Candlestick charts combine data from multiple time frames and combine them into a single price bar. They are therefore more useful as compared to traditional open-high, low-close bars (OHLC) or lines connecting the dots of a closing price. Candlestick pattern can be used to predict price direction and in most cases are usually color-coded to make them more reliable in predicting price direction.
Candlestick patterns are credited to Steve Nison who introduced it to the Western world via his famous 1991 book “Japanese Candlestick Charting Techniques.” To date, candlestick patterns have developed to different formations including bearish dark cloud cover, evening star and three black crows. Additionally, single bar patterns such as doji and hammer have been used in long-and short-side trading strategies.
Reliability of Candlestick Patterns
Candlestick patterns do not function equally in predicting price direction since hedge funds and their algorithms have influenced their reliability. The reliability of candlestick patterns mostly relies on technical analysis strategies to establish high-odds bullish or bearish outcomes which have been established to provide short-and long-term profit opportunities. Nevertheless, five candlestick patterns are highly reliable in predicting price direction and momentum. These candlestick patterns collaborate with the surrounding price bars to predict higher or lower prices. Additionally, they are time sensitive as they only work within the limitations of the chart being analyzed and their potency decreases with the completion of the pattern.
Top 5 Candlestick Trading Patterns
Candlestick patterns are broadly grouped into reversal and continuation patterns. Candlestick reversal patterns predict a change in price direction, while continuation patterns predict an extension in the current price direction. Below are top five candlestick patterns.
1. Three Line Strike
The bullish three-line strike reversal pattern constitutes of three black candles within a downtrend. The bars display lower lows with each closing near the intrabar low. The fourth bar opens at an even lower level but reverses in a wide-range outside bar that has closed above the high of the first candle in the series. The fourth bar low is marked by the opening of the print. The tree-line strike has an 84% accuracy in predicting price rise.
2. Two Black Gapping
The two black gapping is a bearish pattern which appears after a prominent top in an uptrend, with a gap down yielding two black bar displaying lower lows. Tow black gapping pattern is used to predict the continuation of price decline even at lower lows even triggering a massive downtrend. This pattern is 68% accurate in predicting lower prices.
3. Three Black Crows
The three black crows is also a bearish reversal pattern that is formed at the start or near the high of an uptrend. The three black bars post lower lows closing near intrabar lows. This pattern predicts a continued decline to even lower lows, with a high probability of prompting a prolonged downtrend. This pattern is 78% in predicting lower prices.
4. Evening Star
The evening star is a bearish reversal pattern which commences with a tall white bar that leads an uptrend to a new high. A narrow range candlestick is formed due to the lack of fresh buyers with higher market gaps on the next bar. The pattern is completed by a gap down on the third bar. This pattern predicts a continuous decline to even lower lows even triggering a broader-scale downtrend. This pattern is 72% in predicting lower prices.
5. Abandoned Baby
The abandoned baby is a bearish reversal pattern that appears at the low of a downtrend following a series of black candles print lower lows. A narrow range doji candlestick is formed from low market gaps on the next bar with lack of sellers. The pattern is completed by a bullish gap on the third bar. This pattern predicts a continuation of recovery to even higher highs even triggering a prolonged uptrend. IT’s 70% accurate in predicting higher prices.
While traders prefer candlestick patterns in predicting price direction, most reversal and continuation patterns are not reliable in predicting price direction in modern trading systems. Nevertheless, the five patterns discussed above are at least reliable and offer traders actionable buy and sell signals.