Intro to Candlestick Patterns
5 Candlestick Patterns Every Trader Should Know
Introduction to Candlestick Patterns
Candlestick charts are a technical tool that groups data from multiple time frames into a single price bar. This makes them more useful than traditional open-high and close-low bars or simple lines connecting closing price points. Candlesticks build patterns that predict price direction once completed. Proper color coding adds depth to this colorful technical tool, which dates back to 18th-century Japanese rice traders.
Many traders can now identify dozens of these formations, which have colorful names such as bearish dark cloud cover, evening star, and three black crows. In addition, single-bar patterns, such as the doji, and hammer, have been incorporated into dozens of long- and short-term trading strategies.
The 5 most powerful candlestick patterns
Candlestick patterns, which are technical trading tools, have been used for centuries to predict price direction.
Several candlestick patterns are used to determine price direction and momentum, such as the three-line strike, two-black gapping, three-black crows, evening star, and abandoned baby.
However, it should be noted that many of the signals emitted by these candlestick patterns may not work reliably in the modern electronic environment.
Reliability of candlestick patterns
Not all candlestick patterns work equally well. Their enormous popularity has reduced reliability because they have been analyzed by hedge funds and their algorithms. These well-funded players rely on lightning-speed execution to trade against retail investors and traditional fund managers executing the technical analysis strategies found in popular texts.
In other words, hedge fund managers use computer programs to trap participants looking for high-risk bullish or bearish outcomes.
However, reliable patterns continue to emerge that allow for short- and long-term profit opportunities.
Below are five candlestick patterns that work exceptionally well as precursors of price direction and momentum. Each works in the context of the surrounding price bars to predict higher or lower prices.
They are also time-sensitive in two ways:
· They only work within the constraints of the chart being reviewed, whether intraday, daily, weekly or monthly.
· Their power diminishes rapidly three to five bars after the pattern is completed.
Candlestick performance
There are two types of expected pattern performance:
· Reversal - Candlestick reversal patterns predict a change in price direction.
· Continuation - Continuation patterns predict an extension in the current price direction.
In the following examples, the hollow white candlestick denotes a closing print higher than the opening, while the black candlestick denotes a closing print lower than the opening.
Three Line Strike
The three-line strike bullish reversal pattern sculpts three black candles within a downtrend. Each bar records a lower low and closes near the intrabar low. The fourth bar opens even lower but reverses into a wide-ranging outer bar that closes above the high of the first candle in the series. The opening trace also marks the low of the fourth bar. This reversal predicts higher prices with an 83% accuracy rate.
Two Black Gapping
The bearish two-black bar continuation pattern appears after a notable high in an uptrend, with a downward gap producing two black bars making lower lows. This pattern predicts that the decline will continue to even lower lows, which could trigger a larger-scale downtrend. This pattern predicts lower prices with a 68% accuracy rate.
Three Black Crows
The three black crows bearish pattern begins at or near the high of an uptrend, with three black bars recording lower lows that close near intrabar lows. This pattern predicts that the decline will continue to even lower lows, perhaps triggering a larger-scale downtrend. The most bearish version begins at a new high (point A on the chart) because it catches buyers entering momentum plays. This pattern predicts lower prices with a 78% accuracy rate.
Evening Star
The bearish evening star reversal pattern begins with a high white bar that takes an uptrend to a new high. A bullish gap up occurs on the next bar, but no new buyers appear, resulting in a narrow range candle. A downward gap on the third bar completes the pattern, which predicts that the decline will continue to even lower lows, perhaps triggering a larger-scale downtrend. This pattern predicts lower prices with an accuracy rate of 72%.
Abandoned Baby
The bullish abandoned baby reversal pattern appears at the low of a downtrend, after a series of black candlesticks prints lower lows. On the next bar, the market opens lower, but no new sellers appear, resulting in a narrow range doji candlestick with opening and closing prints at the same price. A bullish gap on the third bar completes the pattern, which predicts that the rally will continue to even higher highs, perhaps triggering a larger-scale uptrend. This pattern predicts higher prices with an accuracy rate of 49.73%.
Conclusion
Candlestick patterns capture the attention of market traders, but many reversal and continuation signals issued by these patterns do not work reliably in the modern electronic environment. Fortunately, statistics show unusual accuracy for a narrow selection of these patterns, offering traders actionable buy and sell signals.
Putting the knowledge gained from observing candlestick patterns into practice and investing in an asset-based on them would require a brokerage account. To save research time, they have compiled a list of the best online brokers so you can find the right broker for your investment needs.
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