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011_candlestick_patterns

Candlestick Patterns: Statistical Pattern Recognition

Candlestick Patterns: Statistical Pattern Recognition

I. Historical Background

Japanese candlestick charting originated in 18th century Japan, developed by rice trader Munehisa Homma. Steve Nison introduced this methodology to the Western world in 1991.

II. Candlestick Anatomy

Definition 2.1 (Candlestick Components)

A candlestick consists of:

  • Body: |Open - Close|
  • Upper Shadow: High - max(Open, Close)
  • Lower Shadow: min(Open, Close) - Low

Definition 2.2 (Body Types)

  • Bullish (White/Green): Close > Open
  • Bearish (Black/Red): Close < Open
  • Doji: |Close - Open| < ε (typically < 0.1% of range)

III. Single Candlestick Patterns

3.1 Doji Patterns

Definition (Standard Doji): Doji:∣C−O∣<0.1×(H−L)Doji: |C - O| < 0.1 \times (H - L)

Types: | Doji Type | Upper Shadow | Lower Shadow | Signal | |-----------|--------------|--------------|--------| | Standard | Equal | Equal | Indecision | | Dragonfly | None | Long | Bullish reversal | | Gravestone | Long | None | Bearish reversal | | Long-legged | Long | Long | High volatility |

3.2 Hammer and Hanging Man

Definition (Hammer/Hanging Man): LowerShadow≥2×∣Body∣LowerShadow \geq 2 \times |Body| UpperShadow≈0UpperShadow \approx 0

  • Hammer: Appears after downtrend → Bullish reversal
  • Hanging Man: Appears after uptrend → Bearish reversal

3.3 Marubozu

Definition: Marubozu:UpperShadow=LowerShadow=0Marubozu: UpperShadow = LowerShadow = 0

Full control by bulls (bullish) or bears (bearish).

IV. Double Candlestick Patterns

4.1 Engulfing Patterns

Bullish Engulfing: Body2>0∧Body1<0∧O2<C1∧C2>O1Body_2 > 0 \land Body_1 < 0 \land O_2 < C_1 \land C_2 > O_1

Bearish Engulfing: Body2<0∧Body1>0∧O2>C1∧C2<O1Body_2 < 0 \land Body_1 > 0 \land O_2 > C_1 \land C_2 < O_1

4.2 Harami

Definition (Harami = "Pregnant"): The second candle's body is contained within the first candle's body: min⁡(O1,C1)<min⁡(O2,C2)<max⁡(O2,C2)<max⁡(O1,C1)\min(O_1, C_1) < \min(O_2, C_2) < \max(O_2, C_2) < \max(O_1, C_1)

4.3 Piercing Line / Dark Cloud Cover

Piercing Line (Bullish): O2<L1∧C2>(O1+C1)/2∧C2<O1O_2 < L_1 \land C_2 > (O_1 + C_1)/2 \land C_2 < O_1

Dark Cloud Cover (Bearish): O2>H1∧C2<(O1+C1)/2∧C2>O1O_2 > H_1 \land C_2 < (O_1 + C_1)/2 \land C_2 > O_1

V. Triple Candlestick Patterns

5.1 Morning Star / Evening Star

Morning Star (Bullish):

  1. Long bearish candle
  2. Small body (gap down)
  3. Long bullish candle closing into first candle

Evening Star (Bearish):

  1. Long bullish candle
  2. Small body (gap up)
  3. Long bearish candle closing into first candle

5.2 Three White Soldiers / Three Black Crows

Three White Soldiers: ∀i∈{1,2,3}:Ci>Oi∧Ci>Ci−1∧Oi>Oi−1\forall i \in \{1,2,3\}: C_i > O_i \land C_i > C_{i-1} \land O_i > O_{i-1}

Three Black Crows: ∀i∈{1,2,3}:Ci<Oi∧Ci<Ci−1∧Oi<Oi−1\forall i \in \{1,2,3\}: C_i < O_i \land C_i < C_{i-1} \land O_i < O_{i-1}

VI. Statistical Analysis

6.1 Pattern Success Rates (Bulkowski Research)

| Pattern | Bullish | Bearish | Success Rate | |---------|---------|---------|--------------| | Engulfing | 63% | 79% | High | | Hammer | 60% | - | Moderate | | Morning Star | 78% | - | High | | Doji | 51% | 51% | Low |

6.2 Significance Factors

Pattern reliability increases with:

  1. Higher timeframes
  2. Volume confirmation
  3. Location at S/R levels
  4. Trend context

VII. Quantitative Pattern Detection

Algorithm 7.1 (Hammer Detection)

function isHammer(O, H, L, C):
    body = |C - O|
    lower_shadow = min(O, C) - L
    upper_shadow = H - max(O, C)
    range = H - L
    
    return (lower_shadow >= 2 * body) AND 
           (upper_shadow < 0.1 * range) AND
           (body > 0.1 * range)

Algorithm 7.2 (Engulfing Detection)

function isBullishEngulfing(candle1, candle2):
    return (candle1.C < candle1.O) AND       // bearish first
           (candle2.C > candle2.O) AND       // bullish second
           (candle2.O < candle1.C) AND       // opens below close
           (candle2.C > candle1.O)           // closes above open

VIII. Exercises

Exercise 1: Classify the following candle: O=100, H=102, L=95, C=101.

Exercise 2: Write pseudocode to detect an Evening Star pattern.

Exercise 3: Given 500 historical engulfing patterns with 62% success rate, is this statistically significant at α=0.05?

Exercise 4: Calculate the expected value of trading every hammer at S/R with 60% success and 2:1 R:R.

IX. References

  • Nison, S. (1991). Japanese Candlestick Charting Techniques
  • Bulkowski, T. (2008). Encyclopedia of Candlestick Charts
  • Morris, G. (2006). Candlestick Charting Explained
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