3 Bullish Candlestick Patterns That Work – Backtesting and Historical Performance Insights
Very few bullish candlestick patterns work, but this article presents 3 bullish candlestick patterns that work. Even though Candlesticks are a popular charting method, very few patterns have any predictive value. We use candlesticks extensively ourselves for charting because we believe they give an excellent visualization of the price action, even though we never use any candlestick patterns in our quantified trading. Among those who swear to use quantified strategies, traders like us, candlestick patterns have a rather poor reputation. Is it any reason for this negativity?
This article shows you 3 bullish 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 patterns and formations performed pretty well and can most likely be improved.
We would also like to mention that we have a complete candlestick course, in which we have quantified and backtested all 75 candlestick patterns complete with code): backtest of candlestick patterns.
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 quantified tests. Moreover, all analyses are mainly based on the entry and very little focus on the exits.
The quantified tests in this article used a straightforward exit rule: we exit when today’s close ends the day higher than yesterday’s high. We exit on the close:
- How to enter and exit positions at the close (for Amibroker and Tradestation)
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 involve investing 100% of your equity in each trade, which means our results are compounded (CAGR).
Bullish candlestick pattern no. 1: Bearish engulfing Pattern (Backtest)
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. Precisely the opposite of what the textbooks say!
What exactly is a Bearish Engulfing Pattern? We define the pattern like this:
Trading Rules
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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 from SPY’s inception in 1993 until today:
There have been 296 trades. The average gain per trade is 0.53%, the CAGR is 5%, the time invested in the market is 13%, the win ratio is 71%, the max drawdown is 16%, and the profit factor is 2.5.
Bullish candlestick pattern no. 2: Three Outside Down Pattern (Backtest)
What exactly is the Three Outside Down Pattern? We define the pattern like this:
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The green arrows in the chart below show 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 from SPY’s inception in 1993 until today:
There have been 112 trades. The average gain per trade is 0.7%, the CAGR is 2.3%, the time invested in the market is 5%, the win ratio is 78%, the max drawdown is 14%, and the profit factor is 2.6.
This candlestick pattern is pretty similar to the lower highs and lower lows pattern.
Bullish candlestick pattern no. 3: Bullish Harami (Backtest)
What exactly is the Bullish Harami pattern? We define the pattern like this:
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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 from SPY’s inception in 1993 until today:
There have been 306 trades. The average gain per trade is 0.33%, the CAGR is 3.1, the time invested in the market is 11%, the win ratio is 76%, the max drawdown is 25%, and the profit factor is 1.65.
We would say the result is pretty good for such a simple strategy or pattern.
Amibroker code for 23 bullish 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).
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, and all are bullish candlestick patterns that work. 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 had a decent amount of observations).
However, as always, you can most likely improve the patterns by including another variable.
FAQ:
Why is there skepticism around the effectiveness of candlestick patterns in quantitative trading?
Many quantitative traders express skepticism about the effectiveness of candlestick patterns due to the lack of quantified tests supporting their predictive value. While candlesticks are widely used for charting, their patterns are often criticized for relying on anecdotal evidence rather than rigorous testing.
How do you determine the best time frame for analyzing candlestick patterns?
The optimal time frame for analyzing candlestick patterns depends on the trading strategy and goals. In this article, the tests are conducted on the S&P 500 using the ETF with the ticker code SPY, with the testing period spanning from its inception in 1993 until October 2021.
Which three bullish candlestick patterns are discussed in this article?
Bullish candlestick patterns are specific configurations of candlesticks on a price chart that suggest potential upward price movements. The three bullish candlestick patterns discussed in this article are the Bearish Engulfing Pattern, Three Outside Down Pattern, and Bullish Harami. Each pattern is explained, and backtests are provided to assess their historical performance.