The roots of candlestick charting are said to have been around since the 1850s, where it was invented by Japanese rice traders. While the iconic pattern has been shaped and refined since coming to the Western world in the early 1990s, it’s still a pattern whose basic principles of identifying price action, market fluctuation, and acknowledgment of information being wholly reflected in the price are prime movers behind the concept of technical analysis.
The Tricky Nature of Candlestick Chart Patterns
Candlestick chart patterns are not for everyone. In fact, they aren’t nearly as popular as they were when they made their initial splash, as their deconstruction via various algorithms and hedge funds have revealed them to move incredibly fast. Experts take advantage of this lightning speed to prey on slower participants that attempt to strike on bullish or bearish outcomes that manifest.
Nevertheless, for the technical analyst that has an equal measure of speed, mental fortitude, and good funds, utilizing a candlestick pattern can be the way to detect regular patterns that could translate into solid opportunities for short- and long-term profitability. For the investor seriously interested in mastering the ways of technical analysis, it may be worthwhile to dive into this Eastern-influenced method of chart interpretation.
The Different Types of Candlestick Chart Patterns
There are considered to be five candlestick patterns that perform very well regarding indicating price momentum and direction. Each of these patterns works with the context of surrounding price bars in predicting a stock’s price, both regarding higher and lower price. These patterns are also time sensitive, as they only work within the parameters of the chart; in other words, they aren’t for extrapolating data beyond the pattern. In fact, their potency will drop off sharply after the pattern is completed.
The five different candlestick chart patterns are as follows:
- Three Line Strike – This bullish reversal pattern pinpoints three black “candles” within a downtrend, with each candle trending lower than the previous one. The candle that forms next to the trio tends to dip down even lower than the third candle but ends up closing higher than the first candle in the trio.
- Two Black Gapping – This bearish pattern manifests itself after a clearly visible top in an uptrend is followed with a gap down that produces two black candles posting lower lows. This pattern predicates a continuing plunge to further declining lows. It could even predict a broader scale downtrend.
- Three Black Crows – In this bearish reversal pattern, the element worth paying attention to starts at or near an uptrend’s high mark, with a trio of black bars posting lower lose that close near intrabar lows. This is used to predict a decline that will dip to even lower lows, which could potentially trigger a wider scale downtrend. In the most bearish version of this pattern, the trends start at a new high because it sets a trap for buyers that choose to enter momentum plays.
- Evening Star – Another bearish pattern, this reversal pattern begins with a tall white bar that brings an uptrend to a new high. The market will gap higher on the following bar, but new buys will fail to manifest. This, in turn, will produce a narrow range candlestick. The pattern is finished off by a gap down on the third bar, and this completion predicts the decline will continue to trend lower, to the point of a wider scale downtrend may occur.
- Abandoned Baby – This somewhat morbidly-titled bullish reversal pattern will manifest itself at the low of a downtrend after a series of declining black candles. The market will gap lower on the following bar, but new sellers will not show up. This lack of manifestation produced a narrow range candlestick where the opening and closing price are equal. The pattern is completed with a bullish gap on the third candlestick. This pattern predicts a stock recovery that will shoot up to higher highs, with the potential of a wider scale uptrend.
Candlestick Charts and Colors
There is one crucial thing that an investor must bear in mind when deciphering candlestick charts in search of patterns. Unlike other chart patterns, the look of a candlestick chart can vary from broker to broker. Specifically, the color of the candles is not universally agreed upon.
Some brokers will color the candles black to indicate a downtrend, while others will use red. Furthermore, some brokers will shade up trending candles with a green hue, while others will fill them in with white. While this may not appear to be a huge deal in some cases – it may be able to spot certain uptrends or downtrends pretty easily if the market is wildly fluctuating – the color schemes may be the source of confusion if a chart pattern is showing signs of horizontal or sideways movement.
Fortunately, the length of the candlesticks’ “wicks” are universal. Regardless of candle color, the investor can scrutinize the wick length to determine the gap between the opening/closing price and the daily high/low of each stock.
Effective, but Not for Everyone
There is a certain skill that’s required to use candlestick charts effectively. On paper, these patterns look pretty clear cut. As such, they can easily capture the attention of fresh investors new to the world of technical analysis, because they may look like relatively easy-reading patterns to decipher.
However, candlestick chart patterns can move very fast, even in the context of the already-speedy world of technical analysis. The speed at which they travel makes them somewhat unreliable in a modern electronic environment, particularly to those that aren’t used to patterns traveling at high-speed. What’s more, savvy, well-funded traders that can operate in this “fast lane” can use their acumen to pounce on those that don’t?
The highest recommended course that I have found on candlesticks is by Steve Nison The Candlestick Course.
If you’re interested in jumping into the world of deciphering candlestick chart patterns, it’s advisable that you do so in a gradual, cautious manner. While they may look simple to read and follow, you may find that using them to maximize profitability and minimize loss is harder than it looks.