Japanese candlesticks

Candlestick charts are a type of price chart that visually represents the open, close, high and low of a market price over a given period of time. The system was developed in Japan.

Japanese rice traders discovered recurring patterns in these candlesticks that helped them predict price changes in the immediate future. These patterns are now an established method for analysing price action and are used across all modern financial markets. They’ve been found especially useful when trading forex. 

The most popular way of using candlestick charts is to look for candlestick reversal patterns. These have been proven to be a good way of confirming when support and resistance levels have held, giving traders a green light to enter a trade predicated on a trend ending.

However, the focus on reversal misses some of the best trading opportunities. By trading continuations – setups in which an ongoing trend can be seen to be likely to continue, at least for the moment – smart investors can keep riding existing momentum instead of betting that it will dissipate.

What is a continuation pattern?

A continuation pattern is simply a recognisable grouping of prices on the price chart covering a given time period, like a trading day. Each of these patterns has been shown to indicate a continuation of the current price trend. 

Continuation patterns used in practice fall into two main categories. The first is classic chart continuation patterns, which include things like flag and triangle patterns. These are created by drawing imaginary lines bracketing recent price movements. You can see some of the classic types below:

The other category consists of candlestick chart continuation patterns, which we are obviously talking about in this article. 

What is a continuation candlestick pattern?

Candlestick patterns rely on relatively few data points. Rather than being formed across 10-50 candle periods like a classic pattern, this kind of continuation pattern is derived from only 1-5 candles. This is true of both reversals and continuations. To reiterate, candlestick continuation patterns are a signal that the short-term trend over the prior few candles will resume in its current direction. 

Just before this happens, the market typically experiences sideways movement after a strong directional shift; continuation candlestick patterns are reflective of this. They represent a pause in a trend where buyers in an uptrend or sellers in a downtrend take a breath. However, this is not always the case, since some continuation patterns (such as a gap) are a sign that the trend is accelerating.

Benefits of continuation patterns

The concept of a continuation pattern is typically in keeping with a trend-following strategy. In particular, we’re talking about situations when the price has already moved in one direction or the other. The trend follower is now looking for opportunities to enter the market and ride the trend further, should it be likely to pick up again. 

Although reversal patterns are better known and more widely used, applying the concept successfully often depends on picking tops and bottoms. This tends to be a hard thing to do and is prone to generating false signals. Trends will often last longer than many expect, offering alert traders a succession of continuation buy or sell signals along the way before finally reversing. The trend is your friend, until it ends!

Rules to follow with candlesticks

Rule 1: Candlestick patterns alone do not make a profitable trading strategy. If that were the case, we would all be millionaires! 

Buy signals and sell signals from the random formation of one to three candlesticks alone will generate a lot of false positives. That’s because the market generates new candles all the time, so the chances that three of them will come to resemble one of the known patterns just by accident are very high. 

Rule 2: A big part of what makes a candlestick pattern valid is when exactly the pattern takes place on a chart. A trend-reversal candlestick can only be thought of as meaningful if seen near where you’d expect the end of an established trend. It should not, for example, be taken as a valid forex signal in the middle of what otherwise appears to be a sideways range. Continuation patterns are only valid after a trend has started; they cannot predict the beginning of one out of thin air.

Rule 3: Candlestick patterns need to be used in conjunction with other analysis. Their best use case tends to be as a confirmation signal at a price level determined to be a good entry point by other forms of technical analysis. 

Let’s say, for example, that a trader thinks a certain price will continue to trend higher. She’s not totally sure, though: the market is approaching a resistance level that could cause a reversal. A continuation pattern at that resistance level would act as a confirmation signal that her idea is likely correct. Of course, the market could still turn lower, but paying attention to the candlestick pattern increases her odds of success.

Top 5 Candlestick continuation patterns

In no order, here are the 5 best continuation candle patterns to look out for. There are certainly others, including non-canonical ones some traders have identified but others feel sceptical about.

1 Gaps

Gaps are one of the most widely used and relied-upon short-term trading patterns. They are not exclusive to Japanese candlesticks and are often used with traditional bar charts. 

A bullish gap appears because the open of the second candle is higher than the close of the first candle, and the low of the second candle does not reach the close of the first candle. A gap tends to happen at the start of a new trading session due to buyers coming to outnumber sellers while the market was closed. A bearish gap is simply the opposite configuration.

Tasuki gap:

This is a 3-bar pattern where there has been a gap between the first two candles and the third candle partially closes the gap. 

The pattern provides confirmation that the gap has held, as well as indicating a good trade entry point.

Gapping play:

This is a pattern that involves one large-body candle and two or three small-body candles with the same high in an uptrend (or low in a downtrend) that are followed by a gap and another long-bodied candle in the same direction as the first.

Side by side white lines:

Similar to the Tasuki gap, but the third candle lies in the same direction as the first two.

2 Three white soldiers / Three black crows

This pattern is easy to spot and consists of three long-bodied candles in a row, typically also having short wicks. Three white soldiers is the bullish version, while three black crows indicates bearish conditions.

Without knowing any better, you might think this indicates a trend that is getting exhausted. However, the Japanese candlestick interpretation is that it shows a trend with strong momentum that is likely to continue.

3 Rising three methods / Falling three methods

This pattern consists of one large body candle followed by three smaller body candles that form in the opposite direction to the first candle. Then, we see a third candle that matches the first candle in size of body and direction.

The pattern is quite distinctive, making it a relatively rare occurrence on price charts, which makes it tend to offer a better success rate.

A variation of this pattern is called the “mat hold”.

4 Separating lines

This pattern involves a first candlestick that goes against the prevailing trend and then a second candlestick that opens at the same price as the first candlestick. It is like an internal gap pattern.

A variation of this pattern is known as the “thrusting line”.

5. Matching high / Matching low

This pattern involves two or more matching highs or lows which, if broken, is a signal that there will be a resumption of the current trend. 

On a lower-timeframe chart, this pattern will look much like a support or resistance being broken. Such breakouts are used by traders as a trigger to enter the market, with the momentum of the breakout signalling a new leg of a trend.

Using candlestick patterns

It’s important to recognise that Japanese candlesticks, just like other and more complex methods of technical analysis, rely on past market activity for information. They cannot take events like earnings releases or news items into account; they are indications, not prophesies.

It’s also a good idea to be aware that many other players in the market are looking at the same data and interpretations as you are. It may well be that a trend continues just because a number of people expect it to and buy and sell accordingly. Supplementing your candlestick insights with other information, including more fundamental analysis, may help you spot and take advantage of these artificial, temporary price movements.