Overview Of Candlestick Patterns
In financial technical analysis, a candlestick pattern is a movement in prices shown graphically on a candlestick chart that some believe can predict a particular market movement. The recognition of the pattern is subjective and programs that are used for charting have to rely on predefined rules to match the pattern. There are 42 recognised patterns that can be split into simple and complex patterns.
Before reading this guide, you might want to check our charts and bar styles guide. If you know already how to read the Japanese candlestick charts, you can proceed with the guide right away.
Please note that the majority of candlestick patterns are not reliable. Our team at AlgoStorm.com only use the Inverted Hammer and the Three Line Strike patterns from all known 42 patterns. Based on our research which is conducted on the daily time-frame, these are the only two patterns that give passable results. Further more, we found that using candlestick patterns on the high timeframes (e.g. 12 hours, daily, or weekly), is more reliable than on the low timeframes.
Additionally, it is vital to note that bullish candlestick patterns tend to produce better results than bearish candlestick patterns. Generally, candlestick patterns should never be used by themselves but rather combined with other forms of technical analysis like technical indicators, volume analysis, order book analysis, and footprint analysis.
This guide will only explain the two patterns that our team uses instead of listing all known patterns. We will provide though a cheat sheet at the end of this guide if you like to view all other popular patterns.
How To Use Candlestick Patterns
There are countless candlestick patterns that traders can use to identify areas of interest on a chart. These can be used for day trading, swing trading, and even longer-term position trading. While some candlestick patterns may provide insights into the balance between buyers and sellers, others may indicate a reversal, continuation, or indecision.
It’s important to note that candlestick patterns are not buy or sell signal by themselves. They are merely a way to look at market structure and a potential indication of an upcoming opportunity. As such, it is always useful to look at patterns in context. This can be the context of the technical pattern on the chart, but also the broader market environment and other factors.
In short, like any other market analysis tool, candlestick patterns are most useful when used in combination with other techniques. These may include the Wyckoff Method, technical indicators, order book analysis, footprint analysis, or on-chain analysis (in case of Crypto trading).
The Inverted Hammer Pattern
Also called the inverse hammer, it’s just like a hammer, but with a long wick above the body rather than below. Similar to a hammer, the upper wick should be at least twice the size of the body.
An inverted hammer occurs at the bottom of a downtrend and may indicate a potential reversal upward. The upper wick shows that price stopped its continued downward movement, even though the sellers eventually managed to drive it down near the open. As such, the inverted hammer may suggest that buyers soon might gain control of the market.
The Three Line Strike Pattern
A three line strike is a continuation group of candlesticks that has three in the direction of a trend followed by a final candle that pulls back to the start point. Traders use the three line strike as an opportunity to buy at a recent trend low or sell at a recent high.
Bullish Three Line Strike Pattern
The bullish three line strike is made up of three strong bullish candles that close progressively higher followed by a final “strike” candle. The strike candle is bearish and opens at or higher than the third candle but closes at least below the open of the first candle.
Bearish Three Line Strike Pattern
A bearish three line strike is the reverse with three strong falling candles that close increasingly lower followed by a single bullish strike candle. The strike candle should open at or lower than the close of the third candle and close above the open of the first candle.
Validating The Three Line Strike Pattern
For a valid pattern, confirm that the first three candles have full bodies, and are at least of average size. They should have a defined stair-case like appearance. Patterns made up of doji and significantly smaller candles may not be as reliable.