Do Candlestick Patterns Actually Work in Forex?
Candlestick patterns have been a popular form of technical analysis and chartists for a long time. However, the forex market does present a problem for candlestick pattern traders in that the forex market doesn’t tend to gap as much as the other markets most candlestick traders hail from.
It does beg the question then: do candlestick patterns actually work in the forex market?
And surprisingly they do.
In fact there’s one such pattern we will explore in this article which I hope will whet your appetite on continuing to explore the candlestick pattern phenomenon in financial markets.
We’ll start with a pattern that is generally known in the candlestick trading forex market circles as a “pin bar”.
What is a pin bar?
A pin bar can either be bullish or bearish and is derived from the famous candlestick patterns of a hammer and a shooting star.
The pin bar is what is commonly known to those familiar with candlestick patterns as the bullish hammer pattern or the bearish shooting star pattern.
The pattern can be seen in the following charts on the EURUSD.
Here is a bullish pin bar on an hourly chart.
Here is a bearish pin bar on a daily chart.
The only thing you need to be wary of as you scan back through historical prices is that your eye will automatically tend to look for these patterns at peaks and troughs as your scanning back through time.
If you really wanted to test your ability on picking pin bars then you should scroll back to as far left as you can go with your charts (without looking!) and then progress one bar at a time and ask yourself the question, is this a pin bar I would trade?
Then you should the effect of that choice over the next preceding bars to see if you have picked a good bar. Not that every pin bar will be a winning trade.
What makes a pin bar?
To understand what makes a pin bar so effective we will examine one on a high time frame and then look at a lower time frame to see how the bar was formed.
Here is one nice big pin bar seen on 8th May 2019 for the AUDNZD, it stands out like a sore thumb:
The bearish pin bar seen on 8th May 2019 on AUDNZD.
If we explore what happened on that day it will help us to discover how these patterns are formed and to then be able to detect pin bars that are likely to be the most effective.
Here’s the four hourly chart on this day:
How the daily pin bar formed throughout the day on a 4-hourly time chart
Notice the pattern within the pin bar:
Price looked very assertive in one direction from the first 6-8 hours of the day.However, something happened and price rejected the high. In effect we see a pin bar formed within this daily pin bar!We then see price continually peeling away from the advances made in the morning’s moves.To end the day only slightly above where it opened.So hopefully this helps to illustrate what is happening behind the larger pattern to give you an insight into what the market is doing.
Let’s look at a bullish pin bar pattern and see what behaviour is behind these patterns:
Here we can see 2 bullish pin bars forming on the daily AUSNZD chart one on the 13 June 2019 and the other one week later on 20 June 2019.
Here’s what the four hourly chart shows on those two days:
Notice the same underlying formation of each day which results in the bullish pin bar.
Notice with both of these days we see the same underlying features occurring as what we saw in the bearish example above:
Markets start the trading day in one decisive direction. We see there is one good bar on the four-hourly chart which is a definitive down bar. It even looks larger than the bars before.Not long after that decisive down bar we then see price stop in that direction.It then proceeds to reverse for the remainder of the day and peel back on the morning’s entire down move.Price closes near where the day opened.Test your pin bar understanding
Which of the following pin bar patterns below in the USDCAD daily chart would exhibit characteristics that we have defined above?
6 days are labelled and are as follows: 9th May 2019 (bearish); 16th May 2019 (bullish); 17th May 2019 (bearish); 22nd May 2019 (bullish); 31st May 2019 (bearish); 5th June 2019 (bullish)
Let’s have a look inside each of these days and see whether our pattern held up:
Here are the 9th & 16th May 4-hourly bars.
By looking at our first day on the 9th May we can see that there was no real assertive up bar on the 4 hourly chart. There may have been on perhaps an hourly chart, but unfortunately it doesn’t match what we have seen with our other examples.
Our next daily pin bar occurs on the 16th May and it is a bullish pattern, which means we should be expecting a large down bar on our 4 hourly time frame. And we do see a very large down bar during the middle of the day, only to see price reject this move and move sharply higher for the rest of the day.
Here are the 17th & 22nd May daily pin bars on 4-hourly charts
Our next daily pin bar identified on the 17th May shows a decisive couple of up bars that are clearly defeated by one large down candle. Price rejects the move of the day and we then clearly see price peel away and continue the rejection higher.
Similarly, with the 22nd May we see a very decisive down bar, which would make you think that the market was going to continue south, however, price rejects the move lower and continues moving northward.
Here is the 31st May bearish pin bar pattern followed by the 5th June bullish pin bar pattern.
Not one wanting to sound like a broken record here, but I hope for our first highlighted area we can see the same pattern occurring for bearish pin bars: decisive up move with a candle body that is generally bigger than its previous up bars; followed by rejection; and a continual eating away of the gains made in the early morning.
But note the second example on the 5th June.
Why did this daily pin bar fail?
It looked so good!
Do we see the same behaviour that we’ve noticed in successful moves before?
No.
What was missing?
If this was a bullish pin bar we would have expected a decisive down candle prior to the move up.
Do you see a decisive down bar day on the 4 hourly chart?
I don’t.
Don’t you find that a little interesting?
Now obviously, I know not every pin bar will be successful and this is why when we see a pin bar and seek to trade it we don’t put the house on it every time. If you are using the pin bar pattern as a trading entry point strategy you might want also want to consider more deeply about integrating some type of check goes to the next lowest time frame to see if it contains characteristics you’ve observed in pin bars that make good on their next direction.
Conclusion
Hopefully in this article you have seen and understood what a pin bar pattern looks like and what makes one pin bar more successful than another. It’s easy enough to be able to identify what a pin bar looks like, but make sure you analyse its make-up and behaviour.
Ask yourself: How was this pin bar formed? Do I see decisive movement in one direction? Does that move end up being rejected?
When you’ve confirmed that you have a good juicy pin bar found then you can proceed to continue on with your trading mechanics to determine a proper entry point for your trade.
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