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TECHNICAL ANALYSIS TECHNICAL ANALYSIS BASIC EDUCATION

Guide to
Technical
Analysis
The 5 Most Powerful
KEY TECHNICAL ANALYSIS Candlestick Patterns
CONCEPTS

GETTING STARTED WITH

TECHNICAL ANALYSIS

By ALAN FARLEY | Updated Jan 7, 2021

ESSENTIAL TECHNICAL ANALYSIS
STRATEGIES
TABLE OF CONTENTS

TECHNICAL ANALYSIS PATTERNS Candlestick Pattern Reliability Candlestick Performance

Three Line Strike Two Black Gapping
Introduction to Technical Analysis
Price Patterns Three Black Crows Evening Star
5 Most Powerful Candlestick Abandoned Baby The Bottom Line
Patterns

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

Triple Tops and Bottoms

Steve Nison brought candlestick patterns to the Western world in his popular 1991
book, "Japanese Candlestick Charting Techniques." [1] Many traders can now
Head And Shoulders Pattern
identify dozens of these formations, which have colorful names like bearish dark
How to Trade the Head and
cloud cover, evening star and three black crows. In addition, single bar patterns
Shoulders Pattern
including the doji and hammer have been incorporated into dozens of long- and
Flag
short-side trading strategies. 
Pennant

Triangle
KEY TAKEAWAYS
Wedge
Candlestick patterns, which are technical trading tools, have been used
Cup and Handle Pattern
for centuries to predict price direction. 
Trading Fibonacci Retracements
There are various candlestick patterns used to determine price direction
and momentum, including three line strike, two black gapping, three
TECHNICAL ANALYSIS
black crows, evening star, and abandoned baby. 
INDICATORS
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 analyzed 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.

Candlestick Performance
This analysis relies on the work of Thomas Bulkowski, who built performance
rankings for candlestick patterns in his 2008 book, "Encyclopedia of Candlestick
Charts." [2] He offers statistics for two kinds of expected pattern outcomes: 

1. reversal - Candlestick reversal patterns predict a change in price direction

2. continuation - Continuation patterns predict an extension in the current price
direction.  [3]

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

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 83% accuracy rate. [4]

Two Black Gapping

Two Black Gapping

Image by Julie Bang © Investopedia 2020

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. [4]

Three Black Crows

Three Black Crows

Image by Julie Bang © Investopedia 2020

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. [4]

Evening Star

Image by Julie Bang © Investopedia 2020

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. [5]

Abandoned Baby

Image by Julie Bang © Investopedia 2020

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 49.73% accuracy rate. [4]  

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.

ARTICLE SOURCES

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Related Terms
Stick Sandwich Definition
A stick sandwich is a technical trading pattern in which three candlesticks form what
appears to be a sandwich on a trader's screen. more

Matching Low Definition and Example

The matching low is a two-candle bullish reversal pattern that appears on candlestick
charts. In reality, it acts more often as a continuation pattern. more

Dragonfly Doji Candlestick Definition and Tactics

A dragonfly doji is a candlestick pattern that signals a possible price reversal. The candle is
composed of a long lower shadow and an open, high, and close price that equal each
other. more

Kicker Pattern
A kicker pattern is a two-bar candlestick pattern that predicts a change in direction of an
asset's price. more

Downside Tasuki Gap Definition and Example

A Downside Tasuki Gap is a three-candle formation that may signal the continuation of the
current downtrend. more

Red Candlestick Definition and Uses

A red candlestick is a type of price chart indicating that the closing price of a security is
lower than both the open and prior close. more

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