying, prices move out of equilibrium and trend higher until a new equilibrium point is reached (the next landing). The whole process is not time driven, but rather price dependent. And the 'inner force' is investor behavior, which drives price action in a cause-effect relationship.
According to Chen, price is the only event that really matters. Once a trader understands the process of how price interacts and changes, he or she can exploit it more easily.
How It Works
Chen's program, called J-Chart, plots price as a five-part Chinese 'Jeng' or JE character. One part of the character plots each time a transaction occurs at a specific price, allowing the user to determine the level of equilibrium at any given time. Depending on user preference, any time period may be set and periods may be combined. Opening prices are plotted in yellow and closing prices for the period are plotted in cyan.
As price plots in a given frame, a triangle begins to form. If it is top heavy, as is the case in Figure 1 below, the part of the plot with indentations (or caves) will generally be filled in subsequent sessions, unless the market is trending strongly in the opposite direction.
|Figure 1 - Price plots in a J-Chart showing triangular formation from high (point of origin) to low (image point) with open (yellow) and close (cyan) and balance point (solid red line). Chart provided by J-Chart.com
The point of origin is either the high or low where price plots occur. The image point in Figure 1 contains no price plots, making this formation top heavy and out of balance. In a situation where there is equilibrium, the high and low would be equidistant from the balance point (center), where the greatest number of price plots occur and JE plots would symmetrically fill the triangle outlined by the gray lines.
J-Chart treats markets as energetic systems, thereby giving us a new way of looking at them. It is designed to help the trader decide when markets are in equilibrium and when they are not. The closer the price action comes to filling a perfect isosceles triangle in a given period (turned on its end), the more it is in equilibrium.
If markets were efficient, they would also be logical. But as any trader knows, markets are neither totally efficient nor totally logical. The reason is simple: markets are prone to the herd mentality. Herds rarely move efficiently, and they are certainly not driven by rational logic. They are more likely to vacillate between periods of greed (when prices are driven up in the rush as people buy not wanting to miss out) and periods of fear (when people realize they got carried away).
|Figure 2 - J-Chart model of price movement. In reality the price plot triangles are out of balance and must be balanced in subsequent price action. The green line shows how forecasts work. The lowest horizontal green line is the target plotted from taking the high marginal point (high of the period) and connecting the next period balance point.
Figure 3 - Real price action showing double balance points and price vacuum or 'cave' in the middle. The natural tendency is to fill this void in subsequent price action unless there is an overwhelming move either higher or lower. However, sooner or later, this price cave will have to be filled. Chart provided by J-Chart.com.
Even when driven by strong investor sentiment, markets must obey certain laws of energy. As Isaac Newton put it, "For every action there is an equal and opposite reaction." Price moving upward too quickly must come back down and fill the areas it missed at some point. These areas show up on the J-Chart display as voids or caves. If price moves too far in either direction, the equilibrium is broken and a new one must be formed.
Price - Where to Next?
Now the trick is to determine what is more likely to occur when setting price forecasts. Will the target that was set using the forecasting tool with an image or marginal point and subsequent balance point be hit next? Or, will caves left empty from past sessions be filled?
By changing settings on the program, the user can look at price action in a number of ways. It is possible to view up to 45 days of price action at once, but the user also has the option of changing the scaling, or combining price action over a number of periods to get a clearer picture of what is going on. Looking at the market one day at a time gives a different picture than combining 30 or 40 days together. To a certain extent, the number of periods combined will depend on the trader's preferred trade duration. Short-term or day traders will look at past action one day at a time, and then look at 15- or 30-minute intervals on the trading day. Swing traders will prefer to set the current day interval to 60 or 120 minutes to look for ideal entries and exits, but they'll also combine two to five days together to get a longer-term view.
|Figure 4 - In attempting to fill the cave (red ellipse) the previous balance point was broken, necessitating the establishment of a new equilibrium. Chart provided by J-Chart.com.
Ultimately, the trader's experience and skill in reading the program provide him or her with the ability to decide. Stop losses are set using major balance points from prior days, past highs or lows, and at the horizontal blue lines plotted by the program showing significant support/resistance. The trader can also use the previous day together with overnight price activity before markets open on trading day. He or she is looking for more target points and confirmation that the trend is still positive.
Once the trading day begins, with the interval set to anywhere from 15 to 60 minutes (depending on his or her trading horizon), the trader watches the action unfold. As the market moves, he or she sets new targets and stop losses.
J-Chart versus Market Profile
In some ways, J-Chart is similar to Market Profile, developed by J. Peter Steidlmayer in conjunction with the Chicago Board of Trade in the 1980s. Unlike the traditional bar or candlestick charts, both J-Chart and Market Profile provide the trader with a three-dimensional view of market action. But the programs are different in a number of ways as well.
|Figure 5 - Market Profile display of soybeans showing the way the 30-minute chart prints. Letters plotted most often in the middle of the price range (point of control) and least often at the highs (upper tail) and low (lower tail). The letter in the alphabet corresponds to the time of day in which the trade occurred. An 'A' plots if the trade occurred between 0800 and 0830, a 'B' from 0830 to 0900 etc. Trading decisions are based on time price opportunities (TPO). At each 30-minute display, the trader must decide the likelihood of price in a particular direction. The point of control corresponds to the balance point in J-Chart. Chart provided by cisco-futures.com.
Market Profile plots a letter where transactions take place during a 30-minute period so that an 'A' plots for transactions between 8:00 and 8:30 a.m., a 'B' for transactions between 8:30 and 9:00a.m. and so on, plotting a bell-curve-like distribution for daily price action. The display allows the trader to see which prices had the most and the least activity. The value area is where 70% of price activity has occurred (see Figure 5). The premise of Market Profile is that if prices move away from the value area there is a strong likelihood they will move back to this area as volume dries up. In other words, prices have a tendency to revert to the point of control, or the point where most price action takes place. Market Profile plots at 30-minute intervals.
J-Chart's ability to plot in a multitude of time frames and its different interpretation of price action make it different from Market Profile. J-Chart allows the user to look at up to 45 days of price action in one chunk by plotting 45 days with 45 combine, or in daily chunks by plotting 45 days and one combine. On the trading day, the trader can set the interval to anywhere from one minute to a full trading day of 405 minutes (for futures).
From a theoretical standpoint, the biggest distinction between the two programs is that Market Profile is based on a bell-curve distribution of price and has a tendency to revert to the point of control, while J-Chart is based on an energetic distribution of price and the idea that each action will be met with an equal and opposite reaction. J-Chart allows the trader to anticipate future price action and make forecasts based on past activity and the distribution of prices over various time frames.
Price forecasting is also easier with J-Chart, thanks to its forecasting tool. And the J-Chart user does not necessarily assume prices will revert back to the daily mean either. If there are gaps in the price action or if the longer-term price equilibrium is out of balance, the trader can expect a re-balancing in the near future.
Another big advantage that J-Chart has over Market Profile is that traders who have mastered J-Chart have the ability to anticipate price reversals thanks to the principle of resonance. Resonance occurs when forecasts in various time frames give very close or identical values, indicating that a move is getting ready to take a rest or reverse. Resonance points often provide excellent points for the J-Chart trader to take low risk reversal positions and make big profits.
Both programs are very useful in trading forex markets, where volume data is either difficult or impossible to get in most cases. Traders can determine implied volume by the number of times transactions have occurred at various price levels - something that would not be possible using standard candlestick or bar charts.
The End of the Beginning
New indicators and systems are produced on a regular basis by developers and traders looking to capitalize on a better mousetrap. Some will gain popularity and be added to the trader's stable of useful tools, but most will never attain the critical mass necessary to become commercially viable. Unfortunately, the outcome has less to do with the merit of the system and more to do with the marketing acumen of the system's developer or creator.
Revolutionary systems often have the most difficult time gaining public acceptance, simply because the theory or application behind them is unfamiliar. If the developer does not have the staying power to promote it until it gains acceptance, the system will either be hoarded by a small group of traders who will take the time to learn how it works and use it profitably, or it will end up collecting dust in the warehouse of trading ideas that never made it.
As with any worthwhile trading tool, it is up to each trader to add it to their bag of tricks to augment what they are already doing.
If markets do in fact act as thermodynamic systems, traders who use J-Chart will have a distinct advantage over fellow players who use more traditional charting methods such as bars and candlesticks.