1. ABSTRACT Technical Analysis is the study of historical price trends in order to predict future price movements. Traders use various forms of Technical Analysis to improve their trading profitability. Japanese Candlestick Charting, one discipline of Technical Analysis, has a long history of use in Foreign Exchange markets. Traditionally, traders would study price movements in the form of candlestick charts to visually search for well-known patterns that lead to buy or sell signals. However, this method is tedious and inefficient, as traders manually comb through charts to find indicators and make trading decisions. The model created in this project converts the visual signals perceived by traders from candlestick charts into computer logic, effectively automating the technique. Price data is imported for any currency pair, and the model outputs when to buy and sell based on the automated candlestick indicators. This model contains a master indicator, which is refined to only include candle patterns that are historically profitable. The master indicator also takes into account other technical indicators that are used for confirmation. After testing over seven currency pairs and three decades of data, the model has shown an ability to increase trading profits on average. AUTHORS : Simran Bhatia SSE ‘09 Andrew Ruben SSE ‘09 Aman Thapar SSE ‘09 ADVISOR : Dr. Iraj Zandi DEMO TIMES : Thursday, April 23 rd, 2009 11:00 AM, 11:30 AM, 3:00 PM and 03:30 PM GROUP #7 Department of Electrical and Systems Engineering Trading in the Foreign Exchange Markets using an Automated Japanese Candlestick Model SYSTEM FLOWCHART The Automated Candlestick Indicator is combined with other Technical Indicators in order to give a final buy or sell signal. A confirmed Three White Soldiers pattern occurred and is shown below. When the decision to trade occurs, the model outputs a ‘buy’ signal and implements transaction costs. The position is exited based on rules for controlling profit and loss fluctuations. In order to determine which currencies to trade, the system starts by analyzing the fundamental strength of 7 major currencies relative to the US Dollar. Once the currency pair is chosen, the system inputs the relevant price data. The data is inputted through the Automated Indicator Recognition Process to see if sequences in the data match up with well known Candlestick Indicators. This gives a preliminary indication of whether to buy or sell the currency at a given time. This signal is confirmed with the output of three other well known technical indicators. By confirming with indicators independent of the Candlesticks, the model is able to make more robust trading decisions. In order to match real-world trading conditions, the model implements transaction costs and risk controls. TRADING SYSTEM In this component of the system, illustrated in Figure 4, the model automatically identifies candlestick indicators. The system inputs real-world price data and performs calculations on the price bars. Based on ratios between prices, the model classifies individual candles and then sequences of multiple candles. If the data matches a particular indicator, our system flags a trading signal. This outputs a preliminary decision on whether to buy or sell a currency at this time. A candlestick is a way of visually encapsulating the price movements of a security within a given time period. For each period, a security has an opening price and a closing price, as well as a high price and low price. These four elements are drawn into a candlestick as shown in Figure 2. When the open is higher than the close, the price decreased over the period and the body of the candlestick is black. When the close is higher than the open, the price increased and the body is white. JAPANESE CANDLESTICKS AUTOMATED INDICATOR RECOGNITION Series of candlesticks can be used to identify reoccurring price trends. There are known and published candlestick patterns which traders use to generate buy and sell signals. An example candlestick pattern that generates a ‘buy’ signal is shown in Figure 3. This specific formation is known as the ‘Three White Soldiers’. In this formation, there are three long white days, signifying a string of higher price moves. This suggests the market is strong, and represents a time to buy the underlying security. This is one of thirty indicators tested in the model. Figure 1 – System Flowchart Figure 2 – Japanese Candlesticks Figure 3 – Three White Soldiers Formation Figure 4 – Indicator Recognition Flowchart Figure 5 – Real World Trade Example