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The Profitable Candlestick Patterns

Updated on October 16, 2013
Munehisa Homma
Munehisa Homma

Brief History of Candlestick

Candlestick as one of the most profitable technical analysis method was founded by the Japanese rice trader named Munehisa Homma in 1700. Munehisa (1724 - 1803) was the youngest son from the famous Japanese rice trader at that time. After being pointed to continue his father's business, He started his trades at Sakata in 1750.

In the century of 17, the Japanese people used rice to exchange with another rice with a bid ask price based on the market price. But later, Munehisa founded a revolutionary way to predict the price of the rice, he called this with candlestick. He used the supply & demand rules combined with the market psychology as the basic of his candlestick method.

Because his candlestick method was proved to be successful, he became the godfather of rice trader in his era. For his success, the government asked him to become a consultant and awarded him with a samurai title. Before he died in 1803, he wrote books about his principles in rice trading: "Sakata Senho" & "Soba Sani No Den".

The Anatomy of Candlestick

In general, candlestick is used to measure the price movement from the highest to the lowest price level at the period. We can use candlestick in all period (time frame) of our chart such as one minute, one hour, one day, weekly, etc. In trading, candlestick is very useful to predict the next movement from the price.

Candlestick can be divided into six parts which are: body, shadow, highest price, lowest price, open price, and close price.

  • The body represents the core of the price movement, it consists from the open price and the close price.
  • The shadow is the movement of the highest and the lowest price.
  • The highest price is the highest level that price can reach in the period. It formed when the candlestick has been completed.
  • In reverse with the highest price, the lowest price is the lowest level that price can reach in the period. It formed when the candlestick has been completed.
  • The open price is the level where the price started at the period.
  • The close price is the level where the price ended at the period.

The anatomy of Candlestick
The anatomy of Candlestick

The picture above is the basic anatomy of candlestick. There are two base candlestick forms, that are bullish candlestick for buy signal and bearish candlestick for sell signal.

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The Candlestick Patterns

Ok, now that we have know the basic, we move on to the patterns. There are many candlestick patterns that can be found throughout our chart, but I highly recommend you to trade just several pattern because trading all the patterns will get yourself confused. To make easier, I will only focus on six candlestick patterns that are more than enough to make profit and also I will divide these patterns into three categories:

  1. One candlestick patterns, a signal that generated from only one candlestick: Pin bar & Doji.
  2. Two candlestick patterns, a signal that generated from two candlestick: Engulfing & Tweezers.
  3. Three candlestick patterns, a signal that generated from two candlestick: Evening Star & Falling Three.

Pin bar
Pin bar

One Candlestick Patterns - Pin Bar

The characteristic of a pin bar is it has longer shadow than its body. This pattern usually can be found at the highest or at the lowest of the price movement, making this pattern is ideal for reversal signal. If we see a pin bar at the top of an uptrend, it indicates that a reversal may occur. The same, if we see a pin bar at the bottom of a downtrend, this tells us that a reversal may be in the way.

No lets look at the chart bellow of how we can trade this pattern.

Pin Bar Trade Example

Pin Bar Trade Example
Pin Bar Trade Example

At Pin Bar Trade Example 1, there are three pin bar patterns which are point A, point B, and point C. The first trade at point A is a failed trade because if we look at the red line, it is a strong support from the consolidated area before. Point B is a profitable trade. The pin bar is formed right at the resistance line (red line), makes it a nice rejection area. Point C is also resulted in profit although the pin bar is not formed at the top or bottom but it is still ok to trade regarding the flow of the bearish trend and previously it rejected the previous resistance.

Doji
Doji

One Candlestick Patterns - Doji

Slightly the same with pin bar pattern, doji has the same opening and closing level. This pattern usually occurs at the top or the bottom of a trending market.


Please see the doji trade example bellow to make it clearer.

Doji Trade Example

Doji Trade Example
Doji Trade Example

We can identify three dojis that formed on the chart above. In A, there are two doji patterns and we enter short after the low of the doji is broken. The price makes a good bullish trend until there is another doji pattern (point B) at the top, soon after that, the price reverse down. Point C is a rejection from previous resistance and made a doji pattern, we can enter short.


TIPS: Your analysis of these two pattern, pin bar and doji, will be more accurate if you also add a support and resistance analysis. If they occur at the support or resistance level, it will be a good signal.

Bullish Engulfing
Bullish Engulfing
Bearish Engulfing
Bearish Engulfing

Two Candlestick Patterns - Engulfing

The characteristic of engulfing pattern is the candle must be bigger or engulf the previous candle. This pattern can be bullish or bearish. When we see an engulfing bar at the top of a trend, it means that reversal to the downside may occur. In the other hand if we see it at the bottom of a trend, we know that the trend will be reverse back to the upside. The bigger candle that engulfs the previous candle represent big buyer or seller that suddenly take control of the price (See the pictures on the right).

The common entry level for this pattern is we can place a stop order right at the top or bottom of the engulfing candle. We can easily spot this pattern everyday on every pairs and on every time frame. The higher our time frame, the higher probability of profit.


The picture bellow is the example of engulfing pattern trade.

Engulfing Trade Example

Engulfing Trade Example
Engulfing Trade Example

This is a perfect example of how to trade the engulfing candlestick pattern profitably. Begin in point A, it is a big bullish candle that swallow the previous smaller bearish candle. We buy at the high of the bullish candle. The price makes a good uptrend until another engulfing pattern formed in point B, this one is bearish engulfing. The big bearish candle is bigger than the previous candle, telling us that big sellers is coming in. We can see a nice downturn after that. Point C is also a nice big bullish candle that engulfed the previous candle, go long.

Tweezers
Tweezers

Two Candlestick Patterns - Tweezers

To become a tweezers pattern, the tops or the bottoms of the two candles must be the same. This pattern can be a signal to go short if it formed at the top (tweezers top) and a buy signal if there is tweezers at the bottom of the price (tweezers bottom). The color and the shape of candle body does not matter.

If we see two candles that have the same high formed at a top of an uptrend, it will usually followed by a reversal. In opposite, if we have two candles that have the same low formed at a bottom of a downtrend, we may prepare for going long if the next candle break the high from the previous candle.

Tweezers Trade Example

Tweezers Trade Example
Tweezers Trade Example

As we can see at the chart: Tweezers Trade Example, there are three tweezers patterns. The first one is a sell signal because it forms at the end of an uptrend. The next tweezers pattern, long trade, can be found at the continuation move of the uptrend and it foms right at the previous support, it ok to trade this setup. The last, short trade, is also at the continuation of downtrend, we see that tweezers is form right at the resistance.

Morning Star
Morning Star

Three Candlestick Patterns - Morning Star & Evening Star

Morning star pattern is for bullish or long signal, while evening star pattern is for bearish or short signal. We must have three candlesticks in order to identify the valid pattern. For morning star, the first candle must be bearish followed by smaller (like doji) candle in the bottom, then the third candle must be bullish and close higher than the second candle.

Evening Star
Evening Star

The evening star contains first bullish candle followed by small candle at the top then the third candle must be breaking the low from the small candle and closed lower than the previous small candle.

Morning Star Trade Example

Morning Star Trade Example
Morning Star Trade Example

Now look at the trade examples bellow. The chart: Morning Star Trade Example, gives us two trades example. In A, the morning star pattern is formed a the low of the bearish trend, we get long at the top from the third candle. Noticed that we also have a pin bar pattern that makes it a strong combination of bullish reversal signal. Similar at point B, we also get a nice buy signal but in B is stronger signal because if we looked at the left, it formed in the supply & demand zone that has been generated from point A.

Evening Star Trade Example

Evening Star Trade Example
Evening Star Trade Example

At the chart: Evening Star Trade Example, we have two nice signals to go short. In A, although the second candle is not smaller than the third, it is still valid because the close of the third candle is lower than the second. We have a similar setup from the previous example of morning star in point B. The pattern in B is made an evening star pattern in the supply & demand area which generated in point A, makes it more reliable bearish signal to trade than in point A.

Three White Soldier
Three White Soldier

Three Candlestick Patterns - Three White Soldier & Three Black Crows

The last pattern that I will show you is three white soldiers (for bullish signal) and the opposite, three black crows (for bearish signal).

Three Black Crows
Three Black Crows

Three white soldiers is trade able when there are at least three bullish candles formed at the low of a bearish trend. in the opposite, three black crows is a sign of reversal from a bullish trend, marked with three consecutive bearish candles at the top of a trend.

Three White Soldiers Trade Example

Three White Soldiers Trade Example
Three White Soldiers Trade Example

The chart above is an example of three white soldier trade. First candle (A) is a nice bullish candle followed by another bullish candle (B) that is closed higher than the first candle. As we learned before, this pattern is a signal for bullish trade so that we go long at the high of the third candle (C).

Three Black Crows Trade Example

Three Black Crows Trade Example
Three Black Crows Trade Example

Now look at the chart above, the price is in an uptrend until a bearish candle formed at the top (A). The second candle is also a bearish candle (B) followed by another bearish candle that closed lower than the first and the second candle (C). After see these candles that always closed lower than before, we know that the sellers are stronger than the buyer. We can enter short at the low of the third bearish candle.

The last is that you have to practice and practice to train your eyes spotting those patterns. Although look simple, in fact, only few traders who can be successful with those patterns. I also highly recommend you to trade only one or two patterns, because it will make your trading become focused and relaxed. Forex trading is a very risky business that will cause you to lose money fast if you are not learning, so keep practicing guys.

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    • profile image

      naveed 3 years ago

      Great sharing brother..

    • drpennypincher profile image

      Dr Penny Pincher 3 years ago from Iowa, USA

      Interesting- it would be fun to try this out on some historical trading data and see how well I could predict trends. Good luck on the Rising Star!

    • profile image

      countertrend 3 years ago

      Solid forex candlestick hub! Very well put together.

      Though regarding "can we trade this thing", that's the only way I ever succeed, on timed counter trend reversal trades after sufficient enough extension patterns (like this: http://turntrend.com).

      The stop is small at the swing high (or low). I find the whipsaws and unclear stops in breakout trading make it easier said than done

    • prajwalpokharel profile image

      prajwal pokharel 3 years ago from kathmandu

      I didn't knew candlestick were so old ... 1800's wow.... great article you pip trader