A specialized technique known as a candlestick chart condenses data from many periods into a single price bar. They are thus more valuable than conventional open-high, low-close bars or straight lines that link closing prices. Candlestick patterns forecast price movement. This colorful technical instrument, which goes back to Japanese rice merchants in the 18th century, is made more interesting by proper color coding.
In his well-known 1991 book, Japanese Candlestick Charting Techniques, Steve Nison introduced candlestick patterns to the West. These patterns, which go by colorful names like bearish dark cloud cover, evening star, and three black crows, are now well recognized by traders. Numerous long- and short-side trading systems have also used single bar patterns like the Doji and hammer.
Reliable Candlestick Patterns
Not every candlestick pattern performs as well as others. Because of the algorithms used by hedge funds to examine them, their enormous popularity has reduced their dependability. These well-funded players compete with regular investors and conventional fund managers using technical analysis tactics from well-known literature with lightning-fast execution.
In other words, hedge fund managers use algorithms to lure in traders seeking outcomes with high probabilities of being bullish or negative. Nevertheless, consistent patterns keep emerging, providing both short- and long-term profit potential.
Following are five candlestick patterns that excel in predicting price direction and momentum. Each one functions to forecast higher or lower prices in the context of neighboring price bars. They also have two time-sensitive aspects:
- Whether an intraday, daily, weekly, or monthly chart is being examined, it can only operate inside its parameters.
- Their power quickly declines three to five bars after the pattern is finished.
Performance of Candlestick
In his 2008 book, “Encyclopedia of Candlestick Charts,” Thomas Bulkowski created performance rankings for candlestick patterns used in this research.
He provides data for two categories of anticipated pattern outcomes:
- Reversal Candlestick patterns foretell a shift in price movement.
- Continuation patterns indicate that the present price trend will continue.
The black candlestick in the images below indicates a closing print lower than the opening print. In contrast, the hollow white candlestick indicates a closing print higher than the beginning print.
STRIKES IN 3 LINES
The bullish three-line strike reversal pattern forms three black candles inside a downtrend. The intrabar low is reached by each bar, which also records a lower low. Although the fourth bar reverses in a wide-range outer bar that closes above the high of the series’ opening candle, it opens significantly lower. The opening print likewise indicates the low of the fourth bar. Bulkowski estimates that this reversal has an 83 percent accuracy rate in predicting rising prices.
2 BLACK GAPPING
After a significant uptrend peak, the bearish two-black gapping continuation pattern develops, with a gap down that results in two black bars with lower lows. According to this pattern, the drop will likely continue to even lower lows before beginning to decline on a larger scale. Bulkowski claims this pattern has a 68 percent accuracy rate in predicting decreased pricing.
THREE CROWS IN BLACK
Three black bars with lower lows close to intrabar lows form the bearish three black crows reversal pattern, which begins at or around an uptrend’s top. According to this pattern, the drop will likely continue to even lower lows before beginning to decline on a larger scale. To prevent buyers from initiating momentum plays, the most bearish variant begins at a new high (point A on the chart). Bulkowski claims this pattern has a 78 percent accuracy rate in predicting decreased pricing.
A towering white bar that leads an uptrend to a new high serves as the foundation for the bearish evening star reversal pattern. The following bar sees the market gap higher, but no new buyers show up, resulting in a candlestick with a restricted range. The pattern is completed by a gap down on the third bar and foretells that the slide will go on to even lower lows, perhaps igniting a larger-scale downturn. Bulkowski claims this pattern has a 72% accuracy rate in predicting decreased pricing.
The bullish abandoned baby reversal pattern develops at the bottom of a downtrend after a string of black candles that have printed lower lows. The market gaps are lower on the subsequent bar, but no new sellers materialize, resulting in a narrow range doji candlestick with identical starting and closing price prints. The pattern is finished by a bullish gap on the third bar, which foretells that the recovery will go on to even higher highs, perhaps igniting a larger-scale upswing. This pattern accurately forecasts increased prices by 49.73 percent, according to Bulkowski.
How Accurate Is Trading With Candlesticks?
Candlestick trading may be dependable, but the Candlestick patterns shown shouldn’t be taken as definitive directional movement indications. The candles are just trailing indications of market conditions as timeframes change and consolidate as each candle’s period lengthens. As a result, all the knowledge learned from reading candlesticks is outdated, and basing bets on patterns on hypothetical price movement based on historical patterns and other indicators is risky. The relative strength index (RSI) and moving average convergence divergence are two standard supplemental trading tools (MACD).
How Are Candlesticks Read?
Candlestick reading is relatively easy. Each candle’s height is defined by its opening and closing prices for the period it symbolizes (typically 15 minutes, 30 minutes, one hour, four hours, one day, one week, and one month). Each candle’s wick or tail and the single line above and below the box show the candle’s peak and lowest prices, but not its closing price. Said, this is the highest position that the candle has ever reached. The price closed lower if the body is solid, black, or red. White or green candles that are hollow indicate that the price closed higher than it did at the beginning of the candle.
How Many Different Candlestick Patterns Exist?
Depending on who is asking, the response will change. While conservative traders who only trade on the most well-known patterns would claim there are approximately 25, some who concentrate on less common candlestick patterns may claim over 50. The spectrum of candlestick designs generally acknowledged is between 35 and 42.
Market participants are drawn to candlestick patterns, but many of the reversal and continuation signals that these patterns emanate don’t consistently function in the current technological world. Thankfully, data from Thomas Bulkowski demonstrates extraordinary accuracy for a small subset of these patterns, providing traders with helpful buy and sell recommendations.