Chapter 2 Historical Background

By studying the past, we learn about the present.

This chapter explains how technical analysis was born in Japan centuries ago. This story contains many exciting episodes, but if you are impatient to quickly get to the heart of the matter, that is, to the principles of building and using candles, then you can skip it or, for example, return to it later. One of the first people in Japan to use past prices to predict future prices was the legendary Munehisa Homma [5] who made a huge fortune trading rice in the 1700s. But before I talk about this outstanding man, I would like to dwell on the economic situation of Japan during the time of Homma's commercial success. We will consider the period from the end of the XVI century. until the middle of the 18th century, when 60 disparate Japanese provinces united into a prosperous state. The entire 16th century there were continuous wars in the country, and chaos reigned everywhere, since every major feudal lord (daimyo, literally translated as “big name”) sought to subjugate neighboring territories. This century was later referred to as sengoku jidai, or the Warring States era. And by the early 1600s. three outstanding generals - Nobunaga Oda, Hideyoshi Toyotomi and Ieyasu Tokugawa - were finally able to create a single state, having spent more than 40 years on it. Their courage and exploits were sung in Japanese folklore. For example, one of the sayings says: "Nobunaga pounded the rice, Hideyoshi kneaded the dough, and Ieyasu ate the cake." This means that all three generals contributed to the unification of Japan, but the last one became the shogun - Ieyasu Tokugawa, whose family ruled the country from 1615 to 1867 (this period is called the era of the Tokugawa shogunate). It is not surprising that the wars that have torn apart Japan for centuries are reflected in the terminology of candlestick analysis. The names of many of the candles that you will find in the book are reminiscent of the battlefield: “night and morning attacks”, “three advancing soldiers”, “counterattack lines”, “gravestone”, etc. If you think about it, the trader is required to have skills, necessary to win the battle: you need to be a strategist, a psychologist, not be afraid of rivalry, be able to retreat in time - and, of course, be lucky. The relative stability provided by the centralized feudal system led by Tokugawa created a favorable environment for the growth of the agrarian economy, and, more importantly, the expansion of domestic trade. By the 17th century numerous closed provincial markets were replaced by a nationwide market. The already mentioned General Hideyoshi Toyotomi saw Osaka as the capital of Japan at that time and supported its development as a trading and financial center in every possible way. With easy access to the sea (and in those days, overland travel was time-consuming, dangerous and expensive), Osaka became a transit point for many goods from all over the country, which is why it was sometimes called the "cuisine of Japan." Constantly replenished stocks in extensive warehouses helped smooth out price fluctuations associated with interruptions in supplies from certain regions. Life in Osaka was permeated with the desire to profit, while in other cities, commerce was considered a contemptible occupation. In Japan, there was a hierarchy of four estates: the military was the highest, followed by farmers, then artisans, and finally merchants. Only in the XVIII century. the latter succeeded in breaking down this social barrier. It is noteworthy that even at the end of the XX century. The traditional greeting in Osaka remained “Mokari-makka”, which means “are you making a profit?”. A resident of this city, Jodoya Keian provided supplies for the army of Hideyoshi, one of the three unifier generals. Keyan showed remarkable ability in what is now called logistics, as well as in controlling prices. His courtyard played such an important role in the rice market that it was there that the first rice exchange in Japan was established. Keyan himself became very rich - as it turned out later, even too much. In 1705 Bakufu(the military government headed by the shogun) confiscated his entire fortune, accusing him of excessive luxury inappropriate to his social status. The Bakufu, not without reason, worried about the growing influence of individual businessmen. So, in 1642, together with several representatives of the authorities, merchants tried to establish tight control over the rice market. The punishment was severe: the property of the guilty was confiscated, the children were executed, and they themselves were sent into exile. The exchange rice market, which originated at the court of Jodoi Kayan, finally took shape at the end of the 17th century. with the appearance of the Dojima Rice Exchange in Osaka. At first, trading on it was carried out by rice itself, and after 1710 - by the so-called rice coupons , that is, warehouse receipts, which were issued and accepted by the exchange itself. The rice trade became the backbone of Osaka's economic prosperity, with over 1,300 rice dealers operating on its stock exchange. Since there was no currency standard in Japan at that time (all attempts to introduce a hard currency failed due to fraud with the quality of the coins), rice was often used as a tool for calculations. The feudal lord, in need of money, sent the surplus crops to Osaka, where they were placed in a warehouse in his name. In return, he received a rice coupon, which could be exchanged for another product, that is, actually sold. Due to financial problems, many daimyo sold coupons for the future harvest (peasants gave them 40–60% of the harvested rice). Sometimes the harvest turned out to be laid down in this way for several years in advance. Rice coupons traded against pending deliveries became the first futures in the history of mankind, and the Dojima Rice Exchange, where they were traded, became the first futures exchange. Sometimes they were also called "empty rice coupons" because they were not backed by real rice in warehouses. Some idea of ​​how popular rice futures trading was at the time is given by the following figures: in 1749, the number of empty rice coupons circulating in the Osaka market was equivalent to 110,000 bales of rice (traded in bales), while in reality, there were only 30,000 bales in all of Japan. In such an environment, Munehisa Homma, nicknamed the “god of the markets,” began his activities. He was born in 1724 into a family whose wealth is evidenced by the proverb of that time: "I will never become Homma, it is enough for me that I am an appanage prince." When Munehisa took over the family business in 1750, he first entered the rice market in the port city of Sakata, which was the regional center for the rice market. The hometown of the founder of candlestick analysis is reminiscent of the expression "Sakata's rule", which is often found in Japanese sources. After the death of his father, it was Munehisa who was entrusted with the management of the family capital, despite the fact that he was the youngest son, and in that era the eldest usually became the heir. The reason, perhaps, was his extraordinary commercial abilities, which had time to show themselves early. With the Homma family's money, he went to the Dojima Rice Exchange in Osaka and started trading rice futures there. Homma's family had huge rice plantations and, thanks to their influence, had detailed information about the situation in the rice market. Munehisa organized his own communication system: at the appointed time, he placed people on the roofs of houses all the way from Osaka to Sakata, and they transmitted signals along the chain with flags. In addition, for many years he observed the weather and recorded the results, and in order to better understand the psychology of investors, he analyzed the fluctuations in rice prices up to the time when the exchange was still in the court of Jodoi Keian. This approach to exchange trading allowed Munehisa Homma to achieve tremendous success in Osaka and start trading on the regional exchange in Edo (now Tokyo). He amassed a gigantic fortune thanks to his real talent as a trader: it is said, for example, that he once made 100 successful exchange trades in a row. The authority of Munehisa Homma was so great that in Edo they composed a song about him with the following words: Edo) it's raining." In other words, when there is a good harvest in Sakata, the price of rice falls on the Osaka Stock Exchange and crashes in Edo. This song characterizes Homma's influence on the rice market. Munehisa Homma died in 1803. In the last years of his life, he was a financial adviser to the government and received the honorary title of samurai. The trading principles used by Homma in the rice market and described by him in two books formed the basis of candlestick analysis, which today has spread throughout the world.