Best Candlestick Patterns for Price Action Analysis



As mentioned in a recent post, the key for a better Price Action Analysis with candlesticks is "read" them at a glance and the patterns it forms, mainly when price approaches an S-R level, doing always in conjunction with volume.

Candlesticks are a reflection of what buyers and sellers are doing. You need to know its meaning: indecision, rejection, reversal, or momentum.  In Price Action Analysis, less is more with technical indicators: a few of them are enough. The same idea for candlestick patterns. You can find dozens of candlestick chart patterns, but I feel comfortable with a few of them, the most accurate in my point of view.  No need to memorize them all, just understand the mechanics behind this tool. Consider the following:

Single candlesticks


1- Pin Bar (or long-wick candle): the longer the wick, the better the candle. This candle means that indecision began, as buyers tried to push price higher but failed, causing the wick to show, meaning a rejection. There are bullish pin bars (the longer wick below the small body, been green or red), and bearish pin bars (the longer wick above the small body, been green or red).

2- As a derivative of this, a candle with no wick, represent that price bias is gaining strength in one direction. So, a big green candle without a wick is its the most bullish pattern, and a big red candle without a wick is its the most bearish.  And if this candle body is bigger than the previous candle body, its called a Momentum candle. Its best usage is after a rejection candle (like a Pin Bar or a Harami) or a reversal candle, as the Engulfing.

3- Inside the reversal one-candle ones you have at the end of a downtrend the bullish Hammer, that represents the bottom of a trend, and the Shooting Star, an inverted hammer forms after an uptrend movement, signaling a trend reversal to the downside. Less powerful are the variations of them: the less bullish Inverted Hammer (upper tick longer than the lower tick) form after a downtrend and the less bearish Hanging Man, the end of an uptrend. All these reversal patterns need an increased volume, necessarily greater than the previous candle, otherwise, its signal fades.

4- Finally, the Doji candle means complete indecision between bulls and bears. So, there any signal trade there.


One-candle patterns can be identified in the chart above, taken from slideshare.net, ordered according to the strength of its signal: Momentum Candle (1,6),  Hammer (2), Normal Candle (3,8), Neutral Pin-Bar (4,9), Inverted Hammer (5), Dojis (11-13), Shooting Star (7), Hanging Man (10).





Two-candle pattern


1- Harami: also called Inside Bar, is a popular rejection two-candle pattern, that could mean a reversal or continuation in the trend. It high and low is completely contained by the high and low of the previous candle. It can indicate a pause in a trend, momentum loss, or indecision. Its best usage is at support/resistance levels: if the inside bar is also a Pin Bar or a Doji, it reinforces the probable reversal trend.

2- Engulfing is my favorite bullish/bearish pattern by far. Consists of a two-candle pattern that anticipates possible reversals.  In a support level, a bullish trend can appear if a rejection green candle length (close-open) "engulfs" the previous red candle length (open-close). The same idea at resistance levels. I found this pattern to be very accurate, but need subsequent price action to confirm the reversal.


The key: check candles behavior at support-resistance levels


When price approaches an S-R key level, you have no idea whether there will be a trade or not until you get price action. At that level, candlestick pattern forms, as a result of profit-taking, new positions opened, or a combination of both, and the strength of its signal is increased.

Consider these other patterns formed by single candlesticks:

1- Big candles: Be careful when you see large candles approaching support or resistance levels. Price is gaining momentum and no price action occurs for a trade.

2- Many rejection candles: means more than one pin-bar rejection candle of an S-R level (the more rejections the better). This basically shows that price tried over and over to push through the level but failed and a reversal is near. Consider that no matter the color of the long wick candles.

3- Candle color change: if after consecutive candlesticks of one color, the candle color change, it means momentum loss. Best use at key levels, in combination with other candlestick patterns as shrinking or rejection candles. It can signal a possible trend change.






A simple but powerful Candlestick Strategy


As price approaches an important resistance level, check the size of the candlesticks. If they are shrinking or decreasing each one, it means momentum loss. Bullish traders are losing steam due to they are less interested in the trend and are closing positions or taking profits.
- When the price reaches the resistance level with a small candle, check if the next is an engulfing candlestick. That signals a high probable reverse in the trend for the short-term.
- When the price reaches the resistance level with a small candle, check if the next is a rejection or indecision candle (Pin Bar, Doji, or Inside Bar). In this case wait for one more, as a momentum candle, for a better signal of a trend reversal in the short-term.

This simple strategy, taken from WyseTrade.com, also works for supports and bearish traders.  Check the grey circle in the SPY 1-min chart below: three red candles were shrinking when approaching important support $277.20, followed then by a big green engulfing candle with increased volume. The odds for a trend reversal are huge at that point. Then check the next resistance for an exit point: in this case, $279 seems difficult to crossover, due to many rejection candles there.  This scalping strategy appears only a few times in a daily session but is very powerful. Try it.