By Richard Krugel
There are plenty of bar styles that traders can use to derive information from their favorite market, with the Japanese Candlestick style being the most popular by far. In this article, we will have a look at how candlesticks can be used as a trade confirmation tool to find better entries with a higher probability of success.
What follows will be an explanation of how I use candlestick patterns as one of my confirmation tools to make better trading decisions.
My Favorite Candlestick Patterns
When running an internet search on candlestick patterns you may become overwhelmed by how many patterns are out there and trying to remember them all could be a daunting task indeed.
Traders closely watch candlestick formations to provide them with clues of what the market they are trading might do next. These formations can tell a story, especially when they pop up on their own, or in patterns, at important areas or levels that traders watch for reversals.
I have three favorite candlestick patterns that I look for because they have proven time and time again to be very accurate at confirming my entries at areas I want to trade from. They are:
- Reversal Candlesticks*
- Hammer Candlesticks
- Flanked Doji’s*
*Please note that I have simplified the naming of these patterns for myself as I’m sure that they could go by other names but I like to keep things simple.
- Reversal Candlesticks
Bullish Reversal Candlestick
The image above shows a bullish reversal candlestick and it is a singular candle formation. In this example, one could argue that the previous candle could also have been used to form what is called a bullish engulfing pattern and yes that would be correct but what if the previous candle was not that short in size?
Since I only look for candlestick patterns at areas I want to trade from, looking for that particular candle for a buying opportunity is all I need to signal an entry.
Here is what a bullish candlestick is telling me:
Price made a new low, but selling pressure very quickly dried up as an increase of buyers entered the market resulting in the candle closing high off its lows, signaling buying strength.
There could be variations of this with some reversal candles having taller wicks at their bottoms, but what is important to note is that these candles should leave a wick that made the ultimate low followed by a strong close higher as indicated by the tall green body of the candle.
Bearish Reversal Candlestick
The inverse is true with this type of formation in a bearish scenario and the image above shows how price made the highest high before reversing and closing strongly lower off its highs. This is an example of where the previous bar was quite tall yet price reversed on that bearish reversal candle alone.
Here is what a bearish candlestick is telling me:
Price made a new high, but buying pressure very quickly dried up as an increase of sellers entered the market resulting in the candle closing lower off its highs, signaling selling strength.
- Hammer Candlesticks
Bullish Hammer Candlestick
These candles are easy to spot and they generally have taller wicks than their bodies resembling a hammers handle and head. They tend to close with no or very little upper wicks. Whenever this formation appears I will still consider it to be a legitimate hammer when there is a wick above the head of one to two pips/ticks when closing, as long as the wick below is larger than the actual body of the candle.
Also note that the wick below does not necessarily have to make the ultimate low, but if it did then that’s a bonus.
Here is what a bullish hammer candlestick is telling me:
Price opened near the highs of the candle and although sellers initially succeeded at pushing price lower they lost the final battle when buyers tipped the scales in their favor again by closing price higher than the opening price.
Bearish Hammer Candlestick a.k.a Inverted Hammer
These bearish formations are simply upside down hammers and are also known as inverted hammers. This is a great example where the lower part of the wick left a one tick wick, so I am willing to allow for some leeway as I do not want to miss a trade entry.
Here is what a bearish inverted hammer candlestick is telling me:
Price opened near the lows of the candle and although buyers initially succeeded at pushing price higher they lost the final battle when sellers tipped the scales in their favor again by closing price lower than the opening price.
- Flanked Doji’s
Bullish Flanked Doji’s
These reversal patterns are formed with 3 candlesticks with the middle candle being the doji candle which is then flanked either side by two larger candles. Doji candlesticks generally show up at areas of indecision and they are defined by their very small bodies which tend to form around the middle of the candles length.
Here is what a bullish flanked doji candlestick formation is telling me:
Price came down strongly into an area when sellers where dominating but there was a period of indecision at the next candle because price went up and down not finding any real direction. This indicated a balance between buyers and sellers and at the very next candle buyers tipped the balance over in their favor and immediately moved price back up again.
Bearish Flanked Doji’s
The opposite is true in the case of a bearish flanked doji and in this example the doji had a very small body where the bullish example had none.
Here is what a bearish flanked doji candlestick formation is telling me:
Price moved up strongly into an area when buyers where dominating but there was a period of indecision at the next candle because price went up and down not finding any real direction. This indicated a balance between buyers and sellers and at the very next candle sellers tipped the balance over in their favor and immediately moved price lower again.
Entry Confirmation Example
Using candlestick patterns to confirm areas where price might reverse from is a good addition to any strategy, yet by adding additional entry conditions it becomes possible to filter out the bad setups from the good rather than only relying on reversal candles alone.
What follows is a glimpse of how I use additional confirmation criteria together with candlesticks to enter trades.
My first chart shows a familiar corrective pattern that I love to trade called a Triangle Correction. This one in particular is called an Ascending Triangle and knowing how they develop helps me a lot to pinpoint where the correction is most likely to end AHEAD of time.
My strategy is based on joining the dominant trend at the end of corrections and by combining my knowledge of multiple types of corrections with additional techniques like market geometry and market structure, I am able to enter trades with very little risk and large profit potential.
I then go one step further and apply rules to my entries in the form of specific entry conditions that I need to see first.
- My first rule is that price needs to be at an area of market geometry or Fibonacci level. On the second chart above we can see that price touched my 0.786% Fib retracement line that I measured between label C and D. I knew ahead of time that wave E should end around one of my Fib levels giving me a trade setup that should signal the end of this correction.
- If the first rule occurred THEN I would have to see momentum divergence next at that level. My second rule was fulfilled when price came down the second time around and touched the 0.786% Fib level on declining momentum.
- My third rule involves reversal candlesticks! Look at how well (when combined with the two rules above) that bullish reversal candlestick signaled the exact end of the E wave.
- My fourth and last rule states that I should be able to afford the risk associated with the trade if I placed an entry order a couple of ticks above that reversal candle with a stop loss order a couple of ticks below it. (See chart below)
My last chart shows where the entry and stop loss order would have been placed. Price never came down again and that entry was taken from a 5 minute chart meaning that my risk was very low.
This article showed you how powerful it can be to use candlestick patterns and candlestick confirmation but when you combine these patterns with additional entry confirmation rules then you really have a good strategy going.
It does not matter which market or timeframe you like trading, just have a good look at all the major swing highs/lows that happened on your chart and you will soon see that these candlestick patterns we covered keep popping up over and over again at those turns.
Unfortunately, traders need to have the capability to know where these major swings are most likely to occur before taking any trades because taking setups on reversal candlesticks alone will not work. They should be part of a strategy which is what we teach with my Exponential Profits System or EPS for short.
If you enjoyed this article and you’re interested in taking your trading to the next level by finally understanding price action, then be sure to check out my course info here.
I wish you a successful and profitable trading journey ahead!
All the best,