Candlestick Patterns, an Introduction

The internet is chocked full of blogs, sites and training courses that include a popular approach to market analysis using candlestick patterns.  For those of you who don’t know already, candlestick pattern usage in trading attempts to look at a particular type of candle or group of candles and make a prediction on where the instrument may head after this given formation.  They have catchy names like “gravestone doji”, “hanging man”, and “shooting star” just to name a few of the myriad out there. The problem is, when you go out and look for these formations in the real world of chart analysis, they don’t always seem to work as advertised.  So are they useful or not? Answer – It depends on HOW you use them!

Here are some tips for getting those well-talked about candlestick patterns into information you can use in your trading decisions:

Take The Long View on Candlestick Patterns

Although candlestick patterns theoretically should work on any timeframe, from my experience they only consistently provide useful information on the bigger time frames like daily and above.  By focusing on higher time frames, you will find the candlestick patterns more relevant and with greater consistency in the information they provide.

Go With What You Know

Instead of trying to memorize 30 different candlestick patterns and then attempt to recall them all in a live market, select 2-5 key patterns and only focus on those. One the most important components of understanding how to use candlestick patterns are understanding the relationship of a bar’s “tail” or “wick” (sometimes called the “shadow”) to the body of the candlestick.  This situation is true whether you are using standard minute based candlesticks or the IW’s Mean Renko Bars. Here are some videos of the most popular patterns:  

• Doji – best for identifying potential reversals
• Engulfing – useful for anticipating the strength of a reversal
• Hammer – useful for determining a breakout after consolidation (indecision phase)

When you have less to look for, you will likely find more of them and be stricter on their usage.

The Past Impacts The Present

Rather than only finding candlestick patterns that appear at “random,” try to locate candlestick patterns AFTER an established move in one direction or another.  It makes no sense to put too much stock into a reversal candle if the price is moving sideways.  It makes much more sense to find a significant reversal candle after a move has occurred, and henceforth, can be reversed.

It’s STILL About Support And Resistance

By continuing to view the market from its structural makeup around support and resistance, we can use candlestick patterns to confirm a reversal or breakout against or through a significant support and resistance area.  For example, it makes no sense to put faith in a reversal formation if a breakout has just occurred, and likewise makes no sense in looking for a continuation formation if the price has dramatically failed at a Support and Resistance point.

Use ALL Your Tools

Don’t depend on candlestick patterns by themselves to make trading decisions.  Just as you cannot build a house (or a birdhouse for that matter) by using one tool, great trades are not the result of any single piece of information. Use candlestick patterns to complement or confirm trading decisions based on your full use of many or all of the methods available to find a trade. Hopefully, by following these tips, you can turn those once elaborate candlestick patterns into actionable and usable trading information.  Remember that like anything else in the trading world; they are not going to work 100% of the time so just because they don’t create a winning trade the first time you use them, doesn’t mean they don’t hold value.  By using all your abilities and methods together in a synergistic way, you will surely find a place for candlestick patterns in your trading toolkit.