| Neil A. Costa |
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"The Kagi Chart"
It is believed that the first kagi charts, and candlestick charts, were used around the time the Japanese stock market started trading in the 1870s. Candlestick chart expert Steve Nison introduced Kagi charts to the Western world when he published his book Beyond Candlesticks: New Japanese Charting Techniques Revealed, in 1994.
Kagi charts, at first glance, look like swing charts. Like swing charts, they have no time axis and are made up of a series of vertical lines, however in the case of kagi charts, the vertical lines are based solely on the action of closing prices, not a bar's high and low prices. Another difference is that the thickness of a kagi chart line changes when closing prices penetrate the previous column top or bottom.
Kagi Chart Construction
To draw a kagi chart, we plot closing prices in vertical lines. To commence plotting your kagi chart:
- Choose a reversal amount - say three percent.
- Note the first closing price in your data. This is called the 'base price'.
- If the closing price of Day 2 is greater than the closing price of Day 1 (the base price), draw a thick vertical line upwards from the closing price of Day 1 to the closing price of Day 2.
- If the closing price of Day 2 is less than the closing price of Day 1, draw a thin vertical line downwards from the closing price of Day 1 to the closing price of Day 2.
- If the closing price of Day 2 is equal to the closing price of Day 1, do nothing. Instead, wait until the end of Day 3, and compare this price with the base price.
- If the closing price continues to rise (or fall), we keep moving the kagi chart up (or down) to the close of each day, regardless of how much or how little it moves.
- If the closing price moves in the opposite direction by less than a predetermined number of cents, the reversal amount, we ignore the small move and do nothing to our chart.
- If the kagi line has been moving upwards, and the closing price has fallen by more than the reversal amount, we draw a short horizontal line, called the 'inflection line', then a new line downwards, to the lower close of that day.
- If the kagi line has been moving downwards, and the closing price has risen by more than the reversal amount, we draw an inflection line, then a new line upwards, to the higher close of that day.
Reversal amounts can be a percentage (such as 3 %), or a fixed amount (such as 90 points for an index trading at 3,000, or 60 cents for a stock trading at $20). It is important to find an appropriate reversal amount for the index or stock you are analysing.
If the reversal amount is large, it will help you to stay in a profitable trade longer, however you will lose a little more profit when you exit the trade. If the amount is small, you will lock in more profit when you exit the trade, however you are more likely to exit the trade prematurely.
With experience, you will gain a 'feel' for how to determine the best reversal amount for a particular market at a particular time. In the mean time, I suggest you use a reversal amount of three percent.
If you are using computer software that draws kagi charts, set the default to 3%. If you are charting by hand, find 3% of the market's price and use this number. For example:
- A stock is trading at $21.50. Three percent of $21.50 is 64.5 cents. You will use a reversal amount of 65 cents.
- An index is at 3150. 3% of 3150 is 94.5. You would use a reversal amount of 95.
As mentioned earlier, kagi charts look different from swing charts in that they have thick and thin vertical lines. To draw the line thickness correctly, we do the following:
- If a thin line is extended beyond the previous swing high we thicken the line beyond that point. I prefer to draw this thickened line with a green pen, to give it greater impact.
- A thick line becomes a thin line when the thick line moves below the previous swing low. I prefer to draw the thin line with a red pen.
As you can see, I am a strong advocate of colour-coding charts, as I believe that this makes the chart's message clearer, more distinctive and easier to interpret. I was first introduced to the colour coding of charts by Dawn Bolton-Smith in the early 1990s, and I have used it ever since. (Dawn Bolton-Smith is one of Australia's leading and most respected technical analysts. She has almost 40 years' experience. Dawn has her own column in the Sydney Future's Exchanges Your Trading Edge magazine, and writes a column for the Iris Report.)
"A Market Analyst II Colour-Coded Chart of Davnet Limited"
Kagi Chart Interpretation
Kagi charts are an excellent way of viewing the underlying supply and demand of a market. When the most recent kagi line is thick (and green), it indicates that demand is exceeding supply, and that the market is in an upward trend. Thin (red) lines, on the other hand, show that supply is exceeding demand and that the market is in a downward trend. Alternating thick and thin lines indicate that supply and demand are in an approximate state of balance.
Kagi charts take the 'noise' out of the market, giving you a chart of the market's overall moves. You can gauge the strength of a trend by noting whether or not, in an upward trending market, a swing bottom is above, equal to, or below the previous swing top. The more 'above' it is, the stronger the trend.
Normal technical analysis techniques can be used very effectively. The following chart shows how effective trend lines can be when applied to kagi charts. Note also the strong sell signal when the market broke below two swing bottoms:
"A Market Analyst II Kagi Chart Illustrating Technical Analysis Techniques"
Trading With a Kagi Chart
Kagi charts are of great value to a trader of trending markets. Traders can use kagi charts for their entry and exit signals, and to place their stop-loss orders to lock in profits. They would consider buying a stock when the line changes from thin to thick. They would consider selling the stock when the line changes from thick to thin. I say 'consider' because a trader with a proven trading methodology would also consider factors such as the market phase, the relative strength of the stock and the strength of the stock's trend, in order to maximize profits while minimizing risk.
More experienced traders can use a smaller reversal percentage when entering a trade, then when the trade is in profit, change this to a larger percentage. Should the stock commence an almost vertical climb, called a blow-off top, a smaller reversal percentage can be used to help lock in profits.
As a general rule, when a kagi chart has made eight to ten higher highs, the market is considered to be due for a correction.
Conclusion
I find the kagi chart an ideal tool to be used in conjunction with a candlestick chart.
A candlestick chart gives me the detail of the day-by-day market action, while the kagi chart shows me the underlying market moves. With a few clicks of a mouse, I can change the sensitivity (reversal percentage) of the chart, and use it for fine-tuning my exits. Do not underestimate the usefulness of a kagi chart.
ACKNOWLEDGEMENT:
The charts reproduced in this article were produced by Market Analyst II software.
DISCLAIMER:
Every effort has been made to ensure that the content and conclusions presented in The New W. D. Gann Technical Review are complete and accurate.
No part of The New W. D. Gann Technical Review contains trading advice - stated or implied, nor is an invitation to trade. The directors and associates of Lambert-Gann Educators, Inc. are NOT licensed trading or investment advisors. Lambert-Gann Educators, Inc. is an organization designed to assist traders and investors to become more knowledgeable and independent.
The giving of advice is therefore contrary to the very objectives of Lambert-Gann Educators, Inc.
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