The Kagi Chart is another Japanese chart which attempts to smooth out daily trading noise. Believed originated in the 1870s, the word Kagi was the typical L-shaped key we still use today.

The Kagi Chart (sometimes referred to as “key” charts by the Japanese) uses vertical lines to show market action; the asset supply and demand levels. If the market moves in the same direction as the former Kagi line, the line is lengthened. However, if the maket rises or falls more than a predetermined price, a new Kagi line is drawn in the next column in the opposite direction. As is true of Renko charts, Kagi are independent of time and only change direction once a predefined reversal amount is reached.

When the prices reaches previous highs or lows the Kagi line changes thickness; thick lines show asset prices which surpassed the previous high. They show an increase in demand. Thin lines show increased supply; the price has fallen below the previous low. Curiously, the lines are called Yin and Yang (thin and thick, in that order), the two principles, one negative, dark, and feminine (yin), and one positive, bright, and masculine (yang), whose interaction influences the destinies of all creatures and all things. Make of this what you will. The short horizontal line on these graphs, when a reversal occurs, is known as the inflection line.

Kagi Chart Construction

Kagi charts are based on closing prices. Before beginning, a price for reversal must be decided; the price necessary to draw a new line in the following column. For example, if our reversal price is 4 , the close must be at least 5 points below the previous close to be able to draw a bearish (decending) line. The reverse is true for a bullish (ascending) situation. There are several ways of calculating the parameters. One is to take 1/20th of the average price of the commodity or stock over the time period you decide to chart. Another specifies a percentage. Five percent is typical.

So, we need a starting point which is usually considered to be the first closing price. From here onwards, each day's closing price is compared to the starting price.

A thin vertical line is drawn from the starting price to each day's closing price, while the trend does not reverse. If a day's closing price moves in the opposite direction to the trend by more than the reversal amount, a short horizontal line (the inflection line) is drawn and a new vertical line from the inflection line to the new closing price. If the price on a day is greater than or equal to the previous high, the line becomes thick and continues vertically. If the price on that day is less than or equal to the previous low, the line changes to thin. The place where the lines change from higher to lower prices are called “shoulders”. When they move from lower to higher prices they are called “waists”.

In terms of shoulders and waists, when a yin (thin) line moves above the previous shoulder, it turns into a yang (thick) line. Similarly, if a yang line moves below the previous waist, it turns into a yin line.

Example of a Kagi Graph



The basics are as follows: Changes in line thickness generate transaction signals. Buy signals when the line changes from thin to thick. Sell signals when the reverse is true. Higher highs and lows indicate underlying bullishness. Lower highs and lows show weakness.

Also, a consecutive series of bullish shoulders and waists (on a thick line) indicate underlying market bullishness as both the highs and the lows climb. The opposite is also true. Lower highs and lows (lower shoulders and waists on a thin line) show underlying bearishness. Normally, traders look for reversal signs after the ninth shoulder or waist in a mainly consecutive sequence has appeared.

Conclusion

Kagi charts help you identify trends and patterns such as successive highs or lows. Support and resistance levels help determine when to enter and exit trades.