The rising trend in candlestick trading has led to a sharp spike in the number of new technical traders signing up to use them. The reason behind the surge is that candlesticks are quite versatile, and many believe that these patterns reliably indicate future positive or negative price swings. But are these charting patterns truly reliable, accurate, and do they really work in all trading conditions?
Not all candlestick patterns are reliable, but some are, and these can form part of your trading strategy. However, the reliability of candlestick patterns can vary a lot depending on the market you trade in, the timeframe, and other related conditions relevant to your overall trading strategy.
In this article, you’ll learn all about candlestick trading, how it works, and whether it’s a reliable and accurate way to inform trading decisions.
Candlestick Trading: An Overview
Candlestick charts rank highly among the most favored and widely used price charts in the market and provide you with valuable information on price movements within a given timeframe. But more than that, a single glance at their color codes, shapes, and patterns show you all that is currently happening in the market.
The charting techniques date back to 18th century Japan where rice merchants used them to track the pricing of rice coupons. Today, candlestick charting has almost replaced the bar, point, line, and figure charts.
How Does Candlestick Trading Work?
Candlestick charts consolidate data from a selected time frame into a single candlestick bar. They offer information about a security’s price movements, with each candlestick representing activity over a specified period such as a minute, hours, day, or month.
A candlestick will therefore indicate open, close, high, and low data points over the chosen timeframe.
It’s easy to tell whether a price has gone up or down from the color codes. Green or white colors indicate a positive (bullish) candlestick, while red or black show negative (bearish) candlesticks. A bullish candlestick usually shows a higher close price than the open price, whereas a bearish one shows a lower close price compared to the open price.
To read a candlestick, you check its color, body, and wicks. Different parts of the pattern tell a different story, and while the shape, color, or direction can appear random, sometimes several candlesticks join up to form a pattern. The candlestick patterns can reveal bullish and bearish sentiment in the market and help traders confirm their forecasts about market movements.
Does Candlestick Trading Really Work?
Traders who have experienced marginal success using candlestick trading patterns fail because they wrongly assume that every pattern follows a similar path and that the pattern forms due to a single action, such as selling for bearish pin bars. Unfortunately, this isn’t why the market pattern forms, and traders don’t proceed to conduct an analysis to help them figure out the reason behind the pattern formation.
In a nutshell, traders believe candlestick trading works because once a pattern forms, the price moves as the candlestick pattern suggests. Therefore, they assume the pattern causes the market to move as it did, and any future patterns will behave likewise.
Studies carried out on the effectiveness of candlestick patterns seem to agree that overall, the patterns are successful 50% of the time. As such, traders need to learn how to determine which patterns are likely to turn profitable and which ones will end up losing money.
Candlestick trading works when applied correctly. When this is done:
It Can Assist in Analyzing the Market
Since candlestick shapes and patterns provide valuable information regarding what transpires in the market, you can use this info to try and forecast future happenings. The patterns could signal potential market reversals, while others might indicate a continuation of current trends.
This can be of great help when analyzing the market, and it explains why some price action traders leverage the chart patterns when doing their technical analysis.
Candlesticks Make It Easier To Read Price Action
Interpreting candlesticks is simple and straightforward, even for beginner traders. You can tell the direction of price movements simply by looking at the color-coded candlesticks, which makes it much easier to analyze the market since you base your analysis on the information your chart provides.
How Accurate Is Candlestick Trading?
Most beginner traders get excited to use candlestick patterns since they provide detailed information and are pretty straightforward to use. They mostly use candlesticks to form patterns that emit clues regarding where the price will move next. Unfortunately, things don’t always work out as expected.
There are some things that the candlesticks won’t tell you. For example, you cannot tell why the open and close data points are similar or different using candlesticks and as a result, it’s not advisable to use candlestick patterns on their own.
In order to enhance your trade outcomes, you may want to use additional methods of technical analysis which include the market structure, oversold or overbought conditions, trend direction, as well as support and resistance levels.
Combining the use of candlestick patterns with today’s advanced computing and technical analysis greatly enhances their efficiency, allowing you to improve your trading strategies.
Are Candlestick Patterns Reliable?
Traders use different candlestick patterns to predict price direction. However, some of the signals from the patterns might not be that reliable as the patterns themselves might not be accurate enough.
The candlestick patterns’ massive popularity has also reduced their reliability substantially since hedge funds have analyzed them using their algorithms and use the same to lure retail traders looking to cash in on high-odds bullish or bearish outcomes.
What this means for you as a trader is that you might want to consider using candlestick patterns alongside other strategies rather than on their own. Nevertheless, learning how to use candlesticks patterns effectively is an excellent way to understand the market’s driving forces.
A number of factors highly impact the reliability of candlestick patterns, but you can trade with more confidence if you take note of them. These factors are:
- The timeframe: Short timeframes tend to be less reliable than long ones due to the higher volatility experienced, because trader sentiment is prone to more frequent changes in the short term, whereas daily or weekly timeframes promise more reliable long-term effects.
- The instrument: Trading instruments behave in different ways but what’s crucial is the traded volume (liquidity). Some candles work for forex, while others work better with stocks, but overall, the higher the volumes dealt, the more reliable the candles will be.
- The chart pattern: Consider the environment in which the candlestick happens. If there are support and resistance lines close by, the trade has the potential to work out.
- The pattern size: The larger the patterns, the more reliable they tend to get. Also, significant price movements will give out stronger signals.
- The candlestick pattern: Different candle patterns have different reliability levels. But in general, the more candles a given formation contains, the more reliable it is. The downside is that this doesn’t appear that often.
It’s important to point out that you don’t have to memorize candlestick formations to understand the price movements. This is a common mistake that new traders make. Instead, learn how the markets work, and you’ll be better placed to use trading tools like the candlestick charts.
Candlestick trading patterns form excellent tools for technical analysis, and using them can help you gain a competitive edge in the market.
Understanding how to use the patterns is, therefore, the key. This is because it allows you to interpret potential market trends and make decisions based on those inferences. If used properly, these trading patterns can be a powerful tool in your trading arsenal.