Chapter 4

Additional Note
You may wonder why there are three continuation patterns that are derived
from a failure to complete a Piercing Line. The On Neck Line, In Neck
Line, and Thrusting patterns all represent failed attempts to reverse the
downward trend.
Why, then, are there not similar patterns that represent failed Dark
Cloud Cover patterns? This can be answered by most students of the
market who are familiar with normal topping and bottoming tendencies.
Bottoms (market lows) tend to be sharp and with more emotion. Tops
usually take longer to play out, and cannot be as easily identified.

Japanese history, and Japanese financial trading history, in particular, is

rich with accounts of success, usually dominated by only a few individuals. One such success was a man named Munehisa (Sohkyu) Honma.
Some references use Sohkyu and some use Munehisa.
Honma stepped into Japanese futures trading history in the mid-eighteenth century. When Honma was given control of the wealthy family
business in 1750, he began trading at the local rice exchange in the port
city of Sakata in Dewa Province, now Yamagata Prefecture, on the west
coast of northern Honshu (about 220 miles north of Tokyo). Sakata was a
collection and distribution port for rice and today is still one of the most
important ports on the Sea of Japan.
Stories have it that Honma established a personal communications network that consisted of men on rooftops spaced every four kilometers from
Osaka to Sakata. The distance between Osaka and Sakata is about 380
miles, which would have required well over 100 men. This allowed
Honma the edge he needed to accumulate great wealth in rice trading.
Honma kept many records in order to learn about the psychology of
investors. His studies helped him understand that the initial entry into a
trade must not be rushed. According to Honma, if you feel compelled to
rush into a trade because you believe that you just can't lose, wait three

Sakata's Method and candle Formations

Chapter 5
days to see if you still feel the same way. If you do, you can enter the
trade, probably quite successfully.
The Honma family owned a great rice field near Sakata and they were
considered extremely wealthy in both fact and song. One folk song said
that no man can be as wealthy as a Honma: one can merely hope to be as
rich as a daimyo. A daimyo is the early Japanese term for a feudal lord.
Honma died in 1803. During this period of time a book was published.
"If all other people are bullish, be foolish and sell rice" is some of the
advice contained in San-en Kinsen Horoku. This book was published in
1755 and is known today as the basis of Japan's market philosophy.
Today, in Sakata, a house which once belonged to the Honma family, is
the Honma Museum of Art.
All of the patterns and formations based upon Sakata's Method are
taken from 160 rules that Honma wrote when he was 51 years old.
Sakata's Method, in turn, is what is now considered as the beginnings of
candle pattern recognition. Candlestick charting was not actually developed by Honma, only the pattern philosophy that goes with it. His approach has been credited as the origin of current candlestick analysis.
Since Honma came from Sakata, you may see reference to: Sakata's
Law, the Sakata Method, Sakata's Five Methods, Honma Constitution, and
similar names. While the labels may differ, the analysis technique remains
the same. This book will refer to this approach as Sakata's Method.

Sakata's Method
Sakata's Method, as originated and used by Honma for basic chart analysis, deals with the basic yin (inn) and yang (yon) candle lines along with
two additional lines. The concept is centered around the number 3. The
number 3 appears often in traditional analysis as well as in Japanese charting techniques. Sakata's Method is a technique of chart analysis using the
number 3 at different points and times in the market. Sakata's Method can
be summarized as:

San-zan (three mountains)

San-sen (three rivers)
San-ku (three gaps)
San-pei (three soldiers)
San-poh (three methods)

From this list it is should be obvious that san refers to the ubiquitous
number 3.

San-zan (three mountains)

Three Mountains forms a line that makes a major top in the market. This
is similar to the traditional Western triple top formation in which the price
Figure 5-1A

sakata's Method and candle Formations

Figure 5-2A
^

rises and falls three times, forming a top. This formation is also similar to
the Three Buddha Top (san-son) formation which is the equivalent of the
traditional head and shoulders formation. It comes from the positioning of
three Buddhist images lined up, with a large Buddha in the center and a
smaller one on each side. San-zan also includes the typical Western triple
top where three upmoves are made with comparable corrections that follow. The three tops may be the same height or may be trending in one
direction, most probably down.

San-sen (three rivers)

Three Rivers is the opposite of Three Mountains. It is often used like the
traditional triple bottom or inverted head and shoulders bottom, but this is

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not necessarily correct. The Three Rivers method is based on the theory of
using three lines to forecast the turning point of the market. This can be
seen in a number of bullish candle patterns using three lines, such as the
Morning Star and Three White Soldiers. In Japanese literature, the Morning Star is often called the Three Rivers Morning Star in reference to this
Sakata Method.
There is some confusion about whether Sakata's Method uses Three
Rivers for a bottom formation technique or whether it refers to the use of
three lines for identifying tops and bottoms. There is considerable reference in Japanese literature to Three Rivers Evening Stars (a bearish pattern) and the Three Rivers Upside Gap Two Crows (also a bearish pattern).
Also recall from Chapter 3 that there was a bullish reversal pattern called
the Unique Three Rivers Bottom.

Chapter 5
Figure 5-2B

San-ku (three gaps)

This method uses gaps in price action as a means to time entry and exit
points in the market. The saying goes that after a market bottom, sell on
the third gap. The first gap (ku) demonstrates the appearance of new buying with great force. The second gap represents additional buying and
possibly some covering by the sophisticated bears. The third gap is the
result of short covering by the reluctant bears and any delayed market

Sakata's Method and Candle Formations

orders for buying. Here, on the third gap, Sakata's Method recommends
selling because of the conflict of orders and the possibility of reaching
overbought conditions too soon. This same technique works in reverse for
downward gaps in the market after a top. The Japanese term for filling a
gap is anaume. Gaps (ku) are also called windows (madd) by the Japanese.

Sakata's Method and Candle Formations

white days have long upper shadows. The second variation of the Three
White Soldiers pattern is the Deliberation (stalled) pattern, which also has
a long upper shadow on the second day. However, the third day is a
Spinning Top, and most likely a star. This suggests that a turnaround in the
market is near.
Other patterns that make up the san-pei method are the Three Black
Crows and the Identical Three Crows patterns. Each of these candle patterns is bearish and indicates a weak market (Chapter 3).

San-pei (three soldiers)

San-pei means "three soldiers who are marching in the same direction."
This is typified by the bullish Three White Soldiers candle pattern, which
indicates a steady rise in the market. This steady type of price rise shows
promise as a major move to the upside. Sakata's Method also shows how
this pattern deteriorates and shows weakness in the market rise. These
bearish variations to the bullish Three White Soldiers pattern are discussed
next. The first variation of the Three White Soldiers pattern is the Advance
Block pattern, which is quite similar, except that the second and third

Sakata's Method and candle Formations

Sakata's Method is intended to present a clear and confident way of

looking at charts. Often Sakata's Method is presented along with the following simple philosophy:
1. In an up or a down market, prices will continue to move in the
established direction. This fact was instrumental in the development of candle pattern identification with a computer (Chapter 6).
2. It takes more force to cause a market to rise than to cause it to fall.
This is related directly to the traditional saying that a market can
fall due to its own weight.

3. A market that has risen will eventually fall, and a market that has
fallen will eventually rise. As an article in the September 1991 /
issue of Forbes observed, in bear markets, it's smart to remind
Figure 5-7

San-poh (three methods)

San-poh means "a rest or cease-fire in market action." A popular Japanese
saying is "Buy, sell, and rest." Most traditional books on market psychology and trading suggest taking a break from the markets. This is necessary
for many reasons, not the least of which is to get a perspective on the
market while not having any money involved. San-poh involves the continuation patterns called the Rising Three Methods and the Falling Three
Methods (Chapter 4). Some sources also refer to two other patterns, the
Upside Gap Three Methods and Downside Gap Three Methods, all discussed in Chapter 4.
The Rising and Falling Three Methods continuation patterns are resting patterns. The trend of the market is not broken, only pausing while
preparing for another advance or decline.

Sakata's Method and candle Formations

Chapter 5

Figure 5-8

Candle Formations
There are many Japanese candle formations that resemble price formations
used in traditional technical analysis. Steve Nison coined many of the
names commonly used in the West today. These formations can consist of
many days of data. These formations are used as general market indicators
and lack the precise timing that many investors and traders require. When
a formation does evolve, look for additional evidence of price reversal,
such as a reversal candle pattern. Some interference may occur when a
formation takes shape over a long period of time. Remember that most
candle patterns, and certainly almost all reversal candle patterns, require
that they have a relationship with the current or previous trend. These
trends are greatly influenced by the following candle formations.

Eight New Price Lines (shinne hatte)

Figure 5-9

yourself that the world isn't coming to an end, and in bull markets,
it's smart to remind yourself that trees don't grow to the sky. A
similar and more common analogy is that all good things must
come to an end.
4. Market prices sometimes just stop moving completely. This refers
to lateral trading, a time for all but the most nimble traders to stand
aside.
Sakata's Method, while focusing on the number 3, also involves the
use of broader formations in which numerous candle patterns may exist.