For a beginner, learning Candlestick chart patterns can be a daunting task with so many formations to remember. But, in reality, a trader can can dismiss all of continuation chart patterns as well as many reversal ones. These days, any trader can rely on just four Candlestick Reversal Patterns to survive the market. The four of them are:
1. Harami or Inside Bar
In this formation, the current candle/bar open and close within, or enclosed by, previous candlestick range, as shown by the following pattern:
2. Engulfing or Outside Bar
Contrary to the first formation (Harami or Inside Bar), the current candle/bar open and close outside, or engulf, previous candle range.
Just as the name implies, in this formation the current candle “pierce” the previous one from the opposite direction.
4. Shooting Star and Abandon Baby
This is the only formation which is formed by three candles instead of just two, where the second candle more or less “jump” off the rest.
By themselves, just like any other tools or indicators used in trading, these four formations can present false alarm as many, if not more, as the real deal. Thus the need for some sort of filter to recognize which one is which. And, here's the best part, the price itself already provide the necessary filter.
There are two filters needed to differentiate the real signal from false alarms.
The first filter is the last two candles prior to the formation, which is a confirmation of a previous trend. Thus, a bullish reversal formation must be preceeded by two (2) bearish candles – as shown in the picture below. While two bullish candles must be formed prior to a bearish reversal formation. As it is a confirmation of previous trend, a candle with Open and Close too close to one another (1.0 pip or less) or even at the same price level, is not counted as a confirmation candle. If such candle exist, then the reversal formation is most likely just a false alarm.
The second filter needed is the next candle after the reversal formation, which must conform the reversal. Thus, for a bullish formation the next candle must be a bullish one; and for a bearish formation the confirmation candle must certainly be bearish as well. If the next candle counter the reversal formation (a bearish candle after a bullish reversal or vice-versa) then most probably price tries to reverse but fail.
As a safeguard, a trader can place stop loss at the lowest or highest point of the reversal. And take profit between 30.0 to 50.0 pips for each trade.
Final note: This is note a holy-grail. The accuracy of these four formation is about 60%. Adjust money management accordingly to ensure a profitable trading in the long run.
You might be also interested in: