Do Japanese Candlesticks Help Solving the Trader's Dilemma?

Abstract

In this paper we investigate whether Japanese candlesticks influence the transaction costs of sequences of orders and whether they can help traders with their decision of timing or not. Based on fixed-effect panel regressions on a sample of 81 European stocks, we show that market timing costs are not lower when Hammer-like and Doji configurations occur, indicating that they fail to predict future short-term return. However, market impact costs are much more lower when and after a Doji structure has occurred, suggesting that market members may benefit from candlesticks to solve the trader’s dilemma. We further check the potential gains through order submission simulations and find that a submission strategy based on the occurrence of Dojis significantly results in much lower market impact cost than a random submission strategy.