Kagi charts (Kagi) on the stock exchange

The task of determining the short-term direction of a financial asset may seem too difficult, especially if it requires traders try to look at the price chart. The daily price fluctuations displayed on the chart can look very volatile, making it extremely difficult to determine which price movements are particularly important and determine the direction of the asset in the first place.

Fortunately for traders, several price display methods have been developed that attempt to filter out the random noise and focus on the important movements that determine an asset's trend. One method of filtering out such noise, which is also the subject of this article, is known as Kagi chart (Kagi).

Constructing a Kagi chart

Kagi charts consist of a series of vertical lines which depend on price behavior rather than time like regular charts such as line, bars or candlesticks. As you can see in the chart below, the first thing traders will notice is that the lines on Kagi's graphics change in thickness depending on how the price of the asset behaves. Sometimes the lines are thin, while at other times the lines will be thick. Variable line thickness and direction - the most important event in the Kagi chart, because it is the event that traders use to get a signal to trade.

Figure 1

Kagi and Japanese candles

Constructing a Kagi chart may look confusing at first glance, so it will be easier to understand them with an example. We have also attached a normal candlestick chart to several Kagi's chartsto illustrate exactly what the price of the underlying asset did to cause a particular change in the Kagi chart.

As you can see in Figure 2, shortly after the start date of our chart, the price began to decline. As the price falls created a vertical line on the Kagi chartand the base of this vertical line was equal to the lowest closing price. If the next period's close was below the current base of the line, the line would be extended to equal the new low. The line would not change direction until the price moves away from the base of the Kagi line at a distance greater than the set reversal value, which is usually set at 4%, although this parameter can vary depending on trader preference or asset behavior.

Figure 2

Pivot on Kagi charts

On June 1, 2006, price closed at 4.02% above the Kagi low - further than the 4% reversal, which should have changed the direction of the chart (4%). As you can see in the chart below, the reversal is shown by a small horizontal line to the right, followed by a vertical line in the direction of the reversal. The Kagi line will remain rising vertically until price falls below its high by more than 4%.

Figure 3

The reversal pleased many traders because it was the first Kagi's bull signal since early May. Unfortunately for the bulls, however, the move proved unsustainable as the bears responded by pushing the price further below the high of the Kagi line than the 4% reversal number. The downward reversal is shown on the chart by a new horizontal line to the right, followed by a line going in a downward direction.

As you can see in Figure 4 below, the bulls and bears spent the next few weeks fighting over price direction, forcing the Kagi chart to reverse several times. Three of the upward moves that occurred in June-July took the price away from the chart low by more than 4%, forcing Kagi's schedule unfolding. These movements represented rising bullish sentiment, but they lacked the strength to fully unfold trend.

Figure 4

The thick line of the Kagi indicator

The number of false reversals shows traders that bullish interest in the stock is increasing, but the true trend remains under the control of the bears. That all changed on July 20, 2006, because of a gap that was significantly larger than the reversal 4% needed to change the direction of the chart. In fact, the rise was big enough to send the price above the previous maximum of the Kagi chartshown by the new horizontal line near 57.40$. A move above the previous Kagi high, as shown in the figure below, makes the Kagi chart line thick.

Figure 5

The change of the line from thin to thick or vice versa is used by traders as trade signals. Buy signals appear when the Kagi line rises above the previous maximum, changing from thin to thick. Selling signals occur when the Kagi line falls below the previous low and changes the line thickness from thick to thin. As you can see in Figure 6, the Kagi chart has changed direction after a sharp rise, but a simple reversal does not change the thickness of the line and does not create a signal for a trade. In this example, the bears were unable to bring the price below the previous Kagi chart low.

When the bullish momentum resumed in mid-August, the price moved back upward and created a new local low to be used for future sell signals. Ultimately, the bears were never able to bring the price below the low, which forced the Kagi's schedule remain in a bullish condition for the rest of the study period. The lack of a sell signal allowed traders to capitalize on the strong upward trendwithout being knocked out by random price fluctuations.

Figure 6

Long-term example of using Kagi charts

Now that we have an understanding of how a trade signal is produced on the Kagi chart, let's look at a long-term example using the April 30, 2005 - December 31, 2006 chart. Notice how a move above the previous highs caused the line to become thick, while a move below the lows caused the line to thin again. Variable thickness - key to identifying signals, as this alternation demonstrates who controls momentum - bulls or bears. Remember that changing the line from thin to thick is used by traders as a sign of buying, while changing from thick to thin shows the prevalence of downward momentum - it might be a good time to think about selling. As can be seen from the figure, there were 8 signals (3 false and 5 profitable) during the construction of the Kagi chart, while the amount of profit on the signals is many times greater than losses from false signals.

Figure 7

Conclusion

Daily price fluctuations can make it extremely difficult for traders in the financial markets to determine the true trend of an asset. Fortunately for traders, methods such as Kagi's chartsThe Kagi chart may look like a series of random lines at first, but in fact the movement of each line is price-dependent and can be used to generate very profitable trading signals. At first the Kagi chart may look like a series of random lines, but in fact the movement of each line is price dependent and can be used to generate very profitable trading signals. This technique is relatively uncommon among active traders, but given its ability to identify the true trend of an asset, it should come as no surprise that more and more traders are relying on this chart to make their market decisions.

Author: Casey Murphy