Complex Candlestick Patterns Pt. 2

[RichardCox 10]

Candlestick patterns create one of the easiest ways to spot reversals or other market events and for this reason, these patterns are one of the most popular elements of technical analysis for forex traders. In the first section, some of the less commonly used patterns were explained (the Three Soldiers, the Three Black Crows, the Hikkake Pattern, the Island, the Piercing Pattern, and the Dark Cloud Cover). In the second part of this article, we will look at some of the other lesser known patterns which are less commonly noticed when markets are actively trading.

 

The Abandoned Baby

 

The first complex candlestick pattern we look at is the Abandoned Baby, which is a reversal formation that occurs near the completion of a downtrend or uptrend. In bearish cases, prices fall to an extended exhaustion gap and this is followed by the uptrend reversal which comes in the form an upward breakaway gap. The opposite would be true for bullish cases. Visually, we can see a single candlestick that is separated from the other candlesticks. This candlestick is the figurative “baby” that has been “abandoned” by the rest of the price activity.

 

In many cases, the “abandoned” candle with be a Doji formation (or at least a candle with an extended upper/lower wick). The graphic of this formation shows this tendency. The Abandoned Baby is traded in ways similar to breakaway gaps, with entries above/below the gap and stop losses placed on the other side of the gap. These formations are created by the succession of the exhaustion and breakaway gaps, and this tend to be seen when prices encounter significant levels of support or resistance. This creates the exhaustion gap and and the ensuing reversal. The Island formation is a variation of this pattern, consisting of multiple candles that are separated from the rest of the price activity.

 

The Hook Pattern

 

The Hook candlestick pattern is another reversal formation that is characterized by higher lows and lower highs relative to the previous period. This is true for both bullish and bearish Hook patterns, as price activity is seen constricting in a tighter range. When identifying this pattern in an uptrend, it should be remembered that the open should be close to the previous high while the new closing low is also near the previous low. When dealing with downtrends, the opposite is true (in terms of open and closing values). Similar to the Island candlestick pattern, increases in trading volumes during the second time period lends to the validity of the formation.

 

Looking at the commonly used rules for exiting trades, it should be understood that these patterns are often accompanied by sharp reversals in price. If the secondary candle does show a continuation of the previous trend, the pattern is considered invalid and any positions taken on the basis of this signal should be closed.

 

The San Ku Candlestick Pattern (Three Gaps)

 

The San Ku candlestick patterns are use to spot potential trend reversals that will be seen later. This differs from some of the other commonly used patterns, which are present at the exact area of price reversal. Instead, these patterns essentially signal that a trend is like to change at some point in the near future. Visually, these patterns are characterized by the placement of three price gaps that are seen in a trend that has already been well-established.

 

When identifying this pattern, it should be remembered that prices are likely to retrace after major price moves as traders book profits and prices correct themselves. For this reason, some trading strategies suggest the use of other technical indicators that spot instances where trends are reaching an exhaustion point. So volume patterns and indicators that identify overbought/oversold conditions are often used in conjunction with these formations. With the San Ku pattern, prices will reverse after the third price gap but breakouts (confirmed by volumes surges) are seen, the pattern becomes invalid. In this case, any position based on this pattern should be closed.

 

The Kicker Candlestick Pattern

 

The Kicker candlestick pattern is regarded as one of the higher probability signals. Visually, these formations show sharp changes in price over only two candlestick periods. The formation of a Kicker pattern shows that a battle between bulls and bears has been fought (and then won decisively), and these situations will often occur during major news releases.

 

This finalization of the bulls/bears battle ultimately results in a newly emerging trend. A key characteristic to watch is the gap between the initial and secondary candles and increases in trading volume will help to confirm the pattern. When dealing with the Kicker pattern, traders should look for immediate and strong trend reversals, which ultimately leads to a significant trend move in the opposing direction. Because of these required elements,these patterns should be regarded as invalid if prices experience a period of consolidation (sideways trading) or reverse again, back to the original trending direction. In these cases, any trades that are opened on the basis of the Kicker pattern should be closed.

 

Trading with Price Gaps

 

There are some cases (such as significant increases in trading volumes) where the price gaps associated with these candlestick patterns tend to produce more reliable results. Certain element to watch for include: the identification or breakouts, price movements that are large (in terms of candle length) and in conjunction with surges in trading volumes, and reversal formations that come after the early gap. These reversal candlestick formations (like the ones discussed above) should be within the first few price bars and when these come after periods of market indecision, a stronger pattern is being seen.

 

Trading with reversal patterns does mean taking on risk prospects that are not visible in other aspects of technical analysis since, by definition, this means trading against the dominant momentum that was seen previously. Because of this, reversal trades are often associated with tighter stop losses and these positions should only be considered when strict criteria are met.

 

Candlesticks as an Early Sign of Trend Reversal

 

Looking at the characteristics of these candlestick reversal patterns, it becomes clear that changes in trend become apparent when looking at the various ways price behavior presents itself visually. There is a large number of candlestick patterns that can be outlined but, in many cases, traders tend to focus on the simplest patterns and disregard the rest. The simpler patterns tend to be more common (and visible) but because of their higher frequency, the signals they produce tend to be less reliable.

 

It is very rare for traders to use candlestick formations on their own as the basis of trades, as there are many complementary tools in technical analysis that can help to confirm or deny a pattern as it presents itself. The patterns outlined here deal with gapping formations (in addition to the visual representation of the candle) and the reliability of these signals will rely heavily on the accompanying trading volumes that are seen as these patterns are developing.

[wrbtrader 10]

Hi RichardCox,

 

It would be much better if you included real chart examples of Gap Price Actions in combo with the complex Japanese Candlestick patterns you're discussing to go along with those generic chart images. So far, you've basically only provided a dictionary definition as seen in most candlestick books without any trade management information...

 

Along with mentioning Gap Price Actions without defining any particular types of gaps. Simply, without real chart examples and the typical book like dictionary explanations...where's the beef ?.

 

Also, I'm a little confused about why you refer to these particular Japanese Candlestick patterns as complex. Is it because of the number of intervals involved with the pattern or if its because of the gap price action in combo with the candlestick pattern ???

 

Happy holidays all !!!

Edited December 31, 2012 by wrbtrader

[BlueHorseshoe 10]

Candlestick patterns create one of the easiest ways to spot reversals or other market events and for this reason, these patterns are one of the most popular elements of technical analysis for forex traders.

 

Hi Richard,

 

It would be great if you could provide some sort of statistical information to support the validity of these patterns.

 

Thanks,

 

BlueHorseshoe.

[wrbtrader 10]

Hi Richard,

 

It would be great if you could provide some sort of statistical information to support the validity of these patterns.

 

Thanks,

 

BlueHorseshoe.

 

see part 1...I provided well known names (not direct links) of sources that have done statistical information. Yet, I don't know if RichardCox has done his own personal statistical analysis or if he has used the results of others that have done the work to form his own opinion about Japanese Candlestick patterns without knowing exactly the type of trade management and other variables (see below) that was being used.

 

Basically, from what I've seen, the statistical results I've seen dozens of statistical sources and they are all over the map from reliable to not reliable. Simply, it comes down to the user and how its being applied (e.g. other variables like trading instrument, time frame, trade management, market context, trading plan and so on).

Edited December 31, 2012 by wrbtrader