Thomas Bulkowski - Candlestick Chart patterns
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Thomas Bulkowski the highly regarded author of ‘Encyclopedia of candlestick charts’, not only identified patterns but he was able to build rankings of reliability around them.
Bulkowski managed to retire at the age of 36 from his trading endeavours and soon after he created a website called The Pattern Site.
In this review we provide the top 5 candlestick patterns from the 103 presented in the book. All of which you can apply to your trading strategies straight away.
Let’s take a look..
Thomas Bulkowski defined two kind of pattern outcomes;
A ‘reversal’ pattern which predicts a change in price direction, and a continuation pattern which predicts an extension in the current price direction. This is classed as a bullish example, although the same principle and classification also apply to a bearish pattern.
Let’s get straight into the 5 most reliable candlestick patterns, starting with number 5 the bearish ‘ Two Black Gapping’ continuation formation, this pattern predicts lower prices with a 68% accuracy rate.
The bearish two black gapping continuation pattern appears after a notable top in an uptrend, with a gap down that yields two black bars posting lower lows. This pattern predicts that the decline will continue to even lower lows, perhaps triggering a broader-scale downtrend.
Both black candles can be of any size so long as the second black candle has a lower closing price than the low of the first candle.
Bulkowski used a sample size of 18,264 patterns of this nature to determine a downside continuation, a continuation occurred 68% of the time after the formation.
He also concluded that the predictability performed equally well in bull and bear markets, however as we can see from the performance table below there is a slightly better performance in a bear market, showing a 3.11% decline after 10 days. A great short selling return over such a short period.
In 4th place we have the bullish ‘Abandoned Baby’ reversal formation which predicts an increase in price 70% of the time.
The reversal pattern appears at the low of a downtrend, after a series of black candles print lower lows.
The market gaps lower on the next bar, but fresh sellers fail to appear, yielding a narrow range ‘Doji’ candlestick with opening and closing prints at the same price.
A bullish gap on the third bar completes the pattern, which predicts that the recovery will continue to even higher highs, again, perhaps triggering a broader-scale uptrend.
Of 4.7 million candle formations analysed, Bulkowski found only 293 abandoned baby formations, of which a reversal happened 70% of the time.
There was similar performance calculated in both bull and bear markets, with bull markets nudging ahead over a 10 day period with a 2.59% price increase.
This may be considered a small number but annualised this would equate to almost a 95% return.
In third place we have the ‘Evening Star’ bearish reversal formation, which according to Bulkowski predicts lower prices
with a 72% accuracy rate.
The evening star reversal pattern starts with a tall white bar that carries an uptrend to a new high.
The market gaps higher on the next bar, but fresh buyers fail to appear, yielding a narrow range candlestick. A gap down on the third bar completes the pattern, which predicts that the decline will continue to even lower lows.
Bulkowski found 903 of these candle formations which again performed well in both bull and bear markets, however, we can see here that a bear market outperformed a bull market considerably, with a price change of 4.34% over a 10 day period. Annualised this equates to a very credible 158% return.
In second place we have the bearish Three Black Crows reversal formation.
The pattern starts at or near the high of an uptrend, with three black bars posting lower lows.
This formation predicts that the decline will continue to even lower lows 78% of the time. The most potent setup is when the 1st bearish candle is not only close to the high of the prior uptrend but marks the highest price achieved, Bulkowski says this is due to trapping buyers that entered what seemed to be a momentum play at the time.
2660 formations were found, of which, a bear market provided the best environment.
The table here shows that over a 10 day period the priced changed 1.41% after the completion of the three black crows. Not a huge % decline but with 2660 opportunities and a 78% accuracy rate, the compounding effect would be very significant.
Finally, in 1st place we have the bullish ‘Three Line Strike’ formation.
The bullish three-line strike reversal pattern carves out three black candles within a downtrend, each bar posting lower lows.
The fourth bar opens even lower but reverses with a wide-range outside bar that closes above the high of the first candle in the series.
Bulkowski discovered that this pattern predicted price reversals correctly a commendable 84% of the time. 85 Three Line Strike formations were found through his analysis, of which, a bear market produced the best results.
We can see in the table here that the average price change over a 10 day period was 7.53%, annualised this would be a huge 274% return. Not a bad strategy to add to your trading toolbox.
We can see this winning candlestick pattern in a previous chart example, a company called Brown Forman. Here we can see a downtrend leading into the pattern, the pattern is formed by the three candles hitting lower lows, followed by the 4th candle which opened lower but reversed considerably and closed above the 1st candle of the formation, often referred to as an engulfing candle. Thereafter the price continued to trend higher and achieved an approximate return of 7 % over the following 10 days.
One of the best charting scanners I have seen to pick up such candlestick patterns is a website called Chart Mill, I have put a link below for those interested.
So, to recap Bulkowski’s most reliable candlestick patterns, in 5th place we have the Two Black Gapping formation, providing 68% accuracy, more than 18 thousand pattern frequency and a 3.11% return over 10 days equating to 113% annualised.
In 4th place, the Abandoned Baby formation, providing 70% accuracy, a frequency of 293 and a 2.59% return over 10 days equating to 95% annualised.
In 3rd place, the Evening Star formation, providing 72% accuracy, a frequency of 903 and a 4.34% return over 10 days equating to 158% annualised.
In 2nd place, the Three Black Crows formation, providing 78% accuracy, a frequency of 2660 and a return of 1.41% over a 10 day period equating to 51% annualised.
And finally, in 1st place, the Three Line Strike, offering 84% accuracy, a frequency of 85 and a 7.53% return over 10 days providing an annualised return of 274%.
This concludes the 5 most accurate candlestick formations from Thomas Bulkowski’s book, of which he shares over 100 formations through more than 900 pages.
For those looking to create a system around candlesticks or simply to achieve a better entry point for a current strategy, then this book should form part of your library. Therefore, I rate this book 5 out of 5 stars.
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Thanks for listening.