5 most powerful candlestick patterns

The candlestick chart is a technical tool that can pack data from multiple time frames into a single price bar. This makes them more useful than traditional high opening and low closing bars or simple lines connecting closing price points. The candlestick construction pattern, once completed, can predict the price direction. Correct color coding adds to the depth of this colorful technical tool, which can be traced back to Japanese rice traders in the 18th century.

Steve Nison brought the candlestick pattern to the Western world in the best-selling book “Japanese Candlestick Chart Techniques” published in 1991.Many traders can now recognize dozens of such patterns, which have colorful names such as bearish black cloud cover, evening star, and three black crows. In addition, single patterns including doji and hammer lines have been incorporated into dozens of long and short trading strategies.

Key points

  • The candlestick pattern is a technical trading tool that has been used to predict price direction for centuries.
  • There are a variety of candlestick patterns used to determine price direction and momentum, including three-line strikes, two black gaps, three black crows, evening stars, and abandoned babies.
  • However, it is worth noting that many of the signals emitted by these candlestick patterns may not work reliably in modern electronic environments.

Understanding the basic candlestick chart

Reliability of candlestick patterns

Not all candlestick patterns are equally effective. Their immense popularity reduces reliability because they have been analyzed by hedge funds and their algorithms. These well-funded participants rely on lightning-fast execution speeds to trade with retail investors and traditional fund managers who implement technical analysis strategies in popular texts.

In other words, hedge fund managers use software to lure participants looking for high-probability bullish or bearish outcomes. However, reliable models continue to emerge, allowing short- and long-term profit opportunities.

Here are five candlestick patterns that perform exceptionally well as precursors of price direction and momentum. Each works in the context of surrounding price bars to predict higher or lower prices. They are also time sensitive in two ways:

  1. They only work within the limits of the chart being reviewed, whether it is intraday, daily, weekly, or monthly.
  2. After the pattern is completed, their effectiveness will quickly drop by three to five bars.

Candlestick performance

This analysis relies on the work of Thomas Bulkowski, who established the performance ranking of candlestick patterns in his 2008 book “Encyclopedia of Candlestick Charts”.He provided statistics on the results of two expected models:

  1. Reversal-the candlestick reversal pattern predicts changes in price direction
  2. Continuation-The continuation mode predicts the extension of the current price direction.

In the following example, a hollow white candlestick indicates that the closing price is higher than the opening price, while a black candlestick indicates that the closing price is lower than the opening price.

Three-line blow

The bullish three-line strike reversal pattern has formed three negative lines in the downtrend. Each bar has a lower low and closes near the low in the bar. The fourth bar opened lower, but reversed in a large external bar, which closed above the high of the first candle in the series. The opening chart also marks the low of the fourth bar. According to Bulkowski, this reversal predicts higher prices with 83% accuracy.

Two black gaps

Two bearish black gap continuation patterns appear after the significant top in the uptrend, and the downward gap produces two lower lows with black bars. This pattern indicates that the decline will continue to fall to lower lows and may trigger a broader downtrend. According to Bulkowski, this model predicts lower prices with 68% accuracy.

Three black crows

The bearish three black crow reversal pattern starts at or near the high of the uptrend, and the lows of the three black bars are close to the lows within the bars. This pattern indicates that the decline will continue to fall to lower lows and may trigger a broader downtrend. The most bearish version starts with a new high (point A on the chart) because it entices buyers to enter the momentum game. According to Bulkowski, this model predicts lower prices with 78% accuracy.

Evening star

The bearish evening star reversal pattern starts with a tall white bar that pushes the uptrend to a new high. The market gapped higher at the next bar, but no new buyers appeared, resulting in a narrow candlestick. The downward gap of the third bar completes the pattern, indicating that the downtrend will continue to fall to lower lows, which may trigger a broader downtrend. According to Bulkowski, this model predicts lower prices with 72% accuracy.

Abandoned baby

The bullish abandoned baby reversal pattern appeared at the lows of the downtrend, after a series of black candles printed lower lows. The market gapped lower at the next bar, but no new sellers appeared, resulting in a narrow doji candlestick with the same opening and closing prices. The bullish gap on the third bar completes the pattern, which indicates that the recovery will continue to higher highs and may trigger a broader uptrend. According to Bulkowski, this model predicts higher prices with 49.73% accuracy.

Bottom line

Candlestick patterns attract the attention of market participants, but many reversal and continuation signals from these patterns are not reliable in the modern electronic environment. Fortunately, Thomas Bulkowski’s statistics show that a small selection of these patterns is extremely accurate and provides traders with actionable buy and sell signals.

Using the insights gained by viewing candlestick patterns to use and invest in assets based on them will require a brokerage account. To save some research time, InvestingClue has compiled a list of the best online brokers so that you can find a broker that suits your investment needs.

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