6/18/2019 The 5 Most Powerful Candlestick Patterns

TECHNICAL ANALYSIS TECHNICAL ANALYSIS BASIC EDUCATION

The 5 Most Powerful Candlestick Patterns

BY ALAN FARLEY | Updated Jan 18, 2019

Candlestick charts are a technical tool that pack data for multiple time frames into single price
bars. This makes them more useful than traditional open-high, low-close bars (OHLC) 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.

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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. 

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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.

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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. First, they only work within the
limitations of the chart being reviewed, whether intraday, daily, weekly or monthly. Second,
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: reversal and continuation. Candlestick reversal
patterns predict a change in price direction, 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.

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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
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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

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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

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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

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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

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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.
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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
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Related Terms
Candlestick
A candlestick is a type of price chart that displays the high, low, open, and closing prices of a security for a
specific period and originated from Japan. more

Bearish Abandoned Baby

A bearish abandoned baby is a type of candlestick pattern identified by traders to signal a reversal in the
current uptrend. more

Bullish Abandoned Baby Definition and Strategy

The bullish abandoned baby is a type of candlestick pattern that is used by traders to signal a reversal of
a downtrend. It is rare but can be powerful. more
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Understanding Three Black Crows, What It Means, and Its Limitations

Three black crows is a bearish candlestick pattern that is used to predict the reversal of the current
uptrend. more

Upside Gap Two Crows

Upside gap two crows is a bearish market reversal signal in technical analysis. more

Three White Soldiers

Three white soldiers is a bullish candlestick pattern that is used to predict the reversal of a downtrend.
more

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