A Look at Kagi Charts

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A Look at Kagi Charts

The challenge of determining the short-term trend of any financial asset may seem difficult, particularly when traders attempt to use the commodity’s price chart for direction. The price swings observed on a chart from day to day might look choppy, making it incredibly difficult to tell whether price moves are substantial and will significantly alter the direction of the investment.

Fortunately for traders, various charting and technical analysis approaches that seek to filter out random noise and focus on the essential changes that function as drivers of an asset’s trend have been created. The Kagi chart is one means of filtering out this noise, and it is also the topic of this essay. Although it is not the most frequent or well-known technical tool, it may be useful to have in your toolbox.

Kagi Chart Construction

Kagi charts are made up of a succession of vertical lines that reference an asset’s price activity rather than anchoring to time as other types of charts do.

The first thing traders will note from the Kagi chart below is that the lines on a Kagi chart fluctuate in thickness based on the price of the asset. Sometimes the lines are faint, and other times they are thick and bolded. The most significant component of a Kagi chart is the variable thickness of the lines and their direction since this is what traders use to produce transaction alerts.

Figure 1.

Image by Sabrina Jiang © Investopedia2021

Kagis and Candlesticks

At first look, the many lines on a Kagi chart may seem overwhelming, so let’s go through a historical example using Apple Computer Inc. (NASDAQ: AAPL) between May 8th and December 1st, 2006. We think that this example will help you learn how to build this fascinating style of chart. We’ve also included a conventional candlestick chart to some of the Kagi charts to show what the underlying asset’s price has done to produce a change in the Kagi chart.

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As seen in Figure 2, the price of AAPL shares began to fall quickly after the start date of our chart. As the price dropped, a vertical line formed, with the bottom of the vertical line equal to the lowest closing price. If the closing of the following period is lower than the current bottom of the line, the line will be stretched to match the new low. The line will not reverse direction until the price climbs above the bottom of the Kagi line by more than a predetermined reversal amount, which is often set at 4%, although this parameter may vary based on the securities or the trader’s choice.

Figure 2.

Image by Sabrina Jiang © Investopedia2021

The Reversal

On June 1, 2006, AAPL shares ended 4.02% above the Kagi low, which was more than the 4% reversal amount required to reverse the chart’s trend (4%). The reversal is shown by a short horizontal line to the right followed by a vertical line in the direction of the reversal, as illustrated in the chart below. The rising Kagi line will continue to rise until it falls below the high by more than 4%.

Figure 3.

Image by Sabrina Jiang © Investopedia2021

Many traders cheered the reversal since it was the first positive Kagi signal issued since the chart was developed in early May. Unfortunately for the bulls, the gain proved unsustainable as the bears reacted by pushing the price below the top of the Kagi line by more than 4%. The downward reversal is shown on the chart as another horizontal line to the right, followed by a downward-moving line.

As seen in Figure 4, the bulls and bears fought over the direction of Apple shares over the next two weeks, forcing the Kagi chart to switch directions multiple times. Three of the upward rises between June and July were more than 4% above the chart’s low, causing the Kagi chart to change orientations. These swings reflected a growing positive feeling, but they were insufficient to completely reverse the trend.

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Figure 4.

Image by Sabrina Jiang © Investopedia2021

The Thick Line

The frequency of false reversals began to persuade traders that bullish interest in the stock was rising, but the underlying trend remained under the grip of the bears. On July 20, 2006, the narrative shifted due to a gap that was far higher than the 4% required to flip the chart’s trend. Indeed, the advance was significant enough to move the price above the previous high drawn on the Kagi chart, as shown by the most recent horizontal line formed at $59. A rise above a prior Kagi high, as illustrated in the picture below, leads the Kagi chart line to become bold.

Figure 5.

Image by Sabrina Jiang © Investopedia2021

Traders employ a movement from a thin line to a bolded line, or vice versa, to produce transaction signals. When the Kagi line climbs above the previous high, the signal changes from thin to thick. When the Kagi line goes below the previous low and the line thins, a sell signal is created. The Kagi chart changed directions following the rapid run-up, as seen in Figure 6, but a mere reversal does not affect the width of the line or trigger a transaction signal. On the Kagi chart, the bears were unable to push the price below the previous low.

When the bullish momentum returned in mid-August, the price swung back higher, forming a new swing low that will be utilized to generate future sell signals. Finally, the bulls were unable to drive the price of Apple shares below the low, forcing the Kagi chart to stay positive for the duration of the tested time. Because there was no sell signal, traders were able to profit from the strong upswing without being wiped out by random price changes.

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Figure 6.

Image by Sabrina Jiang © Investopedia2021

A Longer-Term Example

Now that we know what causes a transaction signal when utilizing a Kagi chart, let’s look at a longer-term historical example using Apple Computer’s chart (April 30, 2005 – December 31, 2006).Notice how a move above the previous high makes the line bold, and a fall below a low makes the line thin again. The shifting thickness is crucial in detecting transaction signals since it shows whether the bulls or bears are in charge of the momentum. Remember that traders interpret a move from thin to thick as a buy signal, whilst a change from thick to thin indicates that negative momentum is dominant and that it may be a good time to consider selling.

Figure 7.

Image by Sabrina Jiang © Investopedia2021

The Bottom Line

Day-to-day price swings may make determining an asset’s underlying trend exceedingly challenging for financial market participants. Fortunately for traders, technologies like as Kagi charting have helped put an end to obsessing on little price movements that have no bearing on future momentum.

A Kagi chart may seem to be a confused collection of arbitrarily positioned lines at first glance, but in fact, the movement of each line is determined by the price and may be utilized to provide extremely successful trading signals. This charting approach is largely uncommon among mainstream active traders, but given its ability to detect an asset’s underlying trend, it wouldn’t be unexpected to see an increase in the number of traders who depend on this chart when making market judgments.

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