This publication aims to help fulfil the mission of “Applications In Life” Fondation to support and develop accessible and understandable financial education by improving financial culture and forward-thinking mentality of the civil society.
Candlestick charts are a technical tool that packs data for multiple time frames into single price bands. This makes them more useful than traditional high-opening, low-closing bars or simple lines that connect closing price points. Candlesticks build models that predict the direction of the price once they are completed. Proper color coding adds depth to this colorful technical tool that dates back to Japanese rice merchants of the 18th century.
Steve Neeson brought candlestick models to the Western world in his popular 1991 book, Japanese Candlestick Mapping Techniques. Many traders can now identify dozens of these formations that have colorful names such as bearish dark cloud, evening star and three black crows. In addition, single-bar models, including doji and hammer, are included in dozens of long and short side trading strategies.
Candlestick pattern reliability
Not all candlestick models work equally well. Their huge popularity has lowered reliability as they have been analyzed by hedge funds and their algorithms. These well-funded players rely on lightning-fast performance to trade against retail investors and traditional fund managers who implement technical analysis strategies found in popular texts.
In other words, hedge fund managers use software to capture participants looking for high odds for bullish or bearish results. However, reliable models continue to emerge that allow for short-term and long-term profit opportunities.
Here are five models of candlesticks that perform extremely well as precursors to the direction of price and momentum. Everyone works in the context of the surrounding price bars in forecasting higher or lower prices. They are also sensitive to time in two ways:
- They shall operate only within the limits of the schedule under review, whether during the day, daily, weekly or monthly.
- Their potency decreases rapidly three to five cycles after completion of the model.
This analysis relies on the work of Thomas Bulkowski, who built a performance ranking for candlestick models in his 2008 book, The Encyclopedia of Candlestick Diagrams. It offers statistics for two types of expected results from the model:
1. Inversion – Candlestick inversion patterns predict a change in price direction.
2. Continuation – Continuation patterns predict an extension in the direction of the current price.
In the following examples, the hollow white candlestick means a closing imprint higher than the initial imprint, while the black candlestick means a closing imprint lower than the initial imprint.
Three line strike
The bullish three-line inversion pattern cuts three black candles in a downward trend. Each bar publishes a lower bottom and closes near the inner bottom. The fourth bar opens even lower, but turns into a wide outer bar that closes above the maximum of the first candle in the series. The opening fingerprint also marks the bottom of the fourth bar. According to Bulkowski, this reversal predicts higher prices with 83% accuracy.
Two black gapping
The continuing pattern of bearish two black gaps appears after a remarkable peak in an upward trend, with a gap down, giving two black bands posting lower bottoms. This model predicts that the decline will continue to even lower levels, which may cause a larger downward trend. According to Bulkowski, this model predicts lower prices with an accuracy of 68%.
Three black crows
The bearish pattern of turning three black crows starts at or near the top of an uptrend, with three black bands posting lower bottoms that close near the lowest levels within the bar. This model predicts that the decline will continue to even lower levels, which may cause a larger downward trend. The lowest version starts from a new peak (point A on the chart) because it captures buyers entering inertial games. According to Bulkowski, this model predicts lower prices with an accuracy of 78%.
The model for turning the bear’s evening star begins with a tall white bar, which brings an upward trend to a new peak. Market gaps are higher at the next bar, but new buyers do not appear, leading to a candlestick with a narrow range. The gap down the third band complements the model, which predicts that the decline will continue to even lower levels, which may cause a larger downward trend. According to Bulkowski, this model predicts lower prices with an accuracy of 72%.
The bullish reversal pattern of abandoned baby appears at the bottom of a downtrend after a series of black candles print lower bottoms. Market gaps diminish at the next bar, but new sellers do not appear, resulting in a narrow range of doji candlestick with fingerprints to open and close at the same price. An upward difference in the third band complements the model, which predicts that the recovery will continue to even higher peaks, perhaps triggering a larger uptrend. According to Bulkowski, this model predicts higher prices by 49.73%
The bottom line
Candlestick models attract the attention of market players, but many signals of reversal and continuation emitted by these models do not work reliably in today’s electronic environment. Fortunately, Thomas Bulkowski’s statistics show unusual accuracy for a narrow selection of these models, offering retailers valid signals to buy and sell.
Using the insights gained from looking at candlestick models and investing in an asset based on them will require a brokerage account.
Disclaimer: The publications on this platform aim to provide useful information on financial topics. But they are NOT financial consultation or advice. Therefore they should not be used as a recommendation for making an investment decision on any type of financial products and services. We use in-depth research in the field but do not guarantee the completeness of the published materials. Always consult a specialist in your particular situation. "Applications In Life" Foundation is not responsible for any adverse consequences resulting from actions taken based on the information provided on the platform.