3 Bullish Candlestick Patterns That Work

Last Updated on November 23, 2021 by Oddmund Groette

Candlesticks are a popular charting method. We use them extensively ourselves for charting because we believe they give a very good visualization of the price action, even though we never use any candlestick formations in our own quantified trading. Among those who swear to use quantified strategies, traders like us, candlesticks have a rather poor reputation. Is it any reason for this negativity?

This article shows you 3 candlestick patterns that work. It turns out, perhaps surprisingly, that some candlestick patterns work reasonably well. We test Bearish Engulfing Pattern, Three Outside Down, and Bullish Harami.

Do candlesticks work?

Before you continue reading we would like to remind you of a previous article we did earlier that covered 23 candlestick formations. Most of them failed our quantitative tests, but some of the patterns and formations performed pretty well and can most likely be improved.

Candlestick patterns and when to exit

We have yet to see any candlestick proponent who has given a specific trading strategy based on backtests of the pattern. Practically all “advice” is based on anecdotal evidence without any quantified tests. Moreover, all analysis is mostly based on the entry and very little focus on the exits.

We have covered how and when to exit a trade before.

The quantified tests in this article used a very simple exit rule: we exit when today’s close ends the day higher than yesterday’s high. We exit on the close:

In which markets do we test 3 bullish candlestick patterns?

We test our candlestick patterns on the S&P 500. We use the ETF with the ticker code SPY as a proxy and the testing period is from its inception in 1993 until October 2021.

Our tests are done by investing 100% of your equity into each trade. This means our results are compounded (CAGR).

Candlestick pattern no. 1: Bearish engulfing Pattern

We start by presenting the Bearish Engulfing Pattern. You might be confused by the word “bearish”. Isn’t this an article about 3 bullish candlestick patterns?

Indeed, it is. But ironically, the Bearish Engulfing Pattern is one of the best bullish candlestick patterns we have found. Exactly the opposite of what the textbooks say!

What exactly is a Bearish Engulfing Pattern? We define the pattern like this:

  • Yesterday’s close is bigger than yesterday’s open, and
  • Today’s close is lower than today’s open, and
  • Today’s open is higher than yesterday’s close, and
  • Today’s close is lower than yesterday’s open

The green arrows in the chart below show what the pattern looks like (ignore the red arrows – they are the exits):

Let’s test the Bearish Engulfing Pattern based on the rules above. This is the equity curve and drawdown for the strategy:

There are 268 trades, the average gain per trade is 0.55%, the CAGR is 5.1%, the time invested in the market is 14%, the win ratio is 71%, the max drawdown is 16%, and the profit factor is 2.5. The win ratio is also high.

Candlestick pattern no. 2: Three Outside Down Pattern

What exactly is the Three Outside Down Pattern? We define the pattern like this:

  • The close two days ago is bigger than the open two days ago, and
  • Yesterday’s open is higher than yesterday’s close, and
  • Yesterday’s open is higher than the close two days ago, and
  • The open two days ago is higher than yesterday’s close, and
  • yesterday’s open minus yesterday’s close are higher than the close two days ago minus the open two days ago, and
  • Today’s open is bigger than today’s close, and
  • Today’s close is lower than yesterday’s close

The green arrows in the chart below shows how the pattern and formations look like (ignore the red arrows – they are the exits):

When we backtest the strategy based on the assumptions above we get this equity curve and drawdown for the strategy:

There are 108 trades, the average gain per trade is 0.71%, the CAGR is 2.6%, time invested in the market is 5%, the win ratio is 80%, the max drawdown is 14%, and the profit factor is 2.8.

Candlestick pattern no. 3: Bullish Harami

What exactly is the Bullish Harami pattern? We define the pattern like this:

  • Yesterday’s open is higher than yesterday’s close, and
  • Today’s close is higher than today’s open, and
  • Today’s close is lower than yesterday’s open, and
  • Yesterday’s close is lower than today’s open, and
  • Today’s close minus today’s open is lower than yesterday’s open minus yesterday’s close

The green arrows in the chart below show examples of the Bullish Harami (ignore the red arrows – they are the exits):

A backtest based on the assumptions above produces the following equity curve and drawdown for the Bullish Harami pattern:

There are 291 trades, the average gain per trade is 0.33%, the CAGR is 3.2%, time invested in the market is 12%, the win ratio is 76%, the max drawdown is 26%, and the profit factor is 1.65.

All in all, we would say the result is pretty good for such a simple strategy or pattern.

Conclusion about 3 bullish candlestick patterns that work:

The Bearish Engulfing Pattern, Three Outside Down, and Bullish Harami all produce decent results in our backtests. There are many candlestick patterns – probably hundreds. We picked these patterns because they showed the best results among the 23 candlestick patterns we tested earlier (we a decent amount of observations).

However, as always, you can most likely improve the patterns by including a parameter/variable.

Amibroker code for 23 candlestick patterns:

If you are interested in the Amibroker code for the 3 bullish candlestick patterns in this article plus 20 others, you can order it here (strategy no. 6 – candlesticks).

 

Recommended reading:

 

Disclaimer: We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinions – they are not suggestions to buy or sell any securities.