Last Updated on 10 February, 2024 by Trading System

Candlestick charting has become all the rage in recent years, and is becoming adopted by most people new to trading. That’s not too strange, considering their versatility, and that they form various patterns that are thought to indicate the likelihood of future bearish or bullish price swings. But are candlesticks reliable?

All candlesticks are not reliable, but there are a couple of patterns that are reliable enough to become part of a trading strategy. However, which candlesticks that can be used varies a lot depending on factors like what market you trade, the timeframe, and other conditions that are pertinent to your trading strategy.

So can you really make use of candlestick patterns to successfully trade the markets? Well, that’s what we’re going to look at in this article!

Let’s start off by looking at our view on candlesticks, which might be a little different from what you’re used to hearing!

How We View Candlestick patterns

As you probably know, there are many different kinds of candlestick patterns that are thought to indicate everything from impending price reversals, to the continuation of the current trend. Most of the time, these patterns are given logical reasons as to why they should indicate a certain outcome.

For instance, the bullish engulfing pattern is considered bullish since the buyers managed to recover the fall of the previous day, and close higher than its open.

These types of explanations may seem logical and trustworthy at first sight, but they usually are no more than projections of our preconceived ideas about the market, and how it should behave.

In our experience,  at least most of the time, these explanations hold no value whatsoever. When we perform studies on historical market data, we simply don’t see that the market behaves in line with the meaning that has been given to the patterns in question.

In our view, candlestick patterns aren’t more reliable than any other random patterns that we come up with ourselves and test. Some work as intended and some don’t. Sometimes we even find that some patterns work in the exact opposite way of their original definition!

So, if candlestick patterns on their own don’t work that well in many cases, how do you make sure to include candlesticks in your trading approach in a successful manner?

Well, you really have two alternatives. Let’s explore them separately!

1. Making the Signals More Reliable With Filters

For some traders, it won’t come as a surprise that candlesticks aren’t reliable buy or sell signals on their own. To be worth acting on, it’s often required that you impose additional filters that make sure to rule out patterns that aren’t profitable.

Here are some examples of what filters like these could look like:

1. High ADX Values: By demanding that ADX is high we only take signals that occur in high volatility conditions. This can have a huge impact on some patterns!
2. The Direction of the Long-term trend: Some patterns will only work when the market is in a bullish or bearish trend. This tends to be the case in stocks, where bullish patterns usually work much better if the market trades above its 200-period moving average.
3. Volume Conditions: Sometimes looking closer at the volume of the market could provide valuable insights into whether a pattern is worth acting on or not.

There are many more types of filters we could mention, but these three are some of the most versatile ones, at least from our experience.

In order to know which ones to use for your particular trading setup, you need to make use of backtesting, which is covered right below!

2. Using Backtesting to Know Which Patterns Are Reliable

The second option simply involves testing different candlestick patterns on historical data, to only focus on those patterns that have worked historically.

To get started in backtesting, you need a trading platform that has backtesting features. While there are many platforms to choose from, these three are our favorites.

• Multicharts
• TradeStation
• Amibroker

You also need to learn a coding language to be able to get your ideas down on paper. We recommend that you have a look at Easylanguage, which is a beginner-friendly programming language that still has advanced features in case you would need them!

Here at The Robust Trader, we offer a course on Easylanguage that will get you coding quickly! Do have a look at it if it interests you!

Are Intraday Candlestick Patterns More or less Reliable?

Many people like to use the same patterns and strategies on many different timeframes, and switch rapidly between bar settings to identify promising setups. Unfortunately, it’s uncommon to see that trading patterns work across many timeframes.

When it comes to which timeframe that tends to work best, there is one general guideline that could be good to know:

Daily bars usually are much more reliable than intraday bars.

Here are the two main reasons for this:

1. Randomness impacts prices less: In shorter timeframes, random and short term market moves will have much bigger effects on the outcome of single bars. Since daily bars consist of many more transactions, we’ll get closer to an average of those random moves, which gives a truer image of the market’s moves.
2. It gets more attention: Most big market players, such as hedge funds and the like, use daily bars to make decisions regarding their operations. This means that eventual signals in the daily timeframe will get more attention and that support and resistance levels will be watched more closely by market participants and become stronger as a result.

Related Reading: Do Candlesticks have any predictive value?

Ending Words

Candlestick patterns aren’t as reliable as one might think at a first glance. However, this doesn’t mean that you cannot build great strategies using them. Just make sure to employ backtesting, so that you can be really certain that you have the odds in your favor.

Here you can find our Candlestick archive with many articles covering the subject.

FAQ

Why are there different kinds of candlestick patterns, and what do they indicate?

Candlestick patterns are diverse and are believed to signal various market movements, from impending reversals to trend continuations. Each pattern is given logical reasons based on market behavior, such as the bullish engulfing pattern suggesting buyer recovery.

How can candlestick signals be made more reliable?

Candlestick patterns, on their own, may not be more reliable than random patterns. Some work as intended, while others don’t, and in some cases, patterns may work opposite to their original definition. To enhance reliability, additional filters can be applied. Examples include using high ADX values for signals in high volatility conditions, considering the direction of the long-term trend, and evaluating volume conditions for valuable insights.

How can backtesting be used to determine reliable candlestick patterns?

Backtesting involves testing different candlestick patterns on historical data to identify those that have worked historically. Trading platforms with backtesting features, such as Multicharts, TradeStation, and Amibroker, are recommended. Learning a coding language like Easylanguage is essential for implementing backtesting.