Part 10 Technical Analysis – Candle formations

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Part 10: Technical Analysis – Candle formations

In the previous Technical analysis article we talked a little bit about how to predict the future price movements based on the chart movements and created candle formations. (More about that here: Price formation)

The candle formations are not the only thing we should pay attention to though. We should also look at the size and shape of the individual candles. There are many candle types and their combinations. Sometimes the candle has a long knot, sometimes on the contrary it doesn’t have any. This is exactly what we’ll be talking about today.

Pinbar

How to recognize pinbar (click to zoom in)

Let’s start with the candle pinbar. It’s true that it’s not really a candle formation, because it’s made out of only one candle, but that doesn’t matter.

A pinbar (or a pin bar) is a candle with a very long knot and a smaller body on the other side of this knot. So, there is either a long high knot, and a bearish candle or vice versa.

This candle means that during the process the price has greatly increased, but even though at the end of the candle something happened that influenced the direction of the price development (i.e.: reaching an important line of resistance or support), so the price changed its mind and went the opposite direction. Now, we can predict that the price will indeed continue to move in this same direction.

2 PINBAR candles preview

Three line strike formation

This formation always includes 4 candles in a row. Three of them must be in the same direction and the fourth has to go the opposite way. Formation three line strike indicates the forthcoming trend reversal and works best in the time frame M15 and higher.

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This formation works best with the last candle being a pinbar type.

Preview of the THREE LINE STRIKE formation

Other candle formations

I think that two candle formations are enough for today. Would like to know more about candle formations? Share the article on social media and write in the comments below!

Author

More about the author Step

I’ve wanted to build a business of some kind and earn money since I was in middle school. I wasn’t very successful though until my senior year in highschool, when I finally started to think about doing online business. Nowadays I profitably trade binary options full-time and thus gladly share my experiences with you. More posts by this author

Part 16: Technical Analysis – Candlesticks Formations II.

In the previous episode of technical analysis (Part 10: Technical Analysis – Candle Formations), we described candlesticks formations, for example pin bar, and three line strike. Now it’s time to show you other candle formations. But first we need a bit of theory.

Trading candle formations

Trading candle formations is a type of trading using price action. That means trading strictly according to the price chart, i.e. without indicators. In this case we are using only price changes, candle shapes and candle positions – candle formations . When trading candle formations we also usually use trend lines – support and resistance lines.

Traders of price action consider that this is all that is needed for trading. According to them there is no need to use any indicators or other instruments, because they always just reflect what happened in the market in the past. Therefore they are useless and they only distract you from the real price and are unable to predict the future.

As a signal to open a trade position, we can use different candle formations from a chart (pattern and formations). We can map the actual situation on the market by price action analysis and by identifying quality patterns. Such pattern may provide us with a signal to open a position. If at the same time there are also other factors of the market which are in our favor, we can be sure that it is a very good quality signal.

Various candle formations

A few of formations that are formed during downtrend

There are dozens, maybe even hundreds of various candlesticks formations. I would even say that most of them are nonsense that people invented just to make something up. See the picture above, which summarizes a little what everything you can find in a chart. However, we will focus on the candle formations that make some sense.

Morning Star and Evening Star formation

One of the formations which I love, is called Morning star. The morning star formation is formed during a downtrend. Its exact opposite – Evening star – is formed during an uptrend. Whether it’s one or the other formation, it is always a signal that the price is going to turn.

How can you recognize these formations?

  • For the Morning Star:
    • 1. The downtrend is obvious.
    • 2. The body of the first candle is declining and it is relatively long. It is a continuation of the current downtrend.
    • 3. The third candle shows whether the price started to rise. This candle should close over the half of the first candle.
  • For the Evening Star:
    • 1. The uptrend is obvious.
    • 2. The body of the first candle is rising and it is continuation of the current uptrend.
    • 3- The third candle shows whether the price turned. This candle should close under the half of the first candle.

I’m not going to describe it too much, we can directly check out some examples in the charts and in the real world of trading. BTW if you want a cool article about it, check out candle formations strategies.

Morning Star and Evening Star candle formations

In both examples above you can see lines that help to distinguish when the trend reversal could happen. These lines are of course part of out successful strategy BERSI Scalp.

Do you want to know more about that strategy? Go to: http://bersistrategy.com.

Piercing Pattern formation

This formation can be used for the confirmation of the rotation. Although this is initially the downtrend reversal pattern, it is possible to use this candle formation also vice versa. Piercing pattern formation is very well shown in the video below, but for any case I am also going to describe it.

A video by IQ Option

  • After a series of several (at least 5) consecutive candles going in the same direction we will focus on a series of candles going in the opposite direction. If in the second series we find at least three candles going in the opposite direction, we can invest on the rotation.
  • This formation is even stronger when the price bounces back from, for example, a supporting line. On the other side you have to be careful that it is not just a throwback.

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Author

More about the author Step

I’ve wanted to build a business of some kind and earn money since I was in middle school. I wasn’t very successful though until my senior year in highschool, when I finally started to think about doing online business. Nowadays I profitably trade binary options full-time and thus gladly share my experiences with you. More posts by this author

One Response to “Part 16: Technical Analysis – Candlesticks Formations II.”

This is my first time reading your article and I like it.

The 5 Most Powerful Candlestick Patterns

Candlestick charts are a technical tool that packs data for multiple time frames into single price bars. This makes them more useful than traditional open-high, low-close bars or simple lines that connect the dots of closing prices. Candlesticks build patterns that predict price direction once completed. Proper color coding adds depth to this colorful technical tool, which dates back to 18th-century Japanese rice traders.

Steve Nison brought candlestick patterns to the Western world in his popular 1991 book, “Japanese Candlestick Charting Techniques.”   Many traders can now identify dozens of these formations, which have colorful names like bearish dark cloud cover, evening star and three black crows. In addition, single bar patterns including the doji and hammer have been incorporated into dozens of long- and short-side trading strategies.

Key Takeaways

  • Candlestick patterns, which are technical trading tools, have been used for centuries to predict price direction.
  • There are various candlestick patterns used to determine price direction and momentum, including three line strike, two black gapping, three black crows, evening star, and abandoned baby.
  • However, it’s worth noting that many signals emitted by these candlestick patterns might not work reliably in the modern electronic environment.

Candlestick Pattern Reliability

Not all candlestick patterns work equally well. Their huge popularity has lowered reliability because they’ve been deconstructed by hedge funds and their algorithms. These well-funded players rely on lightning-speed execution to trade against retail investors and traditional fund managers who execute technical analysis strategies found in popular texts.

In other words, hedge fund managers use software to trap participants looking for high-odds bullish or bearish outcomes. However, reliable patterns continue to appear, allowing for short- and long-term profit opportunities.

Here are five candlestick patterns that perform exceptionally well as precursors of price direction and momentum. Each works within the context of surrounding price bars in predicting higher or lower prices. They are also time sensitive in two ways:

  1. they only work within the limitations of the chart being reviewed, whether intraday, daily, weekly or monthly.
  2. their potency decreases rapidly three to five bars after the pattern has completed.

Top 5 Candlestick Patterns

This analysis relies on the work of Thomas Bulkowski, who built performance rankings for candlestick patterns in his 2008 book, “Encyclopedia of Candlestick Charts.”   He offers statistics for two kinds of expected pattern outcomes:

  1. reversal – Candlestick reversal patterns predict a change in price direction
  2. continuation – while continuation patterns predict an extension in the current price direction.

In the following examples, the hollow white candlestick denotes a closing print higher than the opening print, while the black candlestick denotes a closing print lower than the opening print.

  • Three Line Strike

The bullish three line strike reversal pattern carves out three black candles within a downtrend.   Each bar posts a lower low and closes near the intrabar low. The fourth bar opens even lower but reverses in a wide-range outside bar that closes above the high of the first candle in the series. The opening print also marks the low of the fourth bar. According to Bulkowski, this reversal predicts higher prices with an 84% accuracy rate. 

  • Two Black Gapping

The bearish two black gapping continuation pattern appears after a notable top in an uptrend, with a gap down that yields two black bars posting lower lows.   This pattern predicts that the decline will continue to even lower lows, perhaps triggering a broader-scale downtrend. According to Bulkowski, this pattern predicts lower prices with a 68% accuracy rate. 

  • Three Black Crows

The bearish three black crows reversal pattern starts at or near the high of an uptrend, with three black bars posting lower lows that close near intrabar lows. This pattern predicts that the decline will continue to even lower lows, perhaps triggering a broader-scale downtrend. The most bearish version starts at a new high (point A on the chart) because it traps buyers entering momentum plays. According to Bulkowski, this pattern predicts lower prices with a 78% accuracy rate. 

  • Evening Star

The bearish evening star reversal pattern starts with a tall white bar that carries an uptrend to a new high.   The market gaps higher on the next bar, but fresh buyers fail to appear, yielding a narrow range candlestick. A gap down on the third bar completes the pattern, which predicts that the decline will continue to even lower lows, perhaps triggering a broader-scale downtrend. According to Bulkowski, this pattern predicts lower prices with a 72% accuracy rate. 

  • Abandoned Baby

The bullish abandoned baby reversal pattern appears at the low of a downtrend, after a series of black candles print lower lows.   The market gaps lower on the next bar, but fresh sellers fail to appear, yielding a narrow range doji candlestick with opening and closing prints at the same price. A bullish gap on the third bar completes the pattern, which predicts that the recovery will continue to even higher highs, perhaps triggering a broader-scale uptrend. According to Bulkowski, this pattern predicts higher prices with a 70% accuracy rate. 

The Bottom Line

Candlestick patterns capture the attention of market players, but many reversal and continuation signals emitted by these patterns don’t work reliably in the modern electronic environment. Fortunately, statistics by Thomas Bulkowski show unusual accuracy for a narrow selection of these patterns, offering traders actionable buy and sell signals.

Putting the insights gained from looking at candlestick patterns to use and investing in an asset based on them would require a brokerage account. To save some research time, Investopedia has put together a list of the best online brokers so you can find the right broker for your investment needs.

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