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Candlestick charts are an analytical technique that transforms data into single price bars over multiple time frames. It makes them more valuable than conventional open-high, low-close bars or lines that link the closing price points. When charted, candlesticks generate trends that forecast price action. Proper color codes add depth to this technical tool first built by Japanese rice traders in the 18th century.
In his popular 1991 book, the "Japanese candlestick charting techniques," Steve Nison brought candlestick patterns to the west. Now, many traders have the opportunity to identify dozens of these patterns, with names such as harami, spinning top, and three white soldiers. Single bar styles, including the Doji and the hammer, were integrated into hundreds of trading strategies in both long and short strategies.
Not all types of candlesticks work really well. Their immense success has diminished efficiency, as hedge funds and their algorithms have deconstructed them. Many well-funded companies rely on high-speed execution to compete against retail investors and conventional fund managers who execute strategies from technical analysis found in traditional texts.
In other terms, operators of hedge funds employ algorithms to manipulate investors looking for bullish or bearish scenarios at high odds. Reliable trends continue to appear, however, creating incentives for the short and long-term.
Here are five examples of candlesticks doing extremely well as price guidance and momentum predictors. Each works in predicting higher or lower prices in the context of surrounding price bars. They are adaptive to time in two respects. First, they operate only in the boundaries of the chart, whether intraday, daily, weekly or monthly. Second, after completion of the pattern, their effectiveness declines steadily after three to five bars.
Top 5 Patterns
The study is based on the work of Thomas Bulkowski, who in his 2008 book, "Candlestick Charts Encyclopedia," created output rankings for candlestick patterns. He gives figures for two kinds of predicted trend results: reversal and continuation Candlestick reversal trends forecast price changes, while continuation patterns expect an extension of the current price path.
The hollow white candlestick corresponds to a closing print higher than the opening print in the following examples, whereas the black candlestick refers to a closing print lower than the opening print.
Three Line Strike
The reversal pattern of the bullish three-line strike throws out three black candles in a downtrend. Each bar is lower and closes close to the bottom of the intraday candle. The fourth bar opens much lower but reverses in a wide-range closing above the top of the series first high. The first print of the fourth candle should mark the bottom of the fourth candle. This reversal forecasts higher prices with an accuracy rate of 84 percent, according to Bulkowski.
Two Black Gapping
After a remarkable peak in an uptrend, the bearish two black gapping reversal pattern emerges, with a gap down which generates two black candles with lower lows. This trend suggests the downturn will continue lower, possibly triggering a broader downward trend. This pattern forecasts lower prices with an accuracy rate of 68 percent, according to Bulkowski.
Three Black Crows
The bearish three black crows reversal pattern begins at an uptrend's peak, with three black bars marking lower lows closing close to intrabar lows. This pattern suggests the fall will possibly trigger a larger downtrend. The most bearish iteration begins at a new high as it traps investors into pursuing momentum. This model forecasts lower prices with an accuracy rate of 78 percent, according to Bulkowski.
The reversal sequence of the bearish evening star begins with a tall white bar bringing an uptrend to new highs. The market gaps up, but fresh investors do not emerge, resulting in a candlestick with a narrow range. A break down on the third bar completes the sequence, suggesting that the downturn may continue lower, triggering a downtrend on a broader scale. This model forecasts lower prices with an accuracy rate of 72 percent, according to Bulkowski.
Following a series of candles printing lower highs, the bullish abandoned baby reversal pattern emerges at the bottom of a downtrend. A small market gap occurs, but fresh sellers do not emerge, resulting in a small Doji candlestick. A gap up on the third candle suggesting the turnaround would proceed to be even bigger, potentially causing a larger uptrend. This model forecasts higher prices with a precision rate of 70 percent, according to Bulkowski. The bearish abandoned baby forecasts lower prices with a rate of 69%.
Chart patterns catch market players ' interest, but many reversal and continuation signals generated in the current electronic trading environment do not perform reliably. Luckily, Thomas Bulkowski's statistics show extraordinary precision for a narrow set of these trends, enabling traders to buy and sell on these indications.
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