Candlestick Patterns are technical tool that packs data for multiple timeframes into individual price bars. This makes them more useful than traditional open-high, low-close bars, or simple lines connecting close price points. Candlestick patterns that predict price direction after completion.
Candlestick Pattern Reliability
Not all candle models work equally well. Their huge popularity has reduced reliability because they have been analyzed by hedge funds and their algorithms. These well-funded players rely on lightning-fast execution to trade against retail investors and traditional fund managers who apply technical analysis strategies found in popular texts.
In other words, hedge fund managers use the software to trap participants looking for high-odds bullish or bearish results. However, reliable patterns continue to emerge, opening up opportunities for short and long-term gains.
Understanding Candlestick Patterns
Financial and technical analysis is a science that requires sufficient education and experience to master. For the sake of simplicity, we will talk about the main patterns to keep in mind when looking at candlestick patterns and which patterns can predict price action.
Before diving into the implications of each pattern, it is important to understand the difference between bullish and bearish patterns. For reference, Bloomberg represents bullish patterns in green and bearish patterns in red. There are many different types of candlestick patterns.
Bearish Patterns
Bearish patterns are a type of candlestick pattern in which the closing price for a stock period was lower than the opening price. This creates immediate selling pressure for the investor due to the assumption that the price will drop.
Bullish Patterns
Bullish patterns are a type of candlestick pattern in which the closing price for a stock period was higher than the opening price. This creates buying pressure for the investor due to the potential for further price increases.
Mechanics of Harmonic Patterns
Harmonic patterns help traders frame their trades that designed to recognize quality turning points in the market. To be considered valid and tradable, harmonic patterns must meet certain move conditions based on Fibonacci retracement and extension levels. Fibonacci retracements are used to identify levels at which price is likely to resume the direction of the dominant trend, while Fibonacci extensions are used to identify high probability price targets in a trending market.
ABCD Pattern
- Bullish ABCD pattern
- bearish ABCD pattern
The classic ABCD pattern underlies all harmonic patterns. This pattern consists of an AB impulsive move followed by a BC corrective move and finally another CD impulsive move.
When using the Fibonacci retracement tool, the BC leg should ideally be 0.618 (or less) of the AB impulsive leg retracement. The final CD move will be about the same size as the first AB impulsive move.
To trade the ABCD pattern, traders can enter trades after the corrective BC phase to take advantage of the impulsive CD phase. Alternatively, they can wait for the entire pattern to complete to trade the expected reversal at point D.