Profitability of candlestick patterns – ForTrader.org financial magazine


The use of patterns in trading in the forex and financial markets, be it Price Action, candlestick patterns or technical analysis patterns, is one of the popular price prediction methods and is used by many traders. Nevertheless, there are many examples when a seemingly ideal pattern “deceives” the trader by not realizing its potential.

Today we will look at one of the ways increasing the efficiency of chart patterns in the foreign exchange market

Beautiful but unprofitable patterns

Unfortunately, the cases of “non-development” of patterns in the foreign exchange market are common. It is enough to take a closer look at the graph to find them.

Naturally, the older the timeframe, the higher the likelihood that everything will work out, however, there are mistakes at long time intervals.

For example, a losing pin bar

For example, the following situation. The price action pattern is formed on the chart, known as Pinbar (Pin bar)… it reversal patternsignaling that the market sentiment has changed. The Pin Bar looks like a candle with a small body, a long tail on one side and a short tail on the other. In this case, the body of the candlestick should lie within the High-Low range of the previous candlestick. It is assumed that the occurrence of the pattern precedes the price reversal.

An example of a false unprofitable pin bar

As you can see, a beautiful Pin-bar has formed on the chart, which could serve as a prerequisite for opening a sell trade. If this happened, then in such a transaction the trader would have received a loss.

Broken Bearish Engulfing

This situation can arise with any patterns. For example, here is the reversal pattern “Bearish engulfing“, In which, within the framework of an upward trend, a setup occurs in which the body of the previous bullish candlestick is within the Open-Close of the next bearish candlestick. This pattern is assumed to be the end of an upward and the beginning of a downward trend

An example of a false unprofitable "Bearish engulfing"
An example of a false unprofitable “Bearish engulfing”

Here is an example of a classic “Bearish engulfing”, after which the price did not reverse – after a slight correction, the upward trend continued. Although the candlestick pattern itself was formed “like a book writes,” as a result, there is an upward trend on the chart. The attempt to fall was unsuccessful, the price turned up.

The described case is not yet the saddest. Still, the price went down for some time, and the trader could manage to move the stop loss to breakeven.

It is impossible to visually distinguish a “successful” pattern from an “unsuccessful” one. Here is an example with the same “Bearish Engulfing”, but already worked out as it should.

An example of a correctly worked out "Bearish engulfing"
An example of a correctly executed “Bearish engulfing”

The initial conditions for the formation of the setup are the same, but the result is completely opposite. As expected, after the Bearish Engulfing occurred, the uptrend ended, the price reversed and a downward trend began.

How to check the profitability of a pattern?

Considering the above, it is quite obvious that the conclusion is that it is necessary to check the patterns. There are plenty of tools for “filtering” chart patterns – these can be technical indicators, support and resistance levels, etc. The use of volumes, and more specifically, the standard Volumes indicator, has proven to be quite an effective tool.

Consider the same “Bearish Engulfing”, but in combination with the indicator Volumes… The pattern filtering logic is very simple:

  • The volume corresponding to the first candle is small enough. This indicates that the bulls have stopped investing in buying the asset.
  • The volume on the second candlestick increases sharply. Taking into account the fact that the second candlestick “engulfed” the first one, we conclude that the market sentiment has changed.
Bearish engulfing with a volume indicator added to it.
Bearish engulfing with a volume indicator added to it.

At the same time, the difference in volumes often indicates the potential of the pattern. For example, if the volume on the second candlestick is 30% -40% higher than on the first one, then working out the pattern can bring a good profit.

And here is an example of how to use the indicator Volumes can save a trader from a loss.

How volumes indicate that the signal is false.
How volumes indicate that the signal is false.

A Bearish Engulfing has formed on the chart, but the volume on the second candlestick is less than on the first. This means that the sales volumes are insufficient to reverse the upward trend and reverse the price.

Of course, sometimes this filtering method fails, but in most cases it allows you to distinguish a losing pattern from a profitable one.

Conclusion

In conclusion, it should be noted that trading in financial markets, including foreign exchange, based only on the use of patterns, candlesticks and technical figures, in itself carries increased risks. And only the introduction of additional filters, which are essentially different from your main tool, makes it possible to significantly reduce these risks and increase profitability. You just need to not be lazy to research the issue, look for options, consider new items on the market. Our forum, where professional traders consult among themselves regarding these issues, can greatly help you with this.

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