Candlestick Patterns Trading - Backtest's Results on American Stock Market

Candlestick Patterns Trading - Backtest's Results on American Stock Market

Candlestick charts are popular amongst all kind of traders even though they originally come from ancient Japan and were primarily utilzed to trade rice. Today, they are considered a "common knowledge" and there are plenty resources about them on the Internet. Despite everybody agreeing about significance of some of the patterns it looks like nobody performed real tests on past market data to determine actual results.

I have back tested some of the most popular candlestick patterns on NYSE. I used daily data of over 400 most liquid stocks spanning recent 20+ years. Some patterns were confirmed and several turned out to be complete failures. Prior to diving into test's results let's talk about different kinds of patterns:

Reversal patterns -- patterns after which market (or a stock) typically reverses. Vital for trading as they enable traders to exit before the trend changes its direction.

Continuation pattern - patterns after which market usually carries on. Can be helpful for moving stop loss order closer to the market (as breaking a continuation pattern is usually a bad signal) and opening additional position.

I have back tested the following patterns:

Rising Three Methods -- Incredibly strong, and rather widespread, continuation pattern in an up trend. Average stock's change equals +2.2% in 20 trading days.

Bullish Kicking -- Reversal pattern in a down trend. Not as solid as "Falling Three Methods" but good for trading: average market's move equals +1.5% after 20 trading days.

Falling Three Methods -- Reversal pattern in a down trend. Shows strong bullish edge -- mean stock's change is +0.7% in 5 days and +2.0% in 20 days.

Morning Star -- Vastly popular amongst traders but rare reversal pattern in a down trend. Incredibly strong bullish edge -- average change is +4.5% after 20 days.

Evening Star -- Reversal pattern in an up trend, though fairly weak and short term. Exhibits a bearish edge over the next couple of trading days. Mean change in 5 days after the pattern equals -0.2%, after 20 days +0.3%.

Three White Soldiers -- Pattern that is in fact a confirmation of "Bullish Piercing Line". Typical move in 20 trading days equals +1.7%

Bullish Piercing Line -- Extremely frequent reversal pattern in a down trend. Average change after 20 days equals +1.4%

Dark Cloud Cover -- Continuation pattern in an up trend. Incredibly widespread (over 12000 occurrences) with typical change +1.4% in 20 days.

Three Black Soldiers -- Looks like a confirmed "Dark Cloud Cover". Typical market's change is +1.6% in 20 trading days after the pattern.

As can be seen, several patterns offer a substantial market edge and can be used for trading purposes. Obviously any trading technique must be back tested before committing any funds and this is what I've tried to illustrate in this article. Using back tested candlestick patterns you can expect returns of nearly 2% a month which compounds to 26% a year -- much more than broad market's average.

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