Analyzing Candlestick Patterns

In this post, we’re looking at how candlestick patterns can be used to predict future price movement.

Throughout history, humans have used patterns to make sense of the current environment and to make predictions for the future. Our ability to recognize all types of patterns has been essential for our learning process and capacity to make decisions.

But here’s the catch, sometimes the patterns are real, other times they’re just a result of chance. Therefore, constantly looking for patterns can also lead to seeing things that really aren’t there. Still, identifying patterns, even if they’re not real, is generally better than ignoring legitimate patterns. In evolutionary terms, the better choice has been to go with False Positives, not False Negatives. That is also why our brains, along with those of our fellow species, have developed into pattern detecting machines.

Trend Continuation Patterns vs. Trend Reversal Patterns

A candlestick pattern typically consists of one or several candlesticks. The various patterns can be used to predict price reversals or price continuation. The patterns are typically analyzed on time based charts, determining that very little price action occurred on one candle, followed by a lot of activity in the next. Therefore, candlestick patterns are predominantly used on minute and daily bars. An approach for trading candlestick reversal patterns at key support / resistance levels was discussed in a webinar hosted by NinjaTrader. Recording available here:

In a second webinar, we looked at how to align continuation patterns with FastStoch turning points. This presentation was hosted by SharkIndicators and focused on how mechanical trading rules may be used to determine a statistical edge.

The take-away from both presentations was an approach for validating trading ideas. Whatever the observation, a candlestick pattern or sequence of events, you’ll want to establish a cause / effect relationship between the entry point and what happened immediately afterwards. Tutorials on the concepts discussed in the SharkIndicator presentation available here:

More information on the Candlestick Pattern indicator available here.