Munehisa Homma – The Father Of Price Action Trading

In today’s post, we’re going to be taking a look at the life and legacy of one of the most famous traders you’ve probably never heard off. This was a trader who not only made a huge amount of money trading the markets (legend has it has made close to 10 billion when adjusted for inflation) but someone who basically created price action trading as we know it today. Most, if not all of the core concepts we use in our trading today come from him.

So without further ado let get into the article and see who this amazing trader was…..

Munihisa Homma

The trader I was talking about in the introduction is a guy by the name of Munihisa Homma.

Munihisa Homma was a Japanese rice trader who lived in the city of Sakata between the years 1725 and 1803. He was born into a prominent family of rice merchants who had already acquired a significant amount of wealth by the time Homma was born. When he was a teenager Homma’s farther let him run a large portion of the family rice business. Being that he lived in the city of Sakata, Homma decided that it would be a good idea to go and trade at the small rice exchange that was found in the port. The biggest rice exchange at the time was found in the city of Osaka, but this was to far away for Homma to travel on his own so he had to make do trading with the merchants in the Sakata port.

When Homma’s farther died, the entirety of his families rice business was handed over to him and he decided to make the trip to Osaka to go and trade on the rice exchange there. The Osaka rice exchange was very different to the Sakata exchange Homma had been trading since he was a teenager. On the Sakata exchange you could only trade rice on the spot with other rice merchants, but in the Osaka exchange they had a system in place where you could trade rice that hadn’t actually been physically delivered yet through coupons given out by the rice merchants.

This system of trading rice was basically the worlds first version of what we now know today as a futures market.

Homma, like most other rice traders at the time, was highly interested in trading rice through this system of coupons as it meant that he didn’t have to actually know if there was going to be rice available for trading at the time when the coupon specified delivery, just what the price of the rice was likely to be at the time the delivery was set to occur.

It was around this time when Hommma discovered many of the trading concepts he eventually ended up becoming famous for, including the candlestick patterns we all know and use in our trading today. The candlestick patterns he discovered formed the main basis of his trading strategy as they allowed him to see what the overall psychology of the people in market was, which gave him a big advantage over all the other traders in the market. No one knows exactly when Homma discovered candlestick patterns, but he had to have found them sometime before 1755, as in 1755 he released one of the first ever trading books, a book called “The Fountain Of Gold The Three Monkey Record Of Money” in which he spoke about how understanding the psychology of other traders was essential if one was to be successful trading the rice market. He only knew this because of the candlestick patterns he had found as they showed him the emotional state of the traders in the market.

Because Homma’s trading strategy was based on understanding the psychology of the traders in the market, it meant that he needed to see what the price of rice was each day so he could see whether the price action for that day had caused a candlestick pattern to form which jeopardized any of the positions he had open. The problem was that because there was no internet or phones available back in those days the only way to see what the market price of rice was for each day, was to actually go to the Osaka exchange itself and ask the rice merchant’s what the prices of rice were. This was impossible for Homma because he, along with his entire rice business was based in Sakata, and Sakata was a city almost 600 miles away from Osaka so travailing back and forth between the two each day was completely out of the question.

The ingenious method Homma came up with to get around this problem, was to establish a network of people every 6km from Sakata to Osaka to give him the prices of rice each day, so he didn’t have to make the trip all the way to Osaka himself to get the prices. This allowed Homma to monitor his trading positions from home to make sure no patterns appeared which could cause him to lose money.

Eventually Homma had become so successful trading the Osaka rice markets that the Japanese government ended up hiring him as their own financial aid. Later on in life Homma’s work with the government led the emperor of Japan to give him the honored title of samurai, one of the highest honers you could attain in Japan at the time, not bad for a guy who had started off as just a simple rice merchant.

The Creator Of Candlestick Charts

The thing which made Homma so successful, was the fact that he was the first trader to realize the reason price movements occurred in the rice market was not because of rational and logical decision making like most traders believed,  but because of traders making decisions based on emotions like fear and greed. Although nowadays this is quite a well known trading concept, back then it was a revelation and gave Homma a big advantage over his peers, as he could spot from his charts when they were in trouble on their trades and when they were likely to make an emotional decision regarding their position.

The way Homma was able to figure this all out was by constructing candlestick charts on parchment paper based off a days worth of price action in the rice market.

The only information he could use to draw these early candlestick charts, was the price at which the rice market had opened at that day, the highest and lowest prices it had managed to reach during the day, and finally the price the market was at when trading came to an end for that day. These four variables allowed Homma to create the very first candlestick charts in the history of trading. After a while of studying the charts, Homma began to notice that certain patterns formed right before the price of rice was about to change direction. Homma eventually realized the reason these patterns formed was because they were showing a change in the psychology of traders in the market. None of the other rice traders at the time knew this because they didn’t track rice prices using charts, so Homma using his patterns knew when a reversal was about to take place whereas the other rice traders didn’t, which of course gave him a big advantage over all the other rice traders.

Homma ended up finding many more patterns too, most of the candlestick patterns we know of today originate from him. He was the first one to really document all the different patterns and give definitions as to what their appearance signaled in the market. Were it not for him, then following and understanding what’s going on  in today markets would be very difficult.

Not only was Homma the first person to track financial markets using charts, he was also the first trader to realize markets move in trends.

Upon discovering the existence of candlestick patterns, Homma went back and analyzed the price movements of the rice market for the last 100 years to see how long these patterns had been forming for and if they had any kind of statistically validity in the market. What Homma found was that not only had the patterns he discovered been forming since the creation of the modern day rice market, but there had also been lots of times throughout history when the price of rice had spent an extended period of time rising and falling. He found this interesting and decided to create names to describe the times when the market had spent an overly long time rising or falling.

When the price of rice had been falling for a long time Homma said the market was in a Yin rotation, and when it had rising for a while he referred to it as being in a Yang rotation. Basically what he meant was if the rice market was in a Yin rotation it was in a downtrend and if it was in a Yang rotation it was in an uptrend. Homma also realized that within every Yin and Yang rotation was the opposite rotation. I.e during a Yin rotation ( downtrend ) there were times when a Yang rotation ( uptrend ) was taking place, and during a Yang rotation there were times when a Yin rotation was taking place.

Summary

It’s clear that without Homma’s discoveries trading would be very different to what it is today. Had he never decided to create candlestick charts to track the price action in the rice market we may never have used charts in our own trading, and had he never made the connection between the patterns he saw form on his charts to the psychology of the traders in the market, people might not have realized that markets move based on emotional decision-making instead rational decision-making.