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Are candlesticks patterns statistically significant?


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Are candlesticks patterns statistically significant?

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  #1 (permalink)
 anubis 
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Hi, I'm under the impression that analyzing price action based on arbitrary slices of time/range makes not much sense because you can find a slice size that gets you "rejection" wicks at "support" zones, but you can also find another slice size that doesn't show wicks at the same price level.

For example, a 1min chart might show a rejection candle where a 2min won't.

Or they work because many traders are looking at the same slice sizes (5min, 10min, etc.)? But this will make them extremely susceptible to be abused because "everybody" will know where their stops are.

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  #2 (permalink)
 Schnook 
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I agree, to an extent. One time-frame that is not arbitrary, however, is the daily. Candle patterns on an intraday chart are less meaningful to me, but on a daily chart I will always pay attention.

It has been my observation in general that certain price-action trading concepts are far more effective on longer time frames than they are on very short time-frames.

If you really want to know whether candlestick patterns are statistically significant, then download a bunch of price data and do a study. You'll learn a lot more that way than you will by asking strangers on the internet what they think

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  #3 (permalink)
Ozquant
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No

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  #4 (permalink)
 bobwest 
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They probably aren't, because I don't think you can quantify what you mean by a particular pattern well enough to run a statistical analysis on it. (Or, if you just decide that one pattern is described a certain way quantitatively, then probably you are being a bit arbitrary about how you classify them, which puts the whole question in doubt.) Patterns of any sort are largely a matter of human discretion and judgment in identifying them. If you can do it, then fine. But if it's a matter of human judgment, it's not going to be quantifiable well enough to really test their significance... something that is up to judgment is not that easily tested statistically.

So some simple advice is try it and see. We don't see many traders here using the patterns that are found in books all that much, at least not exclusively. If you're a discretionary trader, some of it may be part of your toolkit, but be aware that the more discretionary you are, the more individualized your trading is and the less verifiable by some statistical means. (Other than your profit/loss, that is.)

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  #5 (permalink)
 Schnook 
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One candlestick pattern that is easy to test is a hammer, or shooting star. To adherents of traditional candle pattern analysis, these are important reversal patterns, and just about all of the information required to identify them is contained in one bar.

To test the predictive power of a hammer, for example, establish the following criteria (or something similar; these would be the arbitrary conditions Bob was alluding to above):
  • New 20-period intra-period low = Low < minimum Low of prior 20 periods
  • Very small candle body = Absolute value (Open - Close) < 10% average true range
  • Long lower wick = (Close - Low) > 80% average true range

Then test what happens in the following period, or test what happens in the following 3 periods, or after a confirmation, etc. If you're ambitious, see if volume or range size affects the results.

Even if you determine that there is zero predictive power in these candles, you will have learned something.

By the way, anyone here old enough to remember InletCap's "retail bus" pattern?

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  #6 (permalink)
drm7
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Charles Bulkowski did a pretty thorough study of the most popular chart patterns and candlestick patterns. All of the stats are on his website. thepatternsite.com (no affiliation). He is really thorough and attempts to be as precise as possible, but the stats are still hard to interpret. There seem to be some promising patterns.

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  #7 (permalink)
Ozquant
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drm7 View Post
Charles Bulkowski did a pretty thorough study of the most popular chart patterns and candlestick patterns. All of the stats are on his website. thepatternsite.com (no affiliation). He is really thorough and attempts to be as precise as possible, but the stats are still hard to interpret. There seem to be some promising patterns.

Did he quantify these patterns mathematically with programming ? OR is it some type of subjective analysis . In my experience standalone candle patterns offer zero edge BUT with some context results may be better .

Given the time he died and cannot see his probabilities on candle patterns to be robust in anyway . Without masses of data analyzed by code with powerful computers that he likely had no access to in his lifetime cannot see anyone developing anywhere near robust definitive probabilities ( edge) that you can take to the bank

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  #8 (permalink)
drm7
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Ozquant View Post
Did he quantify these patterns mathematically with programming ? OR is it some type of subjective analysis . In my experience standalone candle patterns offer zero edge BUT with some context results may be better .

Given the time he died and cannot see his probabilities on candle patterns to be robust in anyway . Without masses of data analyzed by code with powerful computers that he likely had no access to in his lifetime cannot see anyone developing anywhere near robust definitive probabilities ( edge) that you can take to the bank

He quantified the performance in a pretty thorough way. You can see for yourself on his site. Most of the patterns weren't very effective.

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  #9 (permalink)
 SBtrader82 
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anubis View Post
Hi, I'm under the impression that analyzing price action based on arbitrary slices of time/range makes not much sense because you can find a slice size that gets you "rejection" wicks at "support" zones, but you can also find another slice size that doesn't show wicks at the same price level.

For example, a 1min chart might show a rejection candle where a 2min won't.

Or they work because many traders are looking at the same slice sizes (5min, 10min, etc.)? But this will make them extremely susceptible to be abused because "everybody" will know where their stops are.

I think patterns are extremely meaningful and important. The importance however is not in the patterns themselves but in what they represents. Patters are representations of the human psychology.
After years of trading you don't look at the pattern but you understand why it "works", because there is a mass psychology behind it.
In one way or another, all systems use patterns, all algos use patterns as well..... call them deep learning, call them time series analysis, call them technical analysis etc.... they are all forms of pattern recognition.

Concerning the second part of your question: the higher the time frame the more relevant the pattern is. For instance if we break above yesterday high, you have a green candle breaking the high of the previous day candle. This is very relevant.
The same patter on a 4H candles is less relevant, and on a 1H candle even less relevant.... but still relevant.

The reason why higher t-frames are more important is that big money mangers need to use higher t-frame.

This is my opinion, of course but I think many traders will tell you exactly the same.

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  #10 (permalink)
Ozquant
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SBtrader82 View Post

The reason why higher t-frames are more important is that big money mangers need to use higher t-frame.

.

Laws of multiple time frames apply to any analysis

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  #11 (permalink)
BullandBear19
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SBtrader82 View Post
I think patterns are extremely meaningful and important. The importance however is not in the patterns themselves but in what they represents. Patters are representations of the human psychology.
After years of trading you don't look at the pattern but you understand why it "works", because there is a mass psychology behind it.
In one way or another, all systems use patterns, all algos use patterns as well..... call them deep learning, call them time series analysis, call them technical analysis etc.... they are all forms of pattern recognition.

Concerning the second part of your question: the higher the time frame the more relevant the pattern is. For instance if we break above yesterday high, you have a green candle breaking the high of the previous day candle. This is very relevant.
The same patter on a 4H candles is less relevant, and on a 1H candle even less relevant.... but still relevant.

The reason why higher t-frames are more important is that big money mangers need to use higher t-frame.

This is my opinion, of course but I think many traders will tell you exactly the same.

I agree with this, though the examples given specifically are more observational, unless you plan on entering a long simply because it broke above YHOD.

If I understand what the OP is essentially asking here correctly - are candlestick patterns able to provide a consistent system to make money?

I use 5min candles myself and spent about 2 years studying candlestick price action, and I agree that candles provide a lot of psychological information on what the market is attempting to do, but the key information is missing... namely volume and aggressiveness. So while some candlesticks show reversal signs like hammers for example, I feel it cannot be a consistent system without taking into account the volume on that rejection.

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 Opstar 
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Each candle stick is a parcel of information. It's really an attempt to give you a rough outline of what happened within that time frame made from thousands or millions of data points(tick).

If you unbox that bar, what you get is a sine wave of sorts. Starting from open to peak point (high) trough point(low) close(last).

Given the nature of the market, you have many many frequency waves entangled into the waves of movements. My observation is that, one candle stick pattern is usually not enough to be statistically significant as a result.

Therefore, you have to provide multiple historical inputs in testing that bar. It can be in the form of multi-time frame, or simply boxing previous movements that happened along with the current movement that just formed, in order to find something statistically meaningful. I guess you can call the other inputs "context" of sorts. In my mind, the moving averages, and other indicators derived from price (and/or volume) is an attempt to gauge this "context".

With something like the ES and NQ futures, bullish hammers are more meaningful than bearish hammers. But this also depends on "context".


TL;DR

Markets tend to operate in higher dimensions than 2D.
One bar pattern from one time-frame tend to be useless without supporting information.

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  #13 (permalink)
Ozquant
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drm7 View Post
He quantified the performance in a pretty thorough way. You can see for yourself on his site. Most of the patterns weren't very effective.

Manually checked with no definable maths seems subjective to me , Hard pass on any data from Bulkowski . If it isn't objective it isn't analysis


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 rlstreet 
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Ozquant View Post
If it isn't objective it isn't analysis

Say that you have an objective to describe candlestick patterns. I guess that if you would datamine different patterns, timeframes , instruments you can find statistical significant patterns. Even some that will pass the White's reality test (book Aronson). But would that mean that they will be predictive of the future returns? I guess slicing prices up in candles by time, price or volume does not give a trader some real edge. I think candlestick pattern trading is the stuff where the MM make their money.

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  #15 (permalink)
 TWDsje   is a Vendor
 
 
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I've done a lot of backtesting stats on this, and I find that candlesticks tend to perform differently from other types of signals. The big benefit is that they seem to be more evenly distributed. For instance, if you trade a moving average crossover your signal might get triggered over and over again in a short period of time. So such strategies often have multiple moving averages and filters in an attempt to deal with this issue. Candlestick patterns in contrast tend to be comparatively rare and isolated events.

Unfortunately, this also seems to lead more easily to overfitting. You'll test it over a year and find patterns that appear to be very predictable with outlays of over 60% with a good number of trades, but when you run it on a different year your results are completely different.

Which suggests to me that the signals are just noise, and that people are being fooled by randomness. I would note that many of the traders out there using such "price action" strategies often rely on stops larger than their targets. Such strategies can basically make money (at least in the short term) simply from taking on excess risk, and tell you nothing about how predictive the entry signal is.

I've tested countless setups like this for people, and the conclusion is always the same. They fall apart when a rigorous analysis is applied. Given how much is going on in markets all the time, it seems kind of silly to me that any kind of analysis of past price movements could tell you much of anything. Any real signal would be small, and obfuscated by the noise. Especially in highly efficient instruments like futures.

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 Schnook 
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TWDsje View Post
Given how much is going on in markets all the time, it seems kind of silly to me that any kind of analysis of past price movements could tell you much of anything.

If that were true, then how would successful price action traders, or anyone who uses charts, explain their success?

Not trying to pick a fight, just trying to understand what you mean by this

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 LastDino 
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I don't know any candlesticks pattern trader in RL or OL who is making money consistently, I do know couple of guys who use them for some sort of system condition though, meaning they aren't trading every pattern but are selective and very conditional.


Personally I don't use them but I do think its not completely worthless. Different people click with different things and trade differently. If everyone had the same edge, it wouldn't be edge anymore.

Just my 2c.

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Schnook View Post
If that were true, then how would successful price action traders, or anyone who uses charts, explain their success?

Not trying to pick a fight, just trying to understand what you mean by this

So let me repeat:


Quoting 
Which suggests to me that the signals are just noise, and that people are being fooled by randomness. I would note that many of the traders out there using such "price action" strategies often rely on stops larger than their targets. Such strategies can basically make money (at least in the short term) simply from taking on excess risk, and tell you nothing about how predictive the entry signal is.

So you can have a strategy that has a stop twice as large as the target, and wins 80% of the time. In such a strategy even if your entry signal was completely random you would have periods of "profitability". You wouldn't see the problems until you run across a losing streak or some sort of tail risk event. Things that if you're lucky you could avoid for a few years. Or to be more technical about it probability distributions apply to datasets with a large number of items, and if it's not a gaussian distribution it can take longer for the true properties of the distribution to emerge.

Retail investors often rely upon such anecdotal evidence. They see that someone else was successful with it, and ignore the fallacies that relying on anecdotal evidence expose you to. They themselves might not know why they were successful. They might have only been successful for that period, and lost it all later. They might have just been lucky.

Which is why when discussing a strategy we focus on empirical evidence. That is evidence that we can look at, and verify for ourselves. If we have a specific strategy and dataset to test against then everyone can run that backtest to verify. They can even try running it against other backtests. If there's any efficacy to such strategies then we should be able to produce empirical evidence that clearly shows the market inefficiency. I continue to look, but I have never seen such evidence using anything that relies solely upon past market generated data. Especially not with price action.

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 rlstreet 
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LastDino View Post
Personally I don't use them but I do think its not completely worthless.

Yeah I can imagine that if you have a macro or other directional view a candlestick pattern can indicate some change in sentiment, and would not completely worthless only we can not prove it using statistical methods.

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