How to Choose a Winning Trading System Using Candlestick Patterns

Candlestick Patterns

Promoters who rely on anecdotal evidence frequently use the popular charting method known as candlesticks. We use candlesticks in our charts but not as a trading strategy indicator. Do candlesticks work?

Candlesticks do indeed work. With strict buy and sell signals, we quantitatively test 23 different candlestick patterns. Unexpectedly, some of the candlestick patterns appear to function fairly well. Some of the patterns would probably benefit from adding a third variable. We charge a little cost for the code.

We have used candlesticks to illustrate quotes on charts ever since reading Gregory Morris’ Candlestick Charting Explained in 1998. However, candlesticks have never been used in our quantified strategies.

candlesticks patterns

Candlesticks Explained

If you’ve never seen a candlestick before, it might be a little perplexing at first, but as you get used to them, you get a much better visual look at the charts, such as the opening and closing prices of the stock. We utilize candlesticks while examining charts for this reason, which is the main and only explanation.

White candlesticks indicate that the close is higher than the open, while black candlesticks indicate that the open was higher. “The body” refers to the distinction between the open and the close. The “tails” on either side represent the day’s high and low readings (or whatever time frame you use).

Are Candlestick Patterns Reliable?

Many articles praising the significance of candlesticks and the formations to look for can be found online with a fast search. Numerous articles describe the formations, but as usual, they do not provide any data to support their ability to foresee the future. That’s unfortunate because testing candlesticks is not difficult. We present some quantitative findings from 23 forms later in the text.

What Is The Best Candlestick Pattern?

Surprisingly numerous candlestick patterns appear promising in the 100% quantified test below. There are a minimum of five patterns with a good number of trades and a high-profit factor.

How Many Candlestick Patterns Are There?

Just a handful of the candlestick patterns that exist go by exotic names like Hanging Man, Bullish Engulfing Pattern, Shooting Star, Bullish Hikkake, One White Soldier, Bearish One Black Crowe, Piercing Line, and Hammer.

How many different candlestick patterns exist, though? We found at least 64. There may be as many as 100 candlestick patterns available online, and we assume that this list does not include all of them.

Although we have no idea how many different candlestick patterns there are, we do suggest visiting this link if you’re interested in learning more.

We chose the 23 candlestick patterns as we essentially already had the backtesting code.

Do Candlesticks Work Best In Daily Or Intraday Bars? (Best Settings)

Although we advise using a variety of time frames when trading, daily bars appear to be the most effective for candlesticks. Weekly and intraday bars aren’t as reliable as daily bars. There are far more transactions in daily bars than intraday ones and daily bars generally garner greater attention are just two of the many causes.

How To Quantify And Backtest Candlesticks (Entry And Exits)

We need to create rules based on tight criteria in order to quantitatively backtest candlesticks. The candlestick forms don’t have a precise or mathematical description, like most things that might be classified as technical analysis. However, most structures are pretty simple to define and are already available online.

You cannot consider a strategy finished until you have exit criteria. Candlestick formations solely look at “bullish or bearish” settings without considering any exit criterion.

Therefore, we must establish our own standards for when to close the position. 

The exit criteria are an essential component of every approach and can significantly alter outcomes. Using the “proper” exit criteria, even a technique based on random entry can produce excellent outcomes. And, to be honest, it would probably be more equitable if we had varied exits dependent on the number of days since entry when backtesting the candlestick formations. However, we’ll save that backtest for another time.

How To Trade And Use Candlesticks?

You might want to include a variable to enhance the outcomes. This variable might be, for instance:

  • The long-term trend’s direction, for instance, as determined by a moving average filter
  • Making use of an ADX filter
  • a short-term RSI filter should be used.
Conclusion

While the majority of candlestick formations provide little clues, some of them do offer some potential. Buy and hold was defeated by a backtest employing the 12 best formations that was slightly data-mined. This is encouraging because 47% of the time has been spent in the market, and the drawdown is only 50% of buy and hold. Candlesticks can function depending on the candlestick pattern.

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