This article was contributed by Hari Babu who works as a part-time writer for various clients.
Many traders use patterns of candlesticks to predict future market movements. They have been around for centuries and are still popular today, despite being discredited as an effective tool by modern economists.
The first thing to understand about candlesticks is that they do not predict anything; instead, they provide information on past price movements to make educated guesses about future ones. This means there is no guarantee that any particular pattern will lead you towards success or failure; however, it does mean there's always some risk involved when trading with them!
Traders need to understand the risk of each pattern before taking a trade. This is especially important for more aggressive patterns; it is much easier to predict the reversal of a trend when it has been in place for weeks or months than when it has only been in place for hours or days. Some of the risks of these patterns are;
They Are Subjective
One risk factor associated with candlesticks patterns is that they are subjective and often open to interpretation. For example, what one person might see as a bullish engulfing pattern could be viewed as a shooting star by someone else. Traders often disagree on what a pattern means and whether it is a bullish or bearish signal.
There is also an element of confirmation bias when interpreting candlesticks patterns and other technical analysis indicators. Once a person sees something they want to see, like an end to a downtrend, they may ignore evidence that shows the move or reversal has not yet occurred and place a trade based on their misinterpretation of the candlestick pattern.
In addition, these patterns can be found in all time frames and combined with other indicators. They can also be used with technical analysis tools to confirm or invalidate other technical indicators. For example, a doji candlestick may be used to verify the presence of a trend reversal if it co-occurs as a bullish divergence on the RSI indicator.
Not All Patterns Are Created Equal And Can Be Found On Any Chart
It's tempting to think that if two candlesticks look alike, they must signal the same thing. But that's not necessarily true at all — each signal is unique and needs to be treated as such. Some are more reliable than others, and identifying which ones may be a waste of time is a skill that all traders need to acquire.
Another issue is that the patterns can be found on any chart at any time. This means they often occur randomly, and just looking for these patterns won't make you money in the long run. What you want to do is use the patterns together with other indicators like support and resistance levels, trend lines, and moving averages to give your more confidence in trading these patterns.
Patterns Can Have Different Names
One thing to remember is that many patterns have multiple names. This can cause confusion when trying to interpret them. For example, the “Bearish Piercing Line” and the “Dark Cloud Cover” are different names for the same pattern. There's nothing wrong with that, but it can be unclear to people who are new to technical analysis — which is why many analysts use multiple names to describe the same pattern. Some patterns only bear a resemblance to each other, such as the evening star and the morning star.
This means that you'll probably come across two different descriptions for what looks like the same pattern – and they might be completely different! Understanding some of these minor differences is essential before entering a trade.
Patterns Often Require Confirmation
Even a pattern that appears to be very reliable may fail without confirmation from another indicator or set of indicators. For example, if you see a “hammer” at the end of a downtrend, it might indicate that a reversal is coming soon. But you might want to wait for confirmation by looking at other indicators such as volume and trend line analysis before you buy.
In a rising market, a gap up followed by a doji is less significant than the same gap up followed by a tiny black body (or vice versa in a falling market). If you see an evening star pattern on your chart, look to see if the next day's price action confirms it with a gap down or long black candle.
Some Patterns May Not Be As Reliable As They Appear And Are Prone To False Positives
Some patterns will occur more frequently than others, but some of them may not be useful in predicting future price movements. Specific bullish patterns, for example, can sometimes indicate a continuation rather than a reversal of an existing bearish trend.
They also tend to showcase false positives. For example, if you're looking at a daily price chart, a doji represents indecision over one trading day – but it could mean very little in the context of the whole trend.
They Won't Tell You How Far A Price Will Move Once It Reverses
These patterns can be beneficial for identifying trends, and they may be something that you want to incorporate into your current trading strategies. However, most of them aren't going to help you predict direction. They are still worth using, even if they only tell you about the probability of a trend continuing or reversing.
Any trader must remember that the patterns of candlesticks are just another reference point – not “the” reference point. You should study them as often as possible and not just focus on one type. The candlestick chart gives you a broad picture, and it's challenging to identify a precise entry or exit point after studying the chart alone. There are no complex rules in trading; they only serve us as reminders on how to be constantly alerted so we don't miss the important events that may help us decide what action to take.
About the author
Hari Babu is a part-time internet marketer with 6 years of experience in various internet marketing activities like SEO, Branding, Press releases etc. He has assisted many businesses to rank on page one of Google for various competitive keywords. He is also a Java developer by profession. Besides providing professional internet marketing services, he likes sharing his ideas on the software industry, internet marketing, and crypto-related topics.