A few weeks ago I released an article where I talk about the reasons why most candlestick patterns are useless and why pin bars along with engulfing candles are the only two patterns you need to have knowledge on. In today’s article we’re going to look at candlestick patterns again only this time I want to see whether candlestick patterns overall work in the market.
By work I mean do they actually have any kind of edge or are they simply meaningless.
Do Retail Traders Believe Candlestick Patterns Work ?
I do think the majority of retail traders believe candlestick patterns to work, it only takes one look at any of the popular forex trading forums to see there are hundreds of trading strategies all based on using candlestick patterns to trade the market. With candlestick patterns used in so many strategies it’s obvious lots of traders believe them to hold some kind of edge in the market.
Retail traders would have looked at the bullish pin bar above and said the reason why the price climbed higher after the pin formed was because of the pin bar itself, they believe the pin is what caused the up-move because they have been told a wick shows a rejection taking place in the market.
When traders see the bullish pin bar above they would say it worked because it caused a reversal, which is what pin bars are supposed to do.
Now when the trader see’s the bearish pin bar above form he would expect the market to reverses as that is what he has been told pin bars do upon appearing in the market.
When the pin doesn’t end up causing a reversal, instead of blaming it on the understanding he has been given regarding pin bars, he blames it on a fault in his analysis of the market. He’ll think its his fault the pin didn’t result in a reversal and will rationalize the reason why it didn’t work was because of the pin bar not having confluence with other technical levels.
The trader doesn’t realize the reason why the pin bar didn’t cause a reversal wasn’t because of it not having any confluence with technical levels or not having the correct characteristics i.e a long wick, it was because the action which caused the pin to form was not the same as the action which caused the bullish pin to form.
The bullish pin was created by bank traders placing buy trades, we know this because the price kept moving up after it formed, the bearish pin formed because bank traders were taking profits off buy trades they had already placed, which is why the price continues to move higher after the bearish pin forms.
The trader wouldn’t know this because he assumes from the information he has been given about candlestick patterns and pin bars that each pattern forms in the same way and is only caused by one action, like selling in the case of bearish pin bars.
This is the main reason why traders have little success trading candlestick patterns, the information they have read about patterns and why the form is always assumed to be correct, so when a patterns fails to work out like its supposed to the traders blames himself for the pattern failing when really it’s not his fault at all, it’s the fault of the information he has read about why the pattern forms in the market.
The 50% Predicament
There have been lots of studies on the profitability of candlestick patterns, most seem to agree overall the probability of a candlestick pattern working out successfully is around 50%. This means if we were to take a sample of 5000 pin bars which have appeared in the market, 2500 of them will have worked out profitably and 2500 will have resulted in us losing money.
Now I don’t want to debate on whether 50% of candlestick patterns do work out successfully or not because I have never carried out any of my own analysis on them, but what I feel is if the patterns do have a 50/50 probability of working out successfully then all we need to do to make decent money trading candlestick patterns is figure out a way to define which patterns are going to work out profitably and which are going to lose us money.
A lot of traders already try to do this by seeing if the candlestick pattern has confluence with other technical levels such as support and resistance. If a candle pattern does have a line of support or resistance going through it then supposedly the pattern has a higher probability of working out successfully than a pattern which does not have a line of support or resistance going through it.
I think this is a flawed method because no analysis is conducted on why the candlestick pattern has formed in the market, like I always say understanding why something happens is far more important than just seeing it happen. Loads of price action websites and books tell you to look for candlestick patterns which have confluence with technical levels yet if you ask traders who use candlestick patterns in conjunction with technical levels if they are more profitable than just trading patterns on their own with no additional confluence, the majority of them will say no.
This tells us patterns which have technical levels going through them doesn’t increase the probability of the pattern resulting in a successful trade, if it did then people would be making lots of money using it, which is evidently not the case.
So Do Candlestick Patterns Actually Work ?
This is where the great misconception occurs.
Traders think candlestick patterns work because they see a pattern form and the price does what the candlestick pattern suggests, this make them believe it was the pattern which caused the market to do whatever it did and any pattern they see in the future should do the same.
It only requires a tiny bit of analysis to see there are loads of candlestick patterns which end up being unsuccessful even if they have confluence with technical levels or have different characteristics like a longer wick, this can only mean the definitions and guidelines given to candlestick patterns are incorrect.
It’s not that the candlestick pattern doesn’t work, it’s that the definition for what the pattern is supposed to do is wrong.
If the books and websites which teach traders about candlestick patterns state a pin bar is supposed to signal a reversal whenever it appears then all pin bars should cause a reversal, if they don’t then the theory is wrong and there must be another reason why they form in the market.
At the end of the day candlestick patterns don’t work if you trade them with the understanding given to them by trading books and websites. If the patterns really worked for the reasons the books and websites state then all patterns will do what they are supposed to do when they appear in the market.
Since this obviously isn’t the case it means the understanding is wrong. If you currently use candlestick patterns in your trading when you see a pattern fail to materialize the way its supposed to and you lose money, don’t blame yourself or your analysis, all blame lies with the information you have read in books on candlestick patterns.
This information is wrong and should not be treated as being true, if candlestick patterns really did what the books say they should do then they we would see them working out as the books suggest all the time, because we don’t see this and actually see them failing a large majority of time it means any theory which says a candlestick pattern should cause something to happen in the market like a reversal is wrong and should not be used by the trader to trade candlestick patterns.
Thanks for reading, if you have any questions please leave them in the comment section below.